A strong portfolio of consumer brands, paired with massive scale, usually produces market-beating sales and profit growth rates over time. Yet for Nestle (OTC:NSRGY) investors, the past year hasn't delivered on that simple promise.
The food and beverage titan's stock fell 4% in 2016 even as the broader market rose nearly 10%. Does this dip signal persistent trouble ahead -- or is it just a short-term pause in a powerful investment thesis? Let's take a closer look.
Nestle kept right on pace with indexes through its first few quarterly reports of 2016. In early February, for example, investors were pleased to see that organic sales grew by 4.2% over the prior twelve months due to a healthy mix of both pricing and volume gains. By the spring, the company revealed evidence of weakening pricing trends but affirmed its overall growth outlook that called for the same strong 4% growth pace to carry through for the year.
Things worsened from there, though. Nestle in October lowered its global growth forecast to 3.5% as pricing pressures mounted. Management announced plans to boost profit margins by cutting costs, but also warned that deflation and increased competitive activity was pinching its results. Ultimately, Nestle failed to meet even that lowered expansion target. Organic growth ended up at 3.2% for the full year, the company announced in February.
Market share and profit gains
In that report, CEO Mark Schneider and his executive team summed up the results by saying, "Our 2016 organic growth was at the high end of the industry but at the lower end of our expectations." In a subsequent conference call with analysts, Schneider was more specific about the volume drop that characterized the last six months of the year. "This is an across-the-board trend; this is not something that is specific to Nestle," he explained.
Schneider has a point. Nestle's 3.2% boost beat the 2.1% gain that Unilever (NYSE:UL) managed in its food division for the year. It also outpaced the 3% decline that J.M. Smuckers is likely to post. Yet investors were simply hoping for a wider market share gap between Nestle and its rivals.
On the bright side, the company made significant strides at boosting its finances last year. Operating profit margin ticked up to 15.4% of sales from 15.1%, putting it just ahead of Unilever. Free cash flow improved to 11.3% of sales, up a full percentage point from 2013's result. Nestle is becoming far more efficient as well, with working capital falling to below 3% of sales from nearly 9% four years ago.
The innovation pipeline appears solid given that nearly one-third of sales are coming from products, like Nescafe Gold, that were launched in just the last three years. Yet Nestle believes 2017 will be characterized by the same negative trends that swamped its latest results. Organic growth will be between 2% and 4%, executives forecast, even as profitability and efficiency metrics march higher.
The company expects to come short of its long-term growth target for the second straight year but is confident about returning to that pace by 2020. Many factors would play into that projected rebound, including increased growth in emerging markets and more aggressive targeting of attractive segments like coffee, pet food, and branded water. As the single biggest food and beverage company on the planet, Nestle also enjoys the scale necessary to fund game-changing mergers and acquisitions.
Its improving finances will likely fund increasing cash returns to shareholders, too, but the stock isn't likely to significantly outpace the market until Nestle starts climbing back toward its growth goal that calls for annual organic gains of about 5%.