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Financial Analysis of Nestle

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Financial Analysis of Nestle - February 18th, 2011

Nestle SA (OTC:NSRGY) is the world's largest food and beverage company, with 2009 sales of over 107 billion CHF ($101 billion USD).[1] Nestle owns several major consumer brands such as Stouffers, Nescafe, Kit-Kat, Carnation, Nestle Water, and many others.[2] All in all, 30 of Nestle's products earned 1 billion CHF or more during 2008, making Nestle a major force in the global food and beverage industry.[3] Nestle competes with companies such as Unilever NV (UN), Hershey Foods (HSY), Kraft Foods (KFT), Cadbury Schweppes (CSG), and GROUPE DANONE (DA) in the packaged food market. With only 42% of its food and beverage sales coming from North America, Nestle is one of the most geographically diverse of the major food and beverage companies.[4]

Although it already occupies the top spot in terms of sales, Nestle is attempting to continue sales and margin growth by increasing the nutritional value of its products[5] - most recently it has promoted the health benefits of its chocolate. The company's stated goal is to transform itself from a food manufacturer to the world's leading nutrition, health, and wellness company.[3] To this end, Nestle created the largest research and development network in the industry, employing over 5,000 scientists and technicians.[6]

Contents
1 Earnings
2 Business Segments
2.1 Beverages
2.2 Milk Products, Nutritional, and Ice Cream
2.3 Prepared Dishes and Cooking Aides
2.4 Confectionery
2.5 Other Food & Beverages
2.6 Pet Care
2.7 Pharmaceutical Products
2.8 Healthcare Nutrition
3 Key Trends and Forces
3.1 Changes in Raw Food Prices put Nestle's Margins at Risk
3.2 Consumers Demanding Healthier Foods
3.3 Strong Swiss Franc Hurts Nestle's Sales
3.4 Nestle Must Capture Growth In Emerging Markets
4 Key Competitors
5 Notes
As retailers push private label products, the ability to earn and maintain shelf space at groceries, convenience stores, and other retail outlets plays a large role in the profitability of packaged food companies. Nestle's large portfolio of prominent consumer brands helps it maintain and increase its shelf space presence despite the growing private label trends, giving it an advantage over competing firms that lack such a strong brand portfolio.[7] These advantages don't, however, insulate Nestle from the impact of rising raw food prices; as grains and dairy prices rise, so do Nestle's costs of production, which can pressure profits.[8].

In December 2010, rumors swirled that Nestle is considering two possible acquisitions: Quorn, a brand of meat-free products currently owned by Premier Foods PLC (LON:PFD), and Yoplait, the world's second largest yogurt maker. Nestle's offer for Quorn is estimated to be worth $359 million[9], while PAI Partners, the majority owner of Yoplait, is looking to sell its 50% stake in the company. Yoplait rejected an unsolicited takeover offer from Groupe Lactalis, Europe's largest dairy group, for the entire company worth $1.9 billion as being too low; General Mills (GIS) and Groupe Lactalis have been mentioned as other possible buyers.[10]

Earnings

Q1 2010

Nestle's first quarter revenues increased by 6.5% compared to the previous year. The company's food and drinks segment revenues increased by 5.1% in Europe and more than 10% in emerging markets.[11] Nespresso sales increased by more than 20% and overall volume for all goods increased by nearly 5%. Nestle Waters saw growth of 2.5% and the company's nutrition unit grew 6.5%.[12] The company is focusing on its core food and beverage products, despite the recent influx of cash following its sale of Alcon ($28 billion) and the purchase of Kraft's frozen pizza business ($3.7 billion). Nestle is in the process of completing a 25 billion franc share buyback program, due to be finished in mid-2010, and then initiating an additional 10 billion franc share buyback. Rumors have also swirled that the company is considering increasing its 30% share in L'Oreal or other acquisitions.[13] The company's Nigerian subsidiary saw its pre-tax profits increase 52% in Q1[14] and net profit for Nestle India increased by a modest 2.5% (however, net revenues increased by 17%).[15]

