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Nestle - out-of-home business struggles in Q2

Sophie Lund-Yates, Equity Analyst | 30 July 2020 | A A A
Nestle - out-of-home business struggles in Q2

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Nestle Sa Ordinary CHF0.01

Sell: 115.16 | Buy: 115.18 | Change 0.84 (0.73%)
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Nestlé has reported a 2.8% rise in organic sales in the first half to CHF 41.2bn. That comprises a 2.6% increase in volumes, while prices were up 0.2%. The group had a better than expected start to the year, but in the second quarter lockdowns had a severe impact on out-of-home businesses, and consumer spending normalised after stockpiling.

Underlying trading operating profit fell by 7.9% to CHF 7.2bn, largely reflecting adverse currency movements.

So long as current conditions don't deteriorate, Nestlé expects full-year organic sales growth between 2% and 3%, and underlying operating margins to improve.

The shares rose 1.4% following the announcement.

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Our View

Coronavirus has been a bit of mixed bag for the Nescafé and KitKat maker. Stockpiling was an initial boost, but now trading's started to normalise it's more important to focus on the bigger picture.

The first thing Nestlé has to shout about is a successful volume-led approach to sales, which we tend to prefer over relying on price increases. That's helped deliver underlying sales growth of at least 2% for over 20 years. Even in these unusual times, not all Nestlé's rival consumer groups have managed to capitalise on the increased demand.

Crucially, the group thinks sales will hold up for the remainder of the year. With margins set to improve too, earnings per share will be taken along for the ride. We should say though that it's still too early to be sure about what's going to happen, and it's not all peachy.

There's long been pressure on prices, which reflects a lack of brand power potency in the wider industry. The volume-centred approach means Nestlé is better placed to tackle this dilemma than some other groups, but any major downward pressure on price tags wouldn't be the best news. A bigger problem would be a generally less brand- loyal customer base.

Nestlé's modus operandi relies on a research and development spend of CHF 1.7bn, providing firepower to create new products and varieties. Once innovations are established, the marketing and admin budget of almost CHF 20bn ensures they're front and centre of consumers' mind, which in turn encourages reliable revenues. Extra sales boost profits, and profits can be paid out as dividends or reinvested in next year's products. The cycle can start again.

Attempts to streamline the business means Nestlé is now focussed on the core food, beverage and nutritional health products. However, what it means for the group's 23% shareholding in L'Oreal remains to be seen.

Overall we don't have worries about Nestlé surviving the current disruption. The priority from here will be protecting its brands and continuing to harness the strong demand for its products. The shares are valued above their longer term average, which means the shares could fall if growth falters. Ultimately, while we can't rule out near-term ups and downs, we think Nestlé is one of the better placed names in the fast moving consumer goods sector.

Nestlé key facts

  • Current forward 12m price to earnings ratio: 24.5
  • 10 year average 12m forward Price/Earnings ratio: 19.4
  • Prospective yield: 2.5%

We've introduced this section in response to recent survey feedback

Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Second quarter trading details (underlying)

Nestlé's largest division, the Americas, saw sales increase 5.3% to CHF 16.7bn, with the vast majority being driven by a rise in volumes. Underlying trading operating profit (UTOP) was CHF 3.2bn (2019: CHF 3.3bn). The largest growth contributor was Purina PetCare, which continued to trade well online.

Asia, Oceania and Africa was impacted by double digit organic sales declines in China, which offset growth in other regions. As a result organic sales fell 2.2% to CHF 10.1bn. Conditions in China are starting to improve. UTOP was CHF 2.3bn (2019: CHF 2.5bn). UTOP margins declined slightly because of rising commodity prices and COVID-19 related costs.

Despite prices falling 0.4% in Europe, Middle-East and North Africa, a 2.8% rise in volumes meant overall organic sales growth was 2.4% and reached CHF 10.0bn. There was a sharp decline in sales in the second quarter, particularly in out-of-home trading including water. Reduced store spending and lower commodity prices meant UTOP margins improved to 18.3% from 17.9%. UTOP was marginally down at CHF 1.9bn.

Sales in the other businesses grew 6.1% to CHF 4.4bn, helped by mid-single-digit growth at Nespresso. UTOP was broadly flat at CHF 1.0bn.

In the first half, COVID-19 related costs were CHF 290m, which includes bonuses paid to frontline workers, employee safety protocols and donations.

Free cash flow fell 19.1% to CHF 3.3bn, reflecting a delayed dividend payment from an associate company as well as the weaker sales performance. Dividend and share buyback costs meant net debt rose to CHF 33.4bn as at June 30, 2020, compared to CHF 27.1bn at the start of the year.

The group's strategic review of the Waters business in North America is ongoing, and agreed to sell the Canadian Nestlé Pure Life business in July. The review of the Yinlu peanut milk and canned rice porridge businesses in China also continues. Both reviews are expected to conclude in early 2021.

Find out more about Nestle shares including how to invest

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.


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