Portfolio Update: Nestlé
Since we originally outlined our investment thesis to investors last June, Nestlé (OTCPK:NSRGY) has responded by taking several logical steps to create stakeholder value. Our periodic interactions with Nestlé management have been well-received and we expect our dialogue to continue.
We wrote in June that Nestlé needed to focus on four areas to improve its performance and reposition the company for continued success: 1) reaccelerate sales growth and improve profitability; 2) optimize balance sheet efficiency and return capital to shareholders and thus improve measures of return on capital; 3) reshape its portfolio through acquisitions and divestitures; and 4) monetize its non-core, financial investment in L’Oréal.
In the months since, Nestlé’s CEO Dr. Mark Schneider has laid out his vision for the company and begun to take needed steps to move the company forward. He made a commitment to reaccelerate organic sales growth to mid-single digits and set a formal margin target of 17.5% to 18.5% by 2020, announced a CHF 20 billion buyback, and articulated plans to make portfolio adjustments worth as much as 10% of sales. Nestlé also recently announced plans to add three well-regarded outsiders to its Board at this year’s Annual Meeting.
These actions are important steps in the right direction that make it clear that Nestlé is responding to calls for action. While we recognize that Nestlé has certain unique cultural and structural constraints, we hope now that Dr. Schneider has completed his first year and there is new blood on the Board, the company is able to move with greater alacrity. In particular, we believe Nestlé should:
- Clarify its corporate strategy: Nestlé defines itself as a company focused on “nutrition, health, and wellness,” but many of its assets do not align with that vision. Within food and beverage, which accounts for 95% of sales, many products like ice cream and frozen pizza do not meet the company’s brand aspiration of being “better-for-you.” Within health sciences, which contributes 5% of sales, forays into “skin health” seem unrelated to Nestlé’s core business and like a costly mistake that should be unwound. We believe Dr. Schneider has an opportunity to better align the company’s strategy with its stated objective by addressing these and other inconsistencies.
- Accelerate portfolio change: Nestlé has an opportunity to move with greater urgency to complete its targeted level of “portfolio adjustments.” To its credit, it secured a very attractive price (more than 3x sales) for its U.S. confectionery assets, but that business makes up approximately 1% of group sales. Based on Dr. Schneider’s remarks at Nestlé’s September Investor Day, we expect a decisive disposal of other ill-fitting businesses. Similarly, Nestlé needs to move faster to increase its exposure to the high-growth categories highlighted by management, namely coffee, pet care, water, and nutrition. These categories are growing faster and have higher margins than the rest of Nestlé’s portfolio, are on-trend with modern consumers, and lend themselves well to premiumization over time. However, acquisitions in these areas have, so far, been limited to a few small deals. We would also like Nestlé to better explain to shareholders the rationale behind expanding further into consumer health care. The recent acquisition of Atrium Innovations (a Canadian vitamin maker) and rumors that the company is bidding on larger assets in this category have left some shareholders confused.
- Deploy the balance sheet: Nestlé also has the opportunity, given its unlevered balance sheet, to accelerate and even expand its buyback program ahead of a large expected improvement in earnings growth. After five years of subpar performance, the market remains somewhat skeptical of the company’s ability to reaccelerate sales growth and improve margins in line with announced targets. As a result, shares remain attractively priced relative to what the company could earn in 2020 and beyond. If management is as confident as we are in its ability to execute, then it should move quickly to retire shares now, i.e., before the stock price better reflects the company’s improving fundamentals. Importantly, Nestlé can do so without impacting its ability to consider deals (even large ones) since leverage remains below 1.0x.
- Monetize the L’Oréal stake: Finally, Nestlé needs to conduct a thoughtful review of its financial stake in L’Oréal. While the investment, made in 1974, has produced excellent returns historically, that alone is not a sufficient reason to maintain the status quo. Today, it is simply unclear how owning a minority stake in a beauty business makes Nestlé a stronger “nutrition, health, and wellness” company. We continue to believe that this financial investment ought to be monetized and that there are better uses for this capital.
We continue to support Dr. Schneider and Nestlé management and believe that the additional strategic, portfolio, and financial improvements we have outlined, and which we hope are already in process, will drive substantial benefits for all Nestlé stakeholders. They will result not only in greater capital appreciation and faster dividend growth for shareholders, but also in more resources for the company to invest in the business and communities in which it operates.
From Daniel Loeb (Trades, Portfolio)'s fourth quarter 2017 shareholder letter.