H1 2010


In the first half of 2010, Nestle's revenues increased 6.1% compared to the first half of 2009; net profits increased 7.5%.[16] In the Americas, organic growth was 6.1% with Purina PetCare, Wonka confections, and the company's new frozen pizza segment all posting positive growth. Frozen food sales decreased in the half, which the company attributes to the weak economy's effect on consumer spending. In Latin America, growth for the half was more 10% with dairy and chocolate both growing. In Europe, company sales increased in nearly all categories, but ice cream sales were lower than normal; revenues increased by 2.2%.[17] The company's growth for half was driven by the emerging markets in its Asia, Oceania, and Africa zone. Sales in Japan and Oceania were flat but revenues from the zone grew 9% with the emerging markets going by 10%. Bucking the trend of low water sales seen by many of its competitors such as Pepsi and Coke, Nestle Waters grew 2.5%; sales in emerging markets grew by nearly 20% and developed market sales grew for the first time in the past few years. The company's nutrition division grew 6.2% with double-digit growth in Russia, China, the Middle East, and Africa.[18] Other food and beverage sales grew by 10.3%; Nespresso alone grew more than 25% in the half.[19]

Q3 2010

In the first nine months of 2010, Nestle's revenues increased 4.5% compared to the first nine months of 2009. Sales increased for every group with 10.7% growth in the Food and Beverages Asia, Oceania, Africa segment. Emerging markets overall grew approximately 11% compared to the previous year.[20] Unfavorable foreign exchange rates, particularly the USD's weakness versus the Swiss Franc, reduced revenues by 2.7%.[21] During Q3 the company completed its sale of eye-care company Alcon to Novartis AG (NVS) for $28.3 billion (USD) and created the Nestle Health Science company.[22] This wholly-owned subsidiary will create food-based products meant to help prevent and treat various medical conditions such as heart disease and diabetes. The company will also oversee the Nestle Institute of Health Sciences which will undertake research aimed at bridging the gap between pharmaceuticals and food and unraveling the web of connections between food, drugs, and disease. Nestle's existing Healthcare Nutrition segment will now become part of the new subsidiary.[23] During the quarter the company also expanded its manufacturing facilities in emerging markets with new factories in Ghana and Mexico and an R&D center in India.[24]

Business Segments

Beverages
Beverages comprised 26% of Nestle's 2009 revenues[25], making it the second-biggest segment after Milk Products, Nutritional and Ice Cream. Nestle owns several international beverage brands including Nescafe, Nesquick, Nestea, and Nestle Waters, each of which generated more than 1 billion CHF in 2007.[26] [27] With more than 400 factories around the world, Nestle is able to formulate each product to local tastes; "Nescafe" in Switzerland has a different recipe to the same product sold in the USA.[3] Nestle's strong brand recognition helps them compete with other brands such as Maxwell House, Lipton, and Evian as well as various store brands. In 2009, Powdered & Liquid Beverages had sales of 19.3 billion CHF. This segment grew 9.5% from 2008.[28]

In 2009, Nestle Waters saw sales decrease 1.4% to 9.1 billion CHF. Nestle Pure Life, the largest water brand in the world, achieved growth of 14%, while both Perrier and Pellegrino also saw positive growth. However the segment's overall decrease reflects a weakening bottled water market, at least in the United States. The combination of the recession and upper class consumers' increased environmental consciousness[29] has lead many customers to cut back on bottled water in favor of tap water and reusable containers. In 2008, bottled water was the third most popular beverage (behind soda and milk) in the US, but compared to 2007, Americans consumption declined for the first time, down to 8.7 billion gallons from 8.8 billion gallons.[30] Although this is a seemingly small decrease, industry experts don't expect bottled water to bounce back anytime soon, and the trend may expand beyond the US.

