EUR 850.00 For Business Accounts Only

Morningstar | Nestle's CMD in Line With Midterm Targets Unchanged; Shares Slightly Rich

Nestle's CMD this year was hosted at its U.S. headquarters in Arlington and shed more light on its 2020 midterm targets (mid-single-digit organic sales growth and EBIT margin of 17.5%-18.5%) with the high-growth categories (pet, nutrition, coffee, health, and waters) being the focus. Nestle also announced the consolidation of the frozen pizza and ice cream distribution from a direct store delivery (DSD) model to warehouse distribution, which will create cost synergies, reduce capital intensity, and improve returns. Notwithstanding the added colour provided including this key announcement, management noted that both the DSD exit and ongoing strategic reviews are already factored in to 2020 midterm targets. Given that both short- (full-year guidance was confirmed) and medium-term expectations remain unchanged, we maintain our CHF 88 (USD 88 for ADR) fair value estimate and wide moat rating for Nestle.

Except for the DSD exit announcement, other highlights from the event were the theme of faster innovation across a number of categories (has been central in management's assessment of the reasons behind Nestle's underperformance over the last couple of years), premiumization (22% and 15% of EMEA and AOA zone sales, respectively), portfolio management (10% of sales churn almost achieved and may exceed initial  expectations), and the criteria used by Nestle for M&A (strategic and cultural fit, financial returns) as well as category specific updates among others.

We still see Nestle delivering close to 4% CAGR organic growth over the next five years and a 18.1% underlying EBIT margin by fiscal 2020 (slightly higher than the midpoint of management's target range), as a result of the company's efforts to increase growth (fix base business, portfolio management, and invest in high growth categories and geographies) and improve margins (reduce structural costs and increase operational efficiency).

On the U.S. frozen DSD exit more specifically, although we welcome the move as it focuses on improving ROICs and profitability and simplifies the business, there are a couple of points we want to highlight. First, since around USD 3.3 billion of sales (more than 4% of group's sales) will transition to warehouse distribution systems owned by retailers themselves from Nestle's owned direct store delivery system (full transition in fiscal 2020), distribution costs for Nestle will be lower, which should have a positive impact on margins all else being equal (no sales volume impact). Second, sales impact will be negative for the group (USD 450 million according to management, predominantly price-related) due to price reduction (less added-value service) and assortment optimization. Although according to management this is already included in organic growth guidance, we have a hard time reconciling the difference as this roughly accounts for 50 basis points of group's sales. Further, as distribution is given away to retailers, one could argue that a portion of Nestle's competitive advantage (versus competitors with no distribution capabilities) weakens, which could negatively affect volumes. Finally, there will be a one-off restructuring cost of USD 500 million related to employees and assets affected, a portion of which presumably is already included in management's fiscal 2019 guidance (but not explicitly stated).