Should you buy, hold or sell Nestlé shares?

Nestlé owns one of the best portfolios of food and beverage brands in the world.

The power of these brands is apparent throughout Nestlé's financial statements, which as bottom-up analysts, is our primary focus and the real litmus test.

Organic sales have consistently grown at around 5% a year since 2009 with volume/mix contributing around half of this, arguably the best measure of brand health.

Nestlé's volumes have proven far more resilient than those of the broader sector, which has witnessed volume weakness thanks to the rise of private labels and changes in consumer preferences.

Encouragingly, this trend has persisted over more recent quarters with Nestle recording volume losses of less than 1%, vs mid-single digit declines for most other food peers.

As the largest player with enormous scale benefits, Nestlé generates an industry-leading ROIC (return on invested capital) of around 17%.

In contrast, most other peers across the sector generate returns anywhere from low-teens to high single-digit levels.

Active portfolio management has also played a crucial factor in ensuring group returns remain attractive, with proceeds from divestments of lower returning assets recycled over the years into higher margin/growth categories such as pet care, powdered beverages (coffee) and nutrients, with these three now accounting for approximately 60% of sales compared to 40% in 2008.

What Nestlé does

Nestlé is a multinational food and drink processing conglomerate corporation headquartered in Switzerland.

It has over 30 billion-dollar brands in its food and beverage stable and dominates most of these categories in terms of market share.

For example, in global coffee, Nestlé enjoys a 22% market share, almost three times larger than the next biggest player, while in US pet care, Nestle's Purina commands a 29% share, larger than the second and third player combined.

Nestlé and ESG

Nestle is on a significant and important journey to improving its ESG performance and has already made decent inroads.,

Its goal is for 100% of its key ingredient volumes (which account for 95% of what they source by volume) to be responsibly sourced by 2030. This includes cereals and grains, cocoa, coconut, coffee, dairy, fish and seafood, hazelnuts meat, poultry and eggs, palm oil, pulp and paper, soy, spices, sugar, and vegetables. In 2023 it achieved 36.2% of this target up from only 16.3% in 2021, so while there is a lot to do, significant progress is being made.

It has a net zero target by 2050, driven by a mixture of renewable energy sources at its locations and low-carbon alternatives in its logistics.

It has demonstrable action plans to address human rights challenges in its operations and supply chains focusing on 10 issues including child labour and access to education, forced labour and responsible recruitment and indigenous peoples and local communities' land rights.

It has high transparency when it comes to governance metrics as measured by ISS, such as improving gender diversity both in employees and management, with executive compensation linked to ESG.

Strategy and outlook  

Nestle has provided FY25 financial targets including EBIT margins of between 17.5 to 18.5%, annual organic growth targets of mid-single digit levels out to FY25 (broadly consistent with historical delivery) and constant currency EPS CAGR targets of 6% to 10% over the same period.

In more recent years, however, Nestlé has been plagued by a series of operational missteps and persistent margin pressures which, in addition to higher interest rates, have contributed to the stock's meaningful de-rating.

The most damaging hiccup has been Nestlé's failure to properly integrate the packaging sites of recently acquired health science businesses. However, we do think that 157 years of supply chain management counts for something and we do think they will manage to turn the ship around.

Should Nestle manage to rectify these issues, and even broadly achieve FY25 targets, we think the shares could potentially be worth about ₣120/share by FY26, inclusive of dividends, or around 28% upside from current levels.

Returns  

While Nestle's FY23 EPS was in-line with guidance, organic sales growth came in slightly below expectations, while FY24 organic guidance was also a little light.

However, the bright spot in FY23 results was cost management and gross margin improvement which together delivered a ~20 basis points improvement in FY EBIT margins. Encouragingly, management is guiding investors to even more improvement next year.

Management also delivered on their guidance for free cash flow and importantly, re-affirmed their FY25 targets.

In terms of shareholder returns, the board proposed a dividend of CHF 3.00 per share, marking 29 consecutive years of dividend growth.

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