Will Nestle's Streamlining Efforts Pay Off?

Now that it's shedding underperforming assets and focused on driving profitability, can Nestle win investors over once again?

Jul 10, 2014 at 10:23AM

Food companies have been battling rising costs and an economic recovery that has underwhelmed. As a result, a business like health and wellness company Nestle (NASDAQOTH:NSRGY), despite its large size, has had to be agile in its response to the new normal. The stock has lagged the broader market, and sales have missed the mark. So how does Nestle compare to its rivals, and is it doing enough to sweet talk investors back to its coffers? Let's take a look.  

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Amid a host of challenges, not the least of which has been declining market share, Nestle is streamlining its operations. The effort has been ongoing for months, but it's not over. In fact, with its broad brand portfolio, Nestle is only now beginning to resemble the company it wants to be.

The industry has been hit by higher food costs and a strapped consumer, the latter of whom has less spending money these days. Indeed, in a recent interview with CNBC, Nestle's Paul Grimwood, chairman and CEO of the company's U.S. operations, suggested that discretionary incomes are perched 11% to 12% below year-end 2007 levels.  

At Nestle, efficiency prevails
Nestle has been able to hold off on passing rising expenses on to consumers by way of price increases thanks to relief in certain commodities coupled with more efficient operations at Nestle, which has helped it to remain competitive. One reason why is the company is intent on reducing its capital expenditures, which it reserves for property, plants, and equipment investments. Last year its capex as a percent of sales declined by 6 percentage points to 5.3%. 

That doesn't mean that future acquisitions are off the table. Nestle's Grimwood on CNBC noted how the company hunts acquisition and "disposal" targets on an ongoing basis. The latest in string of assets to go, however, was its Juicy Juice brand, which the company recently sold to private equity firm Brynwood Partners for an undisclosed sum. It is unclear what Nestle will do with the proceeds, although it has promised shareholders a stock buyback that has yet to occur

The Juicy Juice divestiture isn't the first sale to occur of late, as the company recently unloaded other underperforming assets in hopes of driving profits higher. Here's a look at some of some of the brands that Nestle has sold either entirely or partially:

Nestle's Selling Spree 
Divested asset  Sale Details
Givaudan (fragrances and flavors business)  Sold 10% in late 2013
Jenny Craig Sold across certain geographies in late 2013
Plancoet, Val St Lambert, and Carola (French regional bottled water brands) All three brands sold to multiple buyers since July 2013
Peters Ice Cream (Aussie brand) Sold to Pacific Equity Partners in 2012 

Sources: New York Times and The Wall Street Journal

One of the businesses you won't find on the list any time soon is Nestle's instant coffee Nescafe brand, which according to The Wall Street Journal it believes can thrive despite uneven sales from the category across geographies. Nescafe is huge for the company, bringing in $13 billion, or more than half of sales in its single-largest business segment, powdered and liquid beverages. Nestle, however, has in a way cannibalized sales of its Nescafe instant coffee with its Nespresso espresso machine, which rivals Keurig Green Mountain's K-Cup technology and whose core market is in Europe.    

Peer comparison
Hershey in its first quarter reported disappointing sales results and exposed some cracks in overall efficiency. The company saw a decline in adjusted gross margin of 10 basis points in part due to rising costs. Meanwhile, selling, marketing, and administrative costs rose by 4%, which was less than expected but represents a trend that will persist this year as the company invests in product innovation (including the return of the full-size Krackel bar in addition to the availability of Reese's Peanut Butter Cups in Brazil).

For its part, Mondelez in the midst of merging its coffee business with D.E. Master Blenders 1853 recently launched a restructuring effort that it expects will lead to cost savings $3.5 billion through 2018.

Nestle shares are only up 6.3% year to date, and while returns lag the broader market, they're reasonable in light of the performance of the group. Mondelez shares are up a slightly better 7.6% for the same period, but shares of Hershey have come under the most pressure, down nearly 1%. Nestle also offers long-term value at a P/E of 19.6 compared to 23.5 and 22 for Hershey and Mondelez, respectively.  

For Nestle, analysts are projecting earnings per share of $3.38 and $4.20 in 2014 and 2015, respectively. This compares with basic earnings per share of CHF 3.14 ($3.51) in 2013. Revenue is expected to grow 6% and 5% this year and next, respectively. 

Foolish conclusion
It's very much still a turnaround period for Nestle. But the company's ability to stay focused on its goal of shedding underperforming businesses and focusing on those segments that can drive higher profitability should pay off. Nestle is in the middle of the pack of its peers, and considering the headwinds that's not such a bad place to be. It might be slightly premature to pile in before there's more evidence of growth in the cards, but it's one to watch for sure.

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