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.

Related Articles
  1. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  2. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  3. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  4. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  5. Investing News

    Chipotle Served with Criminal Probe

    Chipotle's beat muted expectations and got a clear bill from the CDC, but it now appears that an investigation into its E.coli breakout has expanded.
  6. Stock Analysis

    Analyzing Sprint Corp's Return on Equity (ROE) (S)

    Learn about Sprint's return on equity. Find out why its ROE is negative and how asset turnover and financial leverage impact ROE relative to Sprint's peers.
  7. Stock Analysis

    Why Alphabet is the Best of the 'FANGs' for 2016

    Alphabet just impressed the street, but is it the best FANG stock?
  8. Investing News

    A 2016 Outlook: What January 2009 Can Teach Us

    January 2009 and January 2016 were similar from an investment standpoint, but from a forward-looking perspective, they were very different.
  9. Mutual Funds & ETFs

    3 Vanguard Equity Fund Underperformers

    Discover three funds from Vanguard Group that consistently underperform their indexes. Learn how consistent most Vanguard low-fee funds are at matching their indexes.
  10. Investing News

    Alphabet Earnings Beat Expectations (GOOGL, AAPL)

    Alphabet's earnings crush analysts' expectations; now bigger than Apple?
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    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 >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    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 >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
Trading Center