Nestlé S.A., the world’s largest food-production company, may hold some appeal for defensive and dividend investors seeking foreign diversification. It produces non-cyclical growth of 5 to 7 per cent a year and pays a nearly 4-per-cent dividend, which has been raised 15 years in a row. Nestlé is also based in Switzerland, a stable country with a strong currency that enjoys safe-haven status similar to gold.
Founded in 1866, there are now over 280,000 employees spread across 86 countries. The company makes and distributes about 6,000 brand-name food products, including Nescafé, Perrier, Nesquik, Carnation, After Eight, Häagen-Dazs, Cheerios, Shreddies, Gerber, PowerBar, Lean Cuisine, and Rowntree.
Nestlé’s shares trade in Switzerland in Swiss Francs. In the U.S., there is an American Depositary Receipt (ADR) trading in U.S. dollars under the symbol NSRGY.PK. Purchases can be arranged by calling an investment representative at a full-service or online brokerage.
Over its long history, the company has encountered just about every environment imaginable, notably the Great Depression of the 1930s and double-digit inflation of the 1970s. During the First and Second World Wars, it grew significantly, responding to the food shortages and requirements of those times.
Food is an essential item; demand typically rises in line with population regardless of economic, social or political conditions. Moreover, the production and distribution of food is a relatively simple business. Throw in Nestlé’s scale and competitive advantages, and you have the makings of a steady, long-term growth story.
One advantage is the large research facility. “Nestlé is constantly bringing new products to the market,” says SNS Securities analyst Richard Withagen – one of the most accurate analysts covering Nestlé, according to StarMine Corp. He has an “accumulate” rating on the shares with a target price of 61 swiss Franc. The shares are trading near $55.
The market power of a portfolio of brand-name products comes in handy, too. Economies wilted during the first half of 2011, but Nestlé’s organic sales (before acquisitions, divestitures and currency fluctuations) still grew 7.5 per cent – as volumes increased even while prices were raised. Organic earnings per share (EPS) increased 5 per cent.
“In addition, it has a diversified profile, both geographically and product-wise, lowering its risk profile,” adds Mr. Withagen. Lastly, geographical diversification provides significant exposure to emerging nations, which was enhanced in July by the acquisition of a major stake in Hsu Fu Chi International, a Chinese confectionary company.
The annual cash dividend is paid just after the annual meeting in April (withholding taxes are deducted from ADR holders). It has been raised every year since 1996, registering a cumulative increase of nearly 600 per cent in the amount paid out (in Swiss Franc terms). In 2011, analysts expect the dividend payout ratio to be 60 to 65 per cent.
Debt is relatively low, and the financial position remains solid following divestiture of the stake in the world’s largest eye-care company, Alcon Inc. The recent suspension of the share buy-back program might be a slight negative to some but analysts say it likely means the company is husbanding capital for some significant acquisitions.
Another top analyst, Jeff Stent at Exane BNP Paribas, has issued an “underperform,” with a price target of CHF 55. His stance is based on relative valuation – the company’s three main European peers (including Unilever N.V. ) are better bargains in his view (since his recommendation was issued, Nestlé’s peers have closed much of the valuation gap).
“But I have to confess that I'm a big bull at heart,” continues Mr. Stent. “On a long-term investment perspective - Nestlé is hard to beat. If I was to invest my own money long-term in one food stock, it would be Nestlé. It is an incredible company.”
In a mid-August report, yet another analyst well ranked by StarMine, Julian Hardwick of the Royal Bank of Scotland, expressed concerns about the substantial run-up in the Swiss Franc during 2011 (caused by international capital searching for a safe haven). He tagged the company’s stock with a “hold” recommendation and CHF 51 price target.
Although Nestlé’s organic sales and EPS went up in the first half of 2011, actual sales and EPS declined by 14 per cent and 9 per cent, respectively, mainly because of the impact of a rising Swiss Franc . Mr. Hardwick’s concern is that currency gains in the second quarter may result in a repeat performance for second-half financial results.
Currency fluctuations are indeed a key variable. In fact, for foreign investors, the ADR has been a way to participate in the upward trend of a historically strong currency. When the Swiss Franc goes up, so does the ADR -- as can be seen in the unit’s 80-per-cent gain over the past five years versus the 20-per-cent gain in Nestlé’s Swiss shares.
Unfortunately, the Swiss Franc’s upward impact on the ADR may be on hold for a while. In an effort to stem the relentless rise in the Swiss currency during 2011, the central bank of Switzerland announced in early September that it would peg the currency to the Euro.
What ADR holders may lose in currency gains could be made up, at least in part, by better company performance -- since the ceiling on currency appreciation is supportive to Nestlé’s exports. Another consideration: as the eurozone crisis drags the Euro down against other currencies, it pulls the Swiss Franc down against those currencies too.
The currency run-up in 2011 prior to the peg has motivated Nestlé’s management to search more diligently for productivity improvements. Given the opportunities exigent in far-flung and diverse enterprises, it wouldn’t be surprising if this initiative results in improvements to operating margins in quarters ahead.
“We believe Nestlé is able to withstand current difficult market conditions better than many other consumer goods companies,” concludes Mr. Withagen. “This is due to its diversified profile and strong brands ….”
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