Swiss food giant Nestle (Nasdaq:NSRGY) is a remarkable company in several respects. Despite being one of the largest food companies in the world, Nestle continues to focus on ongoing product innovation and is closing in on generating half of its sales from emerging markets. Add 20 billion-dollar brands and a long track record of out-earning its cost of capital, and it's not too hard to see why Nestle shares often trade at a premium.
“Often” is not the same as always, though, and a recent slowdown in organic sales growth seems to have created a window of opportunity in these shares. Investors have to accept the risk that the company will fail to deliver 5% organic growth for 2013, but the long-term opportunity makes this a name worth considering.
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Soft Growth In Q2, But Good Margins
For the fourth quarter in a row, Nestle has delivered a top-line organic growth number below the average sell-side estimate. Revenue rose just under 4% for the quarter, coming in about 80bp below expectation on lower pricing. Volume growth of better than 3% was respectable, though, and better than American comps like General Mills (NYSE:GIS), Kraft (Nasdaq:KRFT), and Kellogg (NYSE:K), though more or less in line with more global rivals like Unilever (NYSE: UL) and Mondelez (Nasdaq:MDLZ).
While sales were soft, Nestle redeemed itself somewhat on margins. Trading profits improved 7%, and the company's operating margin expanded about 20bp from last year – good for a small (20bp) beat relative to estimates as the company held off on major promotional activity.
Will Developed Markets Turn Around In The Second Half?
Developed market growth was only about 1% in the first half of the year, as Europe turned unexpectedly negative in the second quarter on poor weather. Emerging markets were considerably stronger (up 8%), helped in part by the company's strong nutrition business.
If Nestle's going to hit the 5% organic growth target for the 2013 full year, better results in developed markets will be an important part. Management is looking for better results in the U.S. from businesses like Haagen-Dazs, Lean Cuisine, and Jenny Craig in the second half, as well as ongoing growth in the Nescafe business. Still, the coffee market is increasingly competitive in the U.S., and it's not clear to me that shoppers are going back to premium brands in a big way just yet.
Leveraging Innovation Around The Globe
While it would be a mistake to think that Nestle skimps on product promotion, the company's basic strategy is to rely more on brand innovation than promotions to achieve sustained growth. That has helped the company offset some of the pressures from private label competition in areas like bottled water, ice cream, confectionery, and coffee. It also puts more pressure on companies like Unilever, Danone, and Kraft to find ways to close the gap, which often means more promotional investments.
At the same time, Nestle is one of the few companies with enough global volume to really utilize its international infrastructure. While many companies continue to invest resources abroad to grow their global presence, they often find Nestle already there with sizable market share and deep roots in the market. This certainly doesn't hurt Nestle when it finds a hit product, as it can quickly test it in multiple markets and drive more significant international launches.
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The Bottom Line
Nestle isn't really cheap in an absolute sense, but this is about as cheap as the shares typically get. Provided that the company can grow its revenue at a mid-single digit rate for the long term, with ongoing margin and cash flow improvements, investors can buy these shares today at about 10% less than they would otherwise seem to be worth. Certainly there is a risk that the shares could underperform if this recent trend of underwhelming organic growth continues, but taking on that risk is really about the only way investors can expect to get Nestle at much, if any, discount to fair value.
Disclosure – At the time of writing, the author did not have a position in any of the companies mentioned in this article.