Standard business school mantra tells us that companies need to be constantly evolving or face extinction, I am sure we are all familiar with the infamous Kodak story.
In laymen terms this means that they need to be investing in R&D to produce new products or expanding to new markets where they have no presence – they also have the option of acquiring companies that provide them with new sources of revenue stream, yet this acquisition always comes at a cost to shareholders in the form of goodwill. There are other options available, but for the sake of argument we will take the textbook definition on how companies grow in this article.
If this is the case, then how does one go about evaluating the forward performance of a large multinational corporation such a Nestle? They are already prevalent in almost every global market, and the once in a lifetime economic booms in huge untapped populations such as China during the early noughties have come and gone. There is a case for underdeveloped continents such as Africa becoming the next frontier for growth, but unlike China they lack a strong central Governments who can implement continent wide economic policies and are fraught with huge gaps in infrastructure along with civil and border wars. Therefore geographical expansion is likely to be limited for them in the medium term and shareholders will have to rely on organic growth from these regions.
So what about the product route?
This is where Nestle, and other MNCs such as Unilever and JnJ excel, and is at the heart of their business model. Shareholder value is built upon Nestle’s ability to acquire up and coming brands outside of their current portfolio, and on marketing teams’ ability to increase market share in already crowded consumer spaces – and they do this very well.
Investors know that diversification is key to mitigating risk of potential downsides – if we take Nestle as an umbrella corporation with many separate business units under its rainproof tarpaulin then this corporation is about as diversified as you can get.
They currently manage over 2000 brands, including one of this authors favorite refreshing beverages, San Pellegrino. This coupled with the 150 years of experience of acquiring the right products for their portfolios does make Nestle a sensible choice as a cornerstone ‘buy and hold company’ for most passive investors. Let’s not forget that they can also develop their own household brands such as Nescafe, which has seen a spin off of products during the past decade such as the Nespresso coffee pods. Interesting fact – Nestle began developing an instant coffee brand in 1930, at the initiative of the Brazilian government, to help to preserve the substantial surplus of the annual Brazilian coffee harvest, and its brand was valued at $16.3B in 2016 – ranking 16th on the Forbes list of the world’s most valuable brands.
The 2008 Lehman bankruptcy taught us that there is no such thing as ‘too big to fail’, but with a market cap of a quarter of a trillion dollars, and a free cash flow of 10b CHF in 2015 – it is unlikely that they run into financial difficulties anytime soon.
All these positive arguments seem to be pointing us in the right direction, but there is one part of the equation that we have yet to tackle – that of Nestle valuation. The stock market, being semi-efficient at pricing assets, will have margins of safety and shareholder expectations of solid future growth built into share prices, and Nestle is no exception.
As of today, Nestle has a P/E ratio of 25.9, and is trading almost three times above its net asset value per share. The Graham multiplier number is well above the 0-22.5 range which we consider ‘cheap’, and the price to book ratio is well above the 1-2 range we like to see at Robur.
So investors are happy to pay a premium to own Nestle shares, but does that mean you should as well?
Share price performance, although it has beaten the Swiss ETF over the past 5 years, hasn’t been stellar – only increasing some 43% since the end of 2011. This is acceptable however, as Nestle is more an income stock favoured by institutions and retirement funds, with 70% of its free floating shares own by institutions.
Yield at today’s share price is 3%, and this is consistent with the previous 5 years of dividend payments (which has ranged from 3.11-3.76%) – although bear in mind Switzerland has a 35% dividend withholding tax for non-citizens. While 3% yield isn’t REIT territory, it is an acceptable amount for income hunters.
I will not attempt to make any fundamental forward forecast in terms of revenue/net profit etc. With such a huge range of products selling in every corner of the globe it is very difficult to estimate these metrics, especially with the volatile forex market we are experiencing this year. But we can be relatively certain that they will continue to churn out profit in the foreseeable future.
While there are companies trading at lower valuation levels who pay a higher dividend and with greater prospects for future growth (see our article regarding Melexis), if you are looking for a buy and hold stock, and are willing to pay a higher premium for the margin of safety and strength of brands Nestle brings to the table, wait for a bad quarter and pounce while the market reacts.