This case study focuses exclusively on Nestle’s Food & Beverage businesses/segments and ignores any analysis of their Pharmaceuticals segments (e.g., results relating to investments in L’Oreal and Alcon)
Business description: Nestle Group is the largest food & beverage business in the world. It is a leading nutrition, health & wellness company and has a history that dates all the way back to 1867. With a manufacturing facility or office in nearly every country of the world, their global scale is large. Nestlé markets approximately 7,500 brands organized into the following categories: baby foods, breakfast cereals, chocolate and confectionery, beverages, bottled water, dairy products, ice cream, prepared foods, foodservice, and pet care; I define this as Core F&B. For a more detailed description of Nestle and its history check out this write-up.
Thesis: Nestle’s wide product portfolio, strong brands, nearly universal consumer goodwill and global scale set it apart the competition and give it a sustainable competitive advantage that should endure in the decades ahead.
High Quality traits:
(1) Long operating history:
Generations of branding – Nestle has been present in most countries longer than most competitors. It literally has decades of local experience in many regions throughout the world and even has operated for over a century in the US, UK, Germany and Australia. As reported by Business Week Nestle was recently chosen as #63 out of the top 100 best global brands by Inter-brand Consulting. Additionally one of its signature products, Nescafe, was also chosen as the 28th best global brand. There is very good chance that their brands are so strong and durable that a competitor could probably spend $50 – 100 million to start a rival product against a Nestle signature product/brand (e.g., KitKat, Nescafe or Nesquick) and not succeed in taking meaningful market share away; that is an enormous barrier to entry.
Established products – Several of their signature products have changed little over the decades and will probably remain similar if not exactly the same 20 years from today. Could KitKat, Nesquick or Nestea benefit from additional amounts of R&D on them? I argue mostly no because they are damn good the way they are. Of course every once in a while a product will need a small tweak to its ingredients here & there when consumers change their taste & preference but for the most part these signature products do not require lots of tinkering. According to this article published by Euromonitor International, Nestle is thought to have as dominant a position against private label products as Coca-cola and Mars do in their respective markets. Specifically Nestle has 28 Food & Beverage brands that have sales over CHF 1Bn annually, of which 14 of those had sales growth of 10% or more in 2008 and they account for approximately 70% of Food & Beverage sales. Nestle calls these their “billionaire brands” but in my mind they are little cash cows that poop nothing but solid EBIT margins. Having products that operate like an annuity ( i.e., reliable sales volume + stable profits) every year is a big advantage. Nestle can continue to profit from products that require a minimum amount of marketing costs and annual R&D and instead can use the profits to acquire additional brands and focus on developing higher growth products that could have a payoff down the road (specialized nutrition, metabolics, etc).
(2) Demonstrated ability to endure prior difficult economic periods:
Nestle has demonstrated the ability to endure all types of economic climates. I literally dug out the historical results of Nestle from the old school Moody’s manuals from decades past to assess how Nestle had performed in prior difficult economic climates. During 3 of the United State’s worst economic climates of the 20th century Nestle had the following performance:
1929 – 1933 – The Great Depression (43 months of recession):
1929: 30.8% EBIT Mgns, 12.0% ROE
1930: 29.7% EBIT Mgns, 15.2% ROE
1931: 28.2% EBIT Mgns, 20.5% ROE
1932: 32.8% EBIT Mgns, 14.5% ROE
1933: 34.9% EBIT Mgns, 11.3% ROE
This insightful anecdote from the International Directory of Company Histories says it all, “Nestlé was becoming so strong that it seemed even the Great Depression would have little effect on its progress. In fact, its U.S. subsidiary, Nestlé’s Food Company Inc. of New York, barely felt the stock market crash of 1929. In 1930 Nestlé created new subsidiaries in Argentina and Cuba. Despite the Depression, Nestlé added more production centers around the world, including a chocolate manufacturer in Copenhagen and a small factory in Moravia, Czechoslovakia, to manufacture milk food, Nescao/Nesquick, and evaporated milk. Factories were also opened in Chile and Mexico in the mid-1930s.”
1973 – 1975 (16 month recession):
Arguably the most illustrative of examples as this recession included severe consumer spending declines and soaring gas & commodity prices.
1972: 8.7% EBIT Mgns, 10.6% ROE
1973: 8.9% EBIT Mgns, 12.4% ROE
1974: 8.7% EBIT Mgns, 11.4% ROE
1975: 8.9% EBIT Mgns, 11.8% ROE
1976: 9.5% EBIT Mgns, 12.1% ROE
1981 – 1982 (16 month recession):
1980: 8.4% EBIT Mgns, 15.8% ROE
1981: 9.5% EBIT Mgns, 10.9% ROE
1982: 9.8% EBIT Mgns, 11.5% ROE
1983: 10.3% EBIT Mgns, 11.9% ROE
1984: 10.3% EBIT Mgns, 12.3% ROE
1985: 10.2% EBIT Mgns, 14.4% ROE
(3) Strong business segments with stable operating margins & pricing power:
Nestle has 5 core product groups which include beverages, milk products, confectionery, prepared dishes and pet care. They all have solid EBIT margins in the 11-15% range (my referenced EBIT margins will be lower than reported EBIT margins as I calculate EBIT % only after factoring in unallocated Corporate costs allocated based on % of segment sales). Further with a deep bench of products that are consumed on a frequent basis and often requested specifically by name/brand Nestle has the ability to reasonably raise its prices consistently without any material negative impact to product demand/volumes. Here is an abstract of the core Nestle Food & Beverage segments performance for the last 15 years:
Being mindful that reported numbers can sometimes skew number as they don’t perfectly adjust for FX fluctuations, acquisitions & disposals nonetheless out of the past 15 years Nestle had only 3 years where Total Core F&B reported sales declined from the prior year. In all 3 instances when sales did decline they did so only modestly. The takeaway here is that the collective Nestle categories are stable to a very high degree and not prone to severe ups or downs in different stages of economic cycles. The Nestle business has so many successful products that they are not overly-reliant on a concentrated number of brands or segments. Their business is the equivalent of “throwing 7 different kinds of smoke” so if & when certain segments temporarily underperform or certain products face-off with new competitive threats/substitutes or a specific brand declines in popularity it has the advantage of diversity of income streams to weather the storm.
Conclusion:
The net impact of all the above and the over-riding key point is that Nestle creates a lot of equity value by earning high Returns on Equity over long periods, and it does so with only modest use of leverage. Yeah they still have their own set of financial headwinds and risks, large & small, that it must manage…
-Constant threat of new & substitute products
-FX swings
-Increasing commodity costs
-Loss of consumer goodwill from public relation concerns (e.g., contaminated food, baby formula ad practices, etc)
-Future risks that may not be identifiable yet
…but nonetheless in my opinion it is a high quality business and appears well suited to remain that way for a long time.
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