Summary Analysis: Nestlé
Food & Beverage giant, with cross holdings in L'Oreal and Sanofi
Keen observers would have noticed that my portfolio contains many well known consumer companies - combined with Unilever, P&G, Mondelez & Pepsi, Nestlé is one of the five FMCG companies I own in the portfolio, along with an indirect stake in Coca Cola through my Berkshire holdings (last post). I like FMCG companies because their brand equity, diverse portfolio, and superior supply chain logistics offers them natural economic moats. They are well capitalised, have good quality managements, produce consistent profits, and take care of their investors through dividends and buybacks. They aren’t cheap, but they are never over-the-top costly too. Goldilocks is how you generally find them. This post will focus on Nestlé.
Nestlé is a multinational food and beverage company based in Switzerland. It is one of the largest food companies in the world, with over 2000 brands and operations in more than 190 countries. Nestlé was founded in 1866 by Henri Nestlé, who created a baby food formula to help infants who could not breastfeed. Today, the company's products include a wide range of food and beverage items, including coffee, chocolate, dairy products, bottled water, pet food, and more. Some of Nestle's well-known brands include Nescafe, KitKat, Gerber, Nestea, Nesquik, Maggi, Purina, and many others.
Nestlé has consistently generated strong profits and cash flows, which has enabled it to invest in growth opportunities, pay dividends to shareholders, and maintain a healthy balance sheet, though in recent years, it’s current ratio has been falling and is worth keeping an eye on.1 In its 2022 Annual Report, Nestlé reported total assets of CHF 135 billion and total liabilities of CHF 92 billion, resulting in a total equity of CHF 43 billion.
Revenue hasn’t been growing a lot, inching up by about 1.1% per year for the past 11 years. However, because the company can extract slightly better profits, and the mix of the products are managed to be kept on the higher margins side, it has managed to keep underlying profit growing at about 4.5% per year in the same period - from CHF 2.58 per share in 2009 to CHF 4.8 per share in 2023, dropping year-on-year only thrice in these 15 years. In 3 months to March 2023, sales continued to hum along growing 9.3% year-on-year2.
If I were to talk just about Nestlé’s core business activities, it is rather boring, so let me switch to something more interesting - Nestlé’s stake in L’Oreal.
L’Oreal Stake
Nestlé became a shareholder in L'Oreal in 1974 when it purchased ~30% stake in the French cosmetics company. The investment came at the request of the Bettencourts’, the family that controlled L’Oreal, who feared that François Mitterrand, presidential candidate for France's Socialist Party at the time, might otherwise nationalise the firm if he was elected.
From L’Oréal Begins to Untangle Its Bonds With Nestlé - The New York Times
It was the support of Ms. Bettencourt’s father, the L’Oréal founder Eugène Schueller, for French fascists, and her marriage to André Bettencourt, a French politician with his own links to far-right groups, that led her to fear nationalization if François Mitterrand’s Socialists were to win the 1974 election against Valéry Giscard d’Estaing. L’Oréal had become a publicly traded company in 1963.
Mr. Bettencourt agreed to trade a 30 percent stake to Nestlé for a small share in the Swiss company, on the assumption that it would be more difficult for the state to intervene if a significant foreign investor were involved.
This transaction was executed by Nestlé investing in Gesperal, presumably a family holding company that controlled the Bettencourts’ interest in Nestlé. In 2004, L’Oreal merged Gesperal onto itself, resulting in Nestlé directly owning just shy of 30% of L’Oreal shares.
Outside of this shareholding relationship, L’Oreal and Nestlé have other business connections, having co-invested in ventures like Galderma and Innéov.
Over the years, Nestlé gradually reduced its stake in L'Oreal. In 2014, Nestlé sold a 6% stake in L'Oreal back to the company as part of a share buyback program, and in 2018, it sold another 8.5% stake to L'Oreal's founding Bettencourt family. And in 2021, Nestlé offloaded another 3% or so to L’Oreal. As of today, Nestle own approximately 20.1% of L'Oreal's current outstanding shares.3
While I was researching this post, I couldn’t find the original price at which Nestlé purchased the sake in Gesperal/L’Oreal, but it seems that they made stupendous returns over the years, somewhere in the range of 11% p.a. pre-dividend or about 14-15% including dividend. When compounded over 49 years, that’s a massive upside!
Back to today, Nestlé holds about 107,621,021 shares in L’Oreal, whose market value today is roughly EUR $45B or about CHF 17 per share of Nestlé. In yet another typical European cross-ownership twist, L'Oreal owns 9.4% of Sanofi, so shares in Nestlé represent 80% economic interests in Nestlé, some 18% in L'Oreal and some 1.9% in Sanofi! As you can see, all 3 are proving to be good businesses over the past 5 years, so we must harbour no complaints:
When analysing the stock today, we must then discount out the value of these cross-holdings when ascertaining value. Nestlé’s shares (at the time of drafting this post) were hovering around CHF 117, allowing us to conveniently take out CHF 17 for it’s cross-holdings, and leaving CHF 100 per share for the core FMCG business. This core FMCG business generates about CHF 4.80 per share of underlying profits today, returning CHF 2.95 in dividend and leaving a little bit in the business for acquisitions (which Nestle does from time to time) or for buy backs - Nestle reduced its outstanding shares by 4.4% last year alone4.
At about 21x P/E (on core underlying earnings basis), Nestlé isn’t cheap, but it has almost never traded significantly below this in the past 10 years, and is the second cheapest of the FMCG companies that I own.
For those who are interested, Nestlé is a dividend aristocrat, having returned the same or higher dividend since 1942 and having increased it for 28 years in a row. I plan to accumulate Nestlé, along with my other FMCG holdings in small drips over future cycles.
If you liked this post, it might be worth your time to read my post on Fresenius, another European company with interesting shareholdings, as well as my post on where I find the most value these days. Happy Investing!
(Disclaimer: This post is not financial advice. Nothing written here is a solicitation to buy any stock mentioned here. Please do your own due diligence before trading in any stocks.)
Current ratio is the ratio of current assets over current liabilities. Higher the better and generally anything over 1 is considered healthy and below that not so much. In effect, the company has more short-term outflows to take care of compared to the short-term inflows in the business. Current ratio for Nestlé over the past 2 years have been 0.98 and 0.87 and has been below 1 since 2015. Up until 2014, it was comfortably above 1.
That said, inflation-adjusted-growth was negative 0.5%. This is somewhat concerning, but to be honest, this will be the trend with a lot of FMCG companies over the next few quarters. They have pricing power and can engage in shrinkflation and therefore they will. I would be a lot more worried if volume growth slows when pricing growth slows too, but let’s wait for then and see. In the past FMCG companies have generally treaded that line well. Read more here.
If you are doing the maths of how a stake of 30% reducing by 6%, 8.5% and 3% leaves you with 20.1%, that’s because L’Oreal themselves have been doing some buyback and canceling a lot of treasury shares. So, the total outstanding shares have been reducing a lot, leaving Nestlé with a favourable 20.1% stake as of today.
The 2022 reduction is not likely to be repeated any time soon. This round of reductions were funded by the capital they received from L’Oreal in exchange for the shares they tendered, which concluded in Dec 2021. On a continuing basis, the amount of retained earnings in the business, after taking out dividends, will likely fund a reduction of 1.5% of the share count at best. We will have to see if that capacity increases with profit growth in coming years.