Milk Products, Nutritional, and Ice Cream
Milk Products, Nutritional, and Ice Cream was Nestle's largest segment in 2009 with 27% of the companies total sales.[31] This division's brands include Carnation, Coffee Mate, Dreyer's, and Edy's, each of which totaled more than 1 billion CHF in 2007 sales. Nestle's milk and ice cream brands compete with products such as Breyer Ice cream and store brands. Their nutritional products include Gerber Brand baby food and Nestle brand yogurts. Nestle's nutritional products compete against brands such as Dannon Yogurt and store brands. In 2009, Nutrition had sales of 10 billion CHF, reflecting organic growth of 2.8%. In particular, Infant Nutrition saw double-digit growth in most emerging markets, including 30% growth in Russia.[32] In 2009, the Milk Products segment had revenues of 19.6 billion CHF with organic growth of 2%.[33] The company's Nutrition segment became part of Nestle HealthCare Nutrition in early 2011 and will report under this wholly owned subsidiary in the future.

Prepared Dishes and Cooking Aides
Nestle's Prepared Dishes and Cooking Aides segment, which contributed 16% of the company's 2009 sales, consists mostly of products, like microwave lasagna, that are designed to be ready to eat very quickly.[34] Nestle owns brands such as Stouffer's, Lean Cuisine, Hot Pockets, and Maggi, which each totaled more than 1 billion CHF in 2007 sales. Nestle has increased the nutritional value of its prepared dishes in order to compete with products such as DiGiorno, Bertoli, and Kraft Macaroni and Cheese.[35] On January 5, Neslte bought Kraft's frozen pizza business for $3.7 billion, approximately 2.3 times its total sales in 2009.[36] The purchase adds the DiGiorno, Tombstone, Jack's and Delissio brands to Nestle's stable of products, as well as the license to sell California Pizza Kitchen frozen pizza. In 2009, these brands generated revenues of $1.6 billion for Kraft. With this acquisition added to Nestle's existing product line, the company controls 33% of the market share for North American frozen foods.[37] In 2009, the segment had sales of 17.2 billion CHF with organic growth of 0.8%. Consumers in the US bought more family-sized frozen products such as Stouffers and Hot Pockets than single-serving dishes such as Lean Cuisine; Pizza was the most dynamic category for Europe throughout the year.[38]

Confectionery
Nestle's Confectionery segment comprised 11% of their total 2009 sales.[39] Nestle's confectionery brands include Kit-Kat and Nestle Chocolate, each of which generated more than 1 billion CHF in 2007 sales. The Nestle Chocolate brand produces famous products such as Baby Ruth and Nestle Crunch.[40] Nestle's confectionery products compete with chocolates and candies from Hershey Foods (HSY) and Cadbury Schweppes (CSG) (recently purchased by Kraft Foods (KFT) and snacks from manufacturers such as Kraft Foods (KFT), as well as various store brands.

With Kraft Foods (KFT)' purchase of Cadbury in January 2010, Nestle dropped to the third largest chocolatier. In response to the merger, many industry analysts are speculating that Nestle may set their sights on H.J. Heinz Company (HNZ), General Mills (GIS), or Hershey Foods (HSY) as potential takeover targets.[41] Officials from the first two companies have not responded to these rumors, however Heinz's stock rose more than 5% on possible takeover speculation. An spokesman for the Hershey Trust, the controlling shareholder in Hershey Foods (HSY) categorically denied any possibility of a merger.[42]

In 2009, Confectionery had sales of 11.8 billion CHF, reflecting organic growth of 4.3% from the previous year. KitKat in particular grew by 7% with large increases in Great Britain, France, and Switzerland. Also, Chocolate grew quickly in the Americas, Asia, Oceania, and Africa.[43]

Other Food & Beverages
In 2009, this group, consisting of "Nespresso", "Nestlé Professional", and "Cereal Partners Worldwide", generated revenues of 10.2 billion CHF. The segment grew 6.8% from 2008, spurred largely by Nespresso's 25% growth; the brand had sales of 3 billion CHF in 2009.[44] Nestlé Professional, previously Nestlé Food Services, saw business remain essentially flat in 2009 as a result of overall declines in the food service industry. Cereal Partners Worldwide had sales of more than 2 billion CHF as a result of mid-single digits growth in 2009. They have ongoing operations in more than 130 countries and account for nearly 25% of all cereal sales outside of the United States and Canada.[45]

