Nestle (OTC:NSRGY) has trained investors and analysts to expect a high level of performance, so although the company had one of the best financial reports of the food sector in the fourth quarter, the overall reaction hasn't been too positive. While Nestle is absolutely one of the best-positioned companies for emerging market growth and one of the best-run companies in the world, today's valuation doesn't offer all that much upside.
Discount Brokers Comparison: Your one-stop shop for finding the perfect broker for your investments.
Final Results for 2012 Come in a Bit Light
Nestle reported organic growth of just over 5% for the final quarter of 2012, a very good result by the standard of the food sector, but about a half-point light of expectations. Nestle saw both solid price performance (up 1.6%) and good volume (3.6%). While European sales growth was modest at under 2%, it was better than expected. Conversely, the growth in "AOA" (Asia, Oceania, Africa) was nearly 6%, but a little light of expectations.
Nestle doesn't report quarterly earnings like American companies, but second half operating profits improved about 17% from the prior year's level and the margin improved more than half a point. That said, the company's overall margin performance was a little short of expectations.
With the Pfizer Deal Done, Time to Leverage It
Nestle paid a steep price to get Pfizer's (NYSE:PFE) infant nutrition business (20 times EBITDA), but the deal gives the company over one-quarter of the global infant formula market and even stronger positioning in key emerging markets like China. As is true for Mead Johnson (NYSE:MJN), the key for Nestle will be increasing the penetration rate of packaged formula in major emerging markets like Brazil and India. Not only are there cultural factors at work, but economic factors as well - as time goes on, however, the increasing percentage of women in the workforce and the improving incomes in key emerging markets should support strong demand growth.
SEE: Don't Ignore These Emerging Markets
Leveraging Leading Brands Around the Globe
With Mondelez (Nasdaq:MDLZ) and Kraft (Nasdaq:KRFT) now split, the former becomes an interesting peer for Nestle. Both are brand leaders in several markets (chocolates, coffee, cereal, powdered beverages, etc.) and both focus primarily on food categories that are growing faster than the overall packaged food averages.
Both are also keenly leveraged to emerging markets, with more than 40% of their sales coming from these areas. That creates some intriguing growth potential for Nestle - it is a brand leader and a share gainer, its addressed categories are growing faster than the norm, and it has high levels of exposure to markets that are seeing greater population and per-capita income growth.
There is a down side to Nestle's growth potential, and that is margins. It takes a substantial amount of infrastructure to support a global food business, and Nestle often has to invest in production and distribution assets well ahead of its ability to fully leverage terms of revenue and volume.
Can Coffee Continue to Carry the Load?
Nestle has over 20 brands worth more than $1 billion in annual sales, but the company's coffee business carries above-average weight. Not only is coffee where Nestle holds its greatest global share (about 27%, more than double Mondelez, and well ahead of DE Master Blenders, Smucker (NYSE:SJM) and Green Mountain (Nasdaq:GMCR)), but it is also disproportionately profitable for Nestle.
The question is whether the company can keep this up. Nestle has done well with its Nespresso machine, but rivals like Starbucks (Nasdaq:SBUX) would certainly like a piece of that premium market. At the same time, the company has been relatively less aggressive in trying to build its share in the U.S., which may be a mistake, given the sheer size of the market.
SEE: Most Affordable Cups Of Coffee
The Bottom Line
Nestle is a pretty solid candidate to be a "hold forever" sort of stock. Unfortunately, this doesn't look like the greatest time to buy, given the stock's valuation. Even if Nestle can outgrow most of the packaged food sector, 6% annual compound free cash flow growth only supports a price target in the low-to-mid $60s. Given relatively modest near-term prospects for margin expansion, I'd wait in the hopes of getting Nestle cheaper at a later date.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.
Mutual Funds & ETFsLearn about arbitrage funds and how this type of investment generates profits by taking advantage of price differentials between the cash and futures markets.
Investing NewsWill Ferrari's shares move fast off the line only to sputter later?
Stock AnalysisHere are five stocks that pay safe dividends and should be at least somewhat resilient to a bear market.
InvestingThe further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
Fundamental AnalysisOptions market trading data can provide important insights about the direction of stocks and the overall market. Here’s how to track it.
Stock AnalysisCan these two oil stocks buck the trend?
Investing NewsAlcoa plans to split into two companies. Is this a bullish catalyst for investors?
EconomicsDiscover the four countries in the world that manufacture the largest amount of chocolate and learn basic facts about the chocolate industry.
Stock AnalysisIf you want to buck the bear market trend by going long on consumer stocks, these three might be your best bets.
Investing NewsA rate hike would certainly alter the investment scene, but would it be for the better or worse?
When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>