Nestlé Feels Commodity Crunch; Missed Sales Expectations Four Quarters in a Row; Nestlé got a serious lift over the past few years from rising commodity costs. It was able to pass these on, and perhaps a bit more, to consumers

August 8, 2013, 2:39 p.m. ET

Nestlé Feels Commodity Crunch

Sales Expectations Have Been Missed Four Quarters in a Row, and a Couple More May Be Needed to Get Back on Track

JOHN JANNARONE

Nestlé NESN.VX -2.16% shares are a bit like its sugary treats: After providing a burst of energy, they have left investors in a funk. The Swiss food conglomerate fell short of revenue expectations for the fourth quarter in a row Thursday, when it reported results for the three months through June. Nestlé acknowledged that it will be “a stretch” to achieve 5% organic sales growth this year, meaning it may miss its typical 5%-6% target. That suggests Nestlé got a serious lift over the past few years from rising commodity costs. It was able to pass these on, and perhaps a bit more, to consumers. But prices of many inputs like sugar have declined over the past several months. That leads to competitive pressure that erodes pricing power. As Andrew Wood of Sanford C. Bernstein points out, Nestlé’s second-quarter pricing growth of 0.8% was the lowest in a decade. It is hard to guess when commodity prices will rebound. Emerging-market growth, a big driver of commodity demand, has cooled and may take a couple of years to resume.It is hard to identify individual Nestlé brands that could make up the difference. Revenue in the Nespresso coffee division, for instance, rose by a double-digit percentage in the first half. But in a company as large as Nestlé, macroeconomic trends can overshadow such bright spots.

That isn’t to say Nestlé can’t get back on track over time. The company’s brands are fundamentally strong, and it spends a double-digit percentage of revenue on advertising, more than many rivals. Nestlé says it ratcheted up advertising in the first half and directed more money to digital media, which is probably more cost effective.

Even so, competitors have many of the same tools at their fingertips and already are outperforming Nestlé. Danone BN.FR -0.64% reported 6.5% organic sales growth in the second quarter, thanks to a healthy combination of price and volume increases.

Nestlé shares might look tempting after their recent weak performance. The stock has risen a mere 6% this year, compared with an 18% rise for Danone and a 27% increase for PepsiCo.

But Nestlé is no bargain. The stock trades at a free-cash-flow yield of 3.9%, compared with an average of 4.5% for peers, says David Hayes of Nomura Equity Research. Investors should wait awhile longer before taking a bite.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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