Pet Care
Nestle's Pet Care group contributed 12% of the company's total 2009 Sales.[46] Nestle owns several pet care brands that produced more than 1 billion CHF in 2007 such as Purina, Dog Chow, and Friskies. Nestle's pet care products compete against brands such as Iam's and store brands. In 2009, Pet Care generated revenues of 12.9 billion CHF with organic growth of 7.9% from 2008. In particular, Purina outperformed the other brands in its market with mid-to-high single digit growth around the globe.[47]

Pharmaceutical Products
Nestle's Pharmaceutical Products division was responsible for 7% of the company's 2009 sales, however continued pharmaceutical operations (after the sale of Alcon) contributed less than 1% of total revenue.[48] This segment consists of pharmaceutical and cosmetics brands. Nestle owns 30% of L'oreal (LRLCY) and recently sold its controlling stake in Alcon Inc. (ACL) for $39.3 billion.[49] Nestle also participates in two joint ventures with L'oreal (LRLCY): Galderma and Laboratoires innéov. Galderma produces the topical acne medication Differin and Laboratoires innéov produces several cosmetics-related nutritional supplements.[50]

On January 4, 2010, Nestle agreed to sell its its 52% stake in Alcon Inc. (ACL) to Novartis AG (NVS) for $39.3 billion. Bought in 1977 for $280 million, the investment's value has since multiplied more than 140 times.[51] This influx of cash has fueled rumors of a possible acquisition by Nestle following Kraft's recent takeover of Cadbury.

Although there was speculation in early March 2010 of Nestle possibly buying out Lillian Bettencourt's share in L'oreal (LRLCY), there have been also been rumors saying the exact opposite, that Nestle is planning to sell its stake in L'oreal (LRLCY) to market investors.[52] In the meantime, certain analysts expect L'oreal to try and expand its market share in order to make a Nestle takeover more difficult.[53]

Healthcare Nutrition
Using funds from its sale of eye-care company Alcon to Novartis AG (NVS) for $28.3 billion (USD), Nestle created the Nestle Health Science company.[54] This wholly-owned subsidiary will create food-based products meant to help prevent and treat various medical conditions such as heart disease and diabetes. The company will also oversee the Nestle Institute of Health Sciences which will undertake research aimed at bridging the gap between pharmaceuticals and food and unraveling the web of connections between food, drugs, and disease. Nestle's existing Healthcare Nutrition segment will now become part of the new subsidiary.[55] The majority of the company's brands were acquired from Novartis AG (NVS) in 2007.[56]

In February 2011, Nestle purchased UK-based CM&D Pharma; the company developed a chewing-gum that helps people with kidney disease that is currently in testing. The purchase is the first for Nestle Health Science as they expand their portfolio of food-based products that help prevent and treat various medical maladies.[57]

Key Trends and Forces

Changes in Raw Food Prices put Nestle's Margins at Risk

The price of raw foods such as corn, wheat, and dairy can change due to factors such as weather and demand from other industries. Nestle's ability to pass cost increases on to consumers will play a big role in their ability to maintain their current profit margins.[58] After releasing their earnings from 2009, Nestle said that they expect commodity prices to continue to rise another 2%-3% in 2010.[59]
Consumers Demanding Healthier Foods
Nearly all of Nestle's revenues come from sales of food and beverage items. Thus, changing consumer demand for different types of food and beverage items can have an impact on Nestle's sales. These changes can be seasonal; for example, consumers tend to demand more hot beverages such as coffee during the colder winter months.[60] Long term trends also affect consumer demand. For example, the National Restaurant Association says that consumers have been demanding healthier food options when dining out, which reflects the larger trend of growing public concern for health and wellness in general.[61] Nestle is attempting to take advantage of trends such as these by putting the "Nutritional Compass", which prominently displays nutritional information, on over 90% of its products' packaging, and repositioning itself as a nutrition and health company.[62]

