Advertisements
Recent

Third Point (Dan Loeb)’s Letter on its $3.5 Billion Position in Nestle

Third Point Letter – Nestle, June 25, 2017

  • Currently owns roughly 40 million shares of Nestle – amounts to over $3.5 billion
  • Nestle, with a market cap of $250+ Bn, is the largest food business in the world
  • Portfolio includes 34 brands that generate more than CHF 1 billion in sales annually – roughly CHF 90 billion in total sales last year
  • Operates across a number of advantaged categories including coffee, infant formula, pet food, and bottled water
  • Also has a strong footprint in emerging markets
  • Despite having arguably the best positioned portfolio in the consumer packaged goods industry, Nestle shares have significantly underperformed most of their US and European consumer staples peers on a 3 year, 5 year, and 10 year total shareholder return basis
    • One year returns have been driven largely by the market’s anticipation that Nestle will improve with a newly appointed CEO
  • While its peers have adapted to a lower growth world, Nestle has remained stuck in its old ways, making it impossible to deliver on the once reliable “Nestle model” that called for 5-6% organic sales growth annually and continuous margin improvement
    • EPS has not grown in 5 years
    • Dividend growth has slowed to low single digits in recent years at a payout ratio of 66% which is at the upper end of the peer group
  • While Nestle has stood still, its peers have pursued productivity increases aggressively and made other changes in order to deliver earnings growth and create shareholder value in a slower growth world
    nestle underperformance
  • Third Point invested in Nestle because we recognized a familiar set of conditions that make it ripe for improvement and change: a conglomerate with unrealized potential for margin improvement and innovation in its core businesses, an unoptimized balance sheet, a number of non-core assets, and a recent history of meaningful underperformance versus peers
  • Nestle’s new leader, Dr. Ulf Mark Schneider, had an impressive track record of value creation as the CEO of Fresenius from 2003 until he joined Nestle
    • Delivered strong organic sales growth and executed well on transformational M&A, and shares appreciated at a roughly 20% CAGR during his tenure
  • Jan Bennink, one of the world’s recognized leaders in the packaged goods space, has been retained to advise us on this investment
    • Jan has direct operating experience in four of Nestle’s key categories: coffee, baby food, medical nutrition, and dairy
    • Jan has also invested a significant personal sum in the Third Point – Nestle SPV
  • Believe Nestle is positioned to create enormous value for shareholders over the next several years if the company focuses on 1) improving productivity; 2) returning capital to shareholders; 3) re-shaping the portfolio; and 4) monetizing its L’Oreal stake

Improving Productivity

  • Believe Nestle should adopt a formal margin target
  • Company has highlighted over CHF 7.5 billion of cost savings since 2012 but these savings have not fueled faster organic sales or earnings growth, leaving shareholders to wonder what benefit Nestle has gotten from them
  • Nestle’s ’16 EBIT margin 15.3% is at the low end of its peers, nearly all of which are now targeting high-teens to low 20’s margins
  • Nestle should be able to improve margins by as much as 400 bps over the next several years
    • Respected analysts from Goldman Sachs and Bank of America have identified a similar opportunity
  • Adopting a formal target range would remove uncertainty around reinvestment and give management the flexibility needed to meet their goals

improving productivity

Capital Return

  • Capital return in conjunction with a formal leverage target makes sense as well
  • Remarkably low leverage of less than 1.0x net debt to EBITDA serves no real business purpose for a non-cyclical business with such strong cash flow and contrasts unfavorably with most peers (2.0 – 4.0x leverage)
  • Believe Nestle should set a target of at least 2.0x which would better optimize the company’s cost of capital
  • Getting to 2.0x and staying there would also produce enormous capacity for share buybacks over time
    • Buybacks offer an attractive alternative to M&A given the high multiples in Nestle’s sector, offering similar EPS uplift with none of the integration risk

Re-shaping the Portfolio

  • Company operates today with over 2,000 brands in Food & Beverage and Health Science
  • Management must determine which of these businesses are key pillars of growth for the company and then strategically reduce exposure to those that are not
  • Given large synergies to potential acquirers, we believe these kinds of businesses could fetch above-market multiples
  • Separating them could also help accelerate organic growth and free up internal resources to increase focus on priority areas

Monetizing the L’Oreal Stake

  • Company acquired 29% of L’Oreal in 1974 and sold 6% in 2014
  • This has been a superb investment, and the remaining 23% stake is equivalent to more than $25Bn, or roughly 10% of Nestle’s market cap today
  • Having L’Oreal in the portfolio is not strategic and shareholders should be free to choose whether they want to invest in Nestle or some combination of Nestle and L’Oreal
  • Current conditions make this the right time to exit the remainder and we believe the stake can be monetized with limited tax or other consequences
    • L’Oreal stake could be divested via an exchange offer for Nestle shares that would accelerate efforts to optimize its capital return policies, immediately enhance ROE, and meaningfully increase its share value in the long run as earnings improve over a reduced share count

Conclusion

  • Situation reminds us of similar conditions that existed when we first invested in Baxter in 2015
    • Some market observers scratched their heads, as they thought the company looked expensive and thus underestimated the uplift that is possible when a new leader dedicates himself to better capital allocation, portfolio optimization, and margin improvement with strong shareholder support
  • Portfolio re-shaping and productivity investments should help to re-accelerate organic sales growth from 2-4% this year to something in the mid-single digit range over the next few years
  • Formal margin and leverage target should help drive EPS from CHF 3.40 last year to CHF 5.00-6.00 by 2020
    • At that point, a more focused, faster growing Nestle, with EPS more than 50% higher than today, would command a premium not just to the market but also to the broader staples group, generating attractive returns for shareholders
    • Improved earnings power will also bring the dividend payout ratio back in line, allowing Nestle to reward shareholders with continued dividend increases and make the necessary investments in its business for the future
  • Third Point intends to be an engaged, long-term shareholder and offer our assistance to the management team and Board as they pursue improved performance for all stakeholders
  • Confident that by following the path we have outlined, Nestle will be able to revive its iconic slogan, with a twist: Nestle makes the very best returns for its shareholders
Image Source: ebay
Advertisements

Leave a Reply

Your email address will not be published.