In the current market environment, I believe value investors should focus on top-tier companies in essential industries. Nestlé S.A. (NSRGY, Financial) is one such company. It is the largest food and beverage company in the world, it is growing organically, shares have low volatility and the company has A+ profitability. I am bullish on the food industry as a whole right now, but Nestlé is a favorite of mine; here's why.
About the company
Nestlé was founded in 1866. At the time, it was called the Anglo-Swiss Condensed Milk Company. The founder invented infant formula in 1867 to tackle the high infant mortality rate. Infant formula is still a staple in the company’s stable of brand name products. Research and development as well as mergers and acquisitions paved the road to Nestlé’s growth as it became a food and beverage conglomerate. Today, the top 10 companies in the industry own nearly all the world’s major packaged food and beverage brands.
Growth industry
Food and beverage is a growth industry as long as the population and average wealth in a country increases. For example, the S&P Food and Beverage Index stood at $5,102 in the fiscal year 2020. As of May 12, 2022, it is $7,015, up 10% over the last three years. The industry is expected to record revenue of $274.10 billion for 2022. The projected market volume is $513.30 billion by 2025; that is an annual growth rate of 23.26% for the 2022-2025 period
China is the largest consumer of food and beverages due to having the largest population. One of Nestlé’s strongest sellers in China is coffee. Nescafé ready-to-drink gave impetus to Nestlé coffee sales, posting double-digit growth last year. Note that most of the company’s sales are from brand names in the U.S., though, where Nestlé operates 70 factories.
Valuation
The GF Score for the company is just 84 out of 100 for the fiscal year 2022, which is ok but not great.
Nestlé garners only 2.5 stars for business predictability from GuruFocus based on historical profitability and share price growth. GuruFocus has detected five medium warning signs with the stock. The company’s financial strength gets a mediocre 6 out of 10. Shares were up 1.5% for the last 12 months but almost 50% over the previous five years.
Other downsides include the potential that inflation might lessen demand, as well as the potential that supply chain impediments continue to hamper inventory fulfillment. The negative impact on the global food supply due to Russia's invasion of Ukraine makes investors skittish. Shares are down ~14% since the first of this year.
The stock is selling close to its 52-week low of $118, down from a high of $141.96. News sentiment is less than enthusiastic about the global food industry. Hedge funds held about $14.1 million worth of shares at the year’s opening, but they sold over $9 million worth of shares between January 1 and March 31.
The consensus among analysts is to buy the stock or hold it. The forward dividend yield is a respectable 2.5%. Analysts discount the value at $121 per share; they cannot agree on a higher average price target above this, but there are few predicting a tumble in share price. Short interest is negligible.
For my part, I think the company’s market power and brand strength makes it reasonable to expect the share price to top $140 over the next 12 months.
Innovation, marketing and good management
Organic growth reached 7.6% in the most recent earnings report despite extrinsic restraints, including China lockdowns. Real internal growth (RIG) was 2.4% amid increased pricing of 5.2%. Margins in the industry held steady or rose on price increases over the past several years. The operating profit margin is between 17.0% and 17.5%.
Nestlé’s CEO reports the company experienced growth across almost all geographies and in most categories despite increasing prices. Total reported sales increased by 5.4% year over year. Growth is forecast to be about 4% in full-year 2022.
Nestlé carries debt that is well offset by cash on hand. Free cash flow is 67% of its earnings before interest and tax (EBIT) and receivables due within a year. With a huge market cap of over $338 billion, the company has no trouble borrowing money if needed to deal with its liabilities or make acquisitions. Nestlé shares might rise slower from management’s cautiousness and short shrift for increasing momentum, but management uses shareholders’ assets wisely in my opinion. Overall, Nestlé shares flourish from a healthy balance sheet.
In April, Nestlé Health Science completed the acquisition of a majority stake in Orgain, a leader in plant-based nutrition. Plant-based “meat” hybrids are increasing revenues. Forecasts are for “fake meat” sales to grow to $8.3 billion by 2025, with a CAGR of 14%. On a side note, plant-based “meat,” “chicken” and “pork” are so popular that rabbis are debating whether or not to certify these items, especially “ham” and “bacon,” as kosher for Jews and Muslims.
Some might wonder why Nestlé isn’t rushing to restock American grocery shelves with its infant formula and baby foods given the shortages. They sell under many different names, including Cerelac, Gerber, Nido and NaturNes. Unfortunately, no infant formula producer was prepared for the number one selling infant formula recall and the subsequent hoarding of remaining stock. Nestlé's infant formula was gobbled up, and supplies are temporarily out of stock. Nestlé is increasing the production of various formulas, but it will take several weeks until demand can be met.
The last bite
Food and beverage sales may dip here and there, but demand will sustain regardless of price increases and margin growth. Food is essential, and processed packaged foods are convenient to those whose jobs leave them no time to cook. I believe Nestlé is unfairly ignored by many investors despite its brand popularity. The shares are not volatile but have steadily increased in price over time. The company's balance sheet is healthy with concomitant revenue increases. Nestlé is profitable and pays a fair dividend. There are some risks, but in the big picture, I think the positives outweigh the downsides.
