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Morningstar | Nestle Well-Positioned to Achieve Mid-Term Targets After in Line FY 2018 but Shares Slightly Rich

Nestle reported full-year results for fiscal-year 2018, with organic growth of 3.0% (2.5% volume growth and 0.5% pricing) in line with our expectations (2.3% volume growth 0.7% pricing respectively) and consensus. Trading operating profit margin improved 50 basis points to 17% (versus 46 basis points in our model). Management expects continued improvement in organic sales growth for fiscal 2019 and further progress in the underlying operating profit or UTOP margin, in line with its 17.5%-18.5% target for fiscal 2020. Given this in line set of results, we maintain our wide moat rating and we plan to increase our CHF 81 ($84 per ADR) fair value estimate by a mid-single-digit percentage to reflect the time value of money as we roll over our model. Shares trade in the 2-star territory after opening on Feb. 14 up 3%.

We note that our 18% UTOP margin estimate in fiscal 2020 is roughly 50 basis points lower than consensus estimates (which in turn is at the high end of management's guidance). On the call, the company said that it has already achieved half of its cost-cutting target (CHF 2.2 billion in total) resulting in 100 basis points of margin improvement (to 17% from 16% in fiscal 2016), with the rest expected to come through by fiscal 2020. Given a favorable backdrop in pricing for fiscal 2019 (and positive momentum in the fourth quarter), we are becoming more constructive on the margin, but still, we believe that the company will need more time to hit the 18.5% mark.

Geographically, Nestle continues to reap the benefits of its high exposure in emerging markets (42% of sales), with robust organic growth (4.9%) and pricing (1.5%) offsetting an unexciting performance of its developed markets businesses (1.7% volume, negative 0.1% pricing). Europe and Americas were up 1.9% and 2.0%, respectively, but pricing is still waning in the former, driven by negative pricing in Western Europe.

Pricing was weak in Waters (2.1% organic growth, negative 0.6% pricing) and Other Businesses as well (5.7% organic growth, 0.3% pricing), with Nespresso, skin health, and health science growing healthily at mid-single-digit rates. Category-wise, Nutrition and Health Science, PetCare and Coffee were standouts with 4.6%, 4.5%, and 3.3% organic growth, respectively. Impact from commodity inputs was largely neutral in fiscal 2018, while management expects inflation to be a tailwind for pricing in fiscal 2019 (1.3% expected pricing contribution in our model versus 0.5% in fiscal 2018).

From a profitability standpoint, the underlying trading operating margin improved 50 basis points with gross margin (up 0.5% of sales) and general operating expenses (SG&A down 0.3% of sales) more than offsetting higher distribution costs (freight costs contribution up 0.3% of sales), supported by pricing, product mix, and structural cost reduction in both manufacturing and G&A.

A regular dividend of CHF 2.45 per share was proposed (up 4.3% year on year) while Nestle intends to complete the current CHF 20 billion share buyback program ahead of schedule by the end of 2019 (versus first-half of 2020 in our model).

As part of the company's efforts to optimize its portfolio of brands to be more in line with its core categories (Coffee, Water, Nutrition, and Petcare) and strategic vision (Health and Wellness), Nestle announced that it explores strategic options for Herta charcuterie, its cold cuts, and meat-based products unit, with sales of around CHF 680 million in 2018. We note that the company will continue to invest in its high-growth plant-based offerings (Garden Gourmet in Europe and Sweet Earth in the U.S.).

Nestle announced that it proposes Dick Boer, former president and CEO of Ahold Delhaize, and Dinesh Paliwal, president and CEO of Harman International Industries (a subsidiary of Samsung Electronics), for election to its board of directors. We believe that both proposals are in the right direction adding considerable food retail and technology experience to Nestle's board.