What Nestle Holder Tom Russo Thinks of Dan Loeb's Activism at Company

Long-term stakeholder comments on Loeb's $3.5 billion activist bet and his push to take on debt to do buybacks, sell L'Oreal and spend money at company

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Jun 30, 2017
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Daniel Loeb (Trades, Portfolio)’s Third Point made the biggest investment in its history this week when it sunk $3.5 billion into the world’s largest food and beverage company, Nestle SA (OTCPK:NSRGY, Financial). Along with it, Loeb released a list of his complaints about the company and plans for change in hopes of jolting its market-lagging share price. As Nestle’s second-biggest shareholder before Loeb bought, star investor Tom Russo (Trades, Portfolio) has welcomed the company’s changes before Loeb arrived and has a nuanced view of his plans.

“I’d say that he will highlight aspects of Nestle’s balance sheet, let’s say, that he would think maybe the owners think could be held in a different fashion,” Russo told GuruFocus in an interview. “And that’s been a long-standing question of management ever since I first invested in it.”

Russo has held shares of the 150-year-old company since 1987 and added to the position quarter after quarter, with a few exceptions, for years. As of March 31, he had 9.52% of his assets at his firm, Gardner Russo & Gardner, wrapped up in the company.

Russo has held shares of the 150-year-old company since 1987 and added to the position quarter after quarter, with a few exceptions, for years. As of March 31, he had 9.52% of his assets at his firm, Gardner Russo & Gardner, wrapped up in the company. Value investors dominate Nestle’s top U.S. investors, with only Oakmark surpassing Russo in percent of shares owned.

Russo’s other long-held top positions include Berkshire Hathaway (BRK.A, Financial), Mastercard (MA) and other European companies like Cie Financiere Richemont SA (OTCPK:CFRHF, Financial).

As a long-term thinker, Russo differed from Loeb in some ways on the best use of Nestle’s cash and debt.

Nestle’s balance sheet has a net debt-to-EBITDA leverage of less than 1.0, compared to an average of 2.0 to 4.0 for similar companies. Loeb said in his letter he wants to see Nestle aim for at least 2.0. This leveraging up would produce more capital that he thinks should be returned to shareholders in buybacks that would boost returns. In the past five years, Nestle stock rose roughly 47% vs. almost 81% for the S&P 500 index.

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Nestle (XSWX:NESN, Financial) has repurchased shares over the years, last buying back $8.8 billion worth of shares 2014 to boost its share price. Prior to that, it made purchases of or exceeding $10 billion in 2007, 2009 and 2010.

On Tuesday, Loeb won the battle to pressure Nestle into buybacks. The company is planning to make its biggest-ever repurchase of $20.8 billion over three years.

Though “largely and entirely unconcerned” with earnings per share, Russo said he is much more interested in the ability that Loeb’s repurchase at prices below intrinsic value will have on the intrinsic value of the company on a per-share basis over time.

“And I embrace that,” Russo said. “And I think the advances in their operations that will come from the hard work that’s under way will lead to stronger increases on a per-share basis.”

Russo has spoken many times about the benefit of a company’s capacity to reinvest for growth, a hallmark of Nestle’s strategy, and believes money may be better spent there. The company has branched out in nutrition, health and wellness, and introduced existing products into new markets. Moving further into international and emerging markets over the long term will require balance sheet strength to invest in property plant and equipment and working capital.

Russo sees share buybacks as a good option when the company runs out of investment opportunities, but said it is not there yet.

Nestle still faces “massive,” capital-sponging challenges like evolving consumer preferences, millennial consumer tastes demanding new products and e-commerce and routes to market. One of Nestle’s key advantages in developed and emerging markets was their dominance of routes to markets. Lately they have faced new competition from Alibaba in China, Amazon in the U.S., and others in South Africa and South America.

“You’re better off addressing with extra resources than if we were trying to fight those fights with a much more aggressively leveraged balance sheet,” Russo said.

Another primary aim for Loeb is divesting the company’s non-core assets and bulk up its bigger growth areas. One of the biggest moves would be to sell its one-third stake in beauty company L’Oreal (XPAR:OR, Financial) that he believes is worth $25 billion. Under his plan, Nestle could divest the stake by an exchange offer for Nestle shares, reducing share count again to “meaningfully increase its share value in the long run as earnings improve over a reduced share count.”

Nestle already announced plans to shop its U.S. confectionary business, which had sales of CHF 900 million in 2016, as it attempts to meet changing consumer demands. The U.S. confectionary is home to sugary U.S. favorites such as Bufferfinger, Baby Ruth, FunDip and Nerds.

The company’s larger global confectionary sales were $8.8 billion in 2016, and the confectionary business equally only about 3% of its business in the U.S., its largest market. It plans to continue investing in the U.S., focusing on its petcare, bottled water, frozen meals, infant food and ice cream categories, it said in a statement.

Russo has applauded Nestle management’s steps with its businesses and brands, but he adds a layer onto the question of L’Oreal and major divestments.

“In 1973 they bought the control of a company called Alcon, and they had a stake in L’Oreal and neither of them were operationally core to the business. But collectively they made investors especially $80 billion over the period of time they held the non-strategic and non-operating assets. I have a different feeling about those because I’ve been treated well over decades by Nestle as a result of those investments in Alcon and L’Oreal,” he said.

Both investors praised Dr. Ulf Mark Schneider, the company’s CEO since 2003 and an outside recruit from German medical supply company Fresenius (FMS). While at his former company, Schneider increased sales growth, conducted strong mergers and saw share growth of 20% CAGR. Loeb called on the leader to take “bold” action plan to avoid the stock underperformance that dogged the company in the past.

Russo said he was “impressed” with the new CEO and the new sense of “urgency and accountability” he believes may have slipped over the past four years. At Fresenius, Schneider set “key performance indicators” with his management and demanded an account when they missed one.

“That’s a skill set that has been in need at nestle over the past several years, and I think Nestle’s new CEO brings it,” Russo said.

Russo said he is watching the events unfold at Nestle with great interest but does not know whether he will sell.

“Every day, every single day as an investor you reassess what is the best use of your investors’ capital. And I do that every single day with every position,” he said.