With a portion of the cash from the Alcon Sale in 2010, Nestle created the Nestle Health Science company.[63] This wholly-owned subsidiary will create food-based products meant to help prevent and treat various medical conditions. The company will also oversee the Nestle Institute of Health Sciences which will undertake research aimed at bridging the gap between pharmaceuticals and food and unraveling the web of connections between food, drugs, and disease. Nestle's existing Healthcare Nutrition segment will now become part of the new subsidiary.[64] The company envisions itself in a race with major pharmaceutical companies to develop consumer products that will prevent or treat serious chronic medical conditions such as Alzheimer's, diabetes, obesity, and high blood pressure.[65]

Strong Swiss Franc Hurts Nestle's Sales

Nearly all of Nestle's sales happen outside of Switzerland, but the company reports its income in Swiss francs.[66] As such, changes in the exchange rates between the Swiss franc and other world currencies can greatly impact Nestle's revenue. When foreign currencies depreciate relative to the Swiss franc, any transactions denominated in those currencies will convert to a smaller number of francs, meaning less revenue for Nestle. In the beginning of 2009, a stronger franc cut sales growth by 2.1%.[67] The opposite is true as well, with a weak franc boosting Nestle's international sales. In order to help minimize the effect of fluctuating exchange rates, Nestle purchases currency futures, swaps, forwards, and options.[68]

Nestle Must Capture Growth In Emerging Markets
In 2008, sales in emerging economies grew organically (ignoring the effects of acquisitions) by 15.4%.[3] The company hopes to continue this trend by doubling its sales in the ten largest emerging market countries by 2018. To realize this goal, the company has introduced its "Popularly Positioned Products." These products are lower cost and are priced at a level where poor consumers in the developing world can purchase them every day. This category saw enormous growth of 27.4% in 2008, and Nestle expects it to continue to grow. Additionally, Nestle is investing heavily in production capacity in new markets. For example, a five year, 3 billion South African Rand (ZAR) investment plan announced in September 2009 is expected to position the company as the premier nutrition, health, and wellness company in the region.[69] In early May 2010, Nestle's CEO told an audience that the company expects emerging markets to account for 60% of future growth.[70]

With the explicit goal of having emerging market sales account for 45% of revenues by 2020, in June 2010, Nestle announced a $1.4 billion investment in Brazil, Russia, and India from 2010-2012.[71] It has been reported that the company's India subsidiary is aggressively pursuing possible takeover opportunities[72], in addition to using the new funds to launch marketing initiatives for its core products, such as Nescafe.[73]

In June 2010, the company also announced a $141 million investment in its Africa operations, doubling its workforce and building new factories in three countries. The company plans to expand its current facilities in Kenya and Zimbabwe while building new factories in Angola, the Democratic Republic of the Congo, and Mozambique. The expansion plan will increase the company's African workforce from 700 employees to nearly 1,500.[74] This new spending commitment doesn't include a $94 million plant that opened in Nigeria in early 2011 or two new factories that are already under construction in South Africa. With its increased investment in Africa, Nestle expects that 76% of the products sold in Africa will be produced in Africa by 2016. As of early 2011, 19% of products sold in Africa were manufactured locally but the company plans to increase this to 52% in 2012 and 76% in 2016.[75]

Key Competitors

Nestle competes with other packaged foods companies as well as store brands from retailers such as Safeway (SWY), Wal-Mart Stores (WMT), Walgreen Company (WAG). Nestle's major competitors are:

Unilever NV (UN) - A Dutch company that produces packaged foods and products for the home and personal care markets. Unilever is one of Nestle's largest international competitors.[76]
Kraft Foods (KFT) - A U.S. company that produces packaged foods products. Kraft is one of Nestle's largest U.S. based competitors.[77] On January 19, 2010, Kraft bought Cadbury Schweppes (CSG) for $19.5 billion, creating the largest candy company in the world and strengthening Kraft's international presence.[78] Cadbury Schweppes (CSG) is a U.K. company that produces products for the confectionery and non-alcoholic beverages markets; they compete with Nestle's beverage and confectionery products internationally and in the U.S.
GROUPE DANONE (DA) - A French company that produces packaged foods and beverages. Groupe Danone competes with Nestle internationally and in the U.S.[79]
Hershey Foods (HSY) - A U.S. company that produces chocolate and sugar confectionery products. Hershey Foods competes with Nestle's confectionery brands mostly in North America.
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