Musings on Nestle

This started as discussion with an investor friend and ended as a blogpost. We both are invested in nestle and agree that it is one of the bluest blue business but have different opinion on valuations. 

One of us, is worried about sharp run up in stock over last 2-3 years and feels that it may stagnate or derate, while other believes that these valuations are justified and reflect business pedigree, past returns and bright future.  

So, we decided to dig up past data and look at possible and plausible future scenarios. Following is summary of discussion which you may find useful if you are interested in Nestle. 

Nestle as Business (2001-20) 

Following graph tells last 20-year story on volumes, sales and earnings.

   

• Over last 20 years, volumes, sales and profits have grown with rate of growth in profit>revenue>volume.
• In first decade, there was good growth both in volumes and sales and margins expanded from 9% to 13%.
• In second decade, volumes stagnated but sales doubled and margins again increased from 13% to 16%.
• In 2015, Maggi crisis hurt both volumes and sales while earnings almost halved. 
• But Nestle fought back with vigour and regained its pre-crisis tonnage by 2018.
• Post 2017, low commodity prices helped Nestle to expand its operating margins.

Let's get into further details at product mix level:

• Milk products & nutrition segment was and is it's biggest segment in value terms contributing to almost half of it's sales.
• Prepared dishes & cooking aids segment (which includes maggi noodles) over last 20 years has doubled its share in overall volumes from 25% to 55% and largest in tonnage terms.
• Chocolates and confectionary segment did well in first decade but post 2010 volumes have stagnated.
• Coffee & Beverages segment is overall laggard with almost stagnant volumes over last two decades.

Nestle as Stock (2001-20)

Now let's look at stock & valuation front -                 

• Over last 20 years, stock has grown at healthy clip, with rate of growth of stock price>profit>revenue>volume.
• Till 2008 crisis stock prices moved in line with underlying sales and earning growth with stock trading 2-3 times sales or 25-30 times earnings.
• Post 2008 crisis valuations outpaced underlying business performance and increased to 5-6 times sales or 40-45 times earnings. 
• Till maggi crisis growth slowed down but stock kept moving higher helped by multiple expansion.
• During Maggi crisis, even though earnings were cut in half, stock though dropped but  retained its expensive looking valuations.
• Post crisis with a) maggi regaining its market share, b) increased earnings due to low commodity prices 3) renewed vigour in new product launches and d) capacity expansion plans led to stock almost trebling in span of 3 years. 

But all this is past, what matters as investor is how future unfolds with business and stock prices :

On business front - 

Sales growth will depend on a) overall sales growth in existing segment and customer acceptance of new launches  b) management execution and c) competitive response etc.

It will be interesting to see, whether last decade trend of volume stagnation continues or management with its many initiatives is able to reverse this trend. 

On positive side Nestle has huge product portfolio in its international stable and can bring those products in Indian market increasing its potential multifold.

Earning trajectory will depend on a) overall volume and sales growth, b) product mix and c) input  prices

In past, Nestle had grown its margin from 8% to 16%, lot will depend on whether it can continue this trend or margin revert back to mean.

On stock front - 

Stock Prices in long term depend on earning trajectory but in short term keep fluctuating based on investor perception about future business prospects and myriad other factors like overall market levels, cash flows, interest rates etc. etc.

On one side, stock seems to be running ahead of its fundamentals and trading at historically highest valuations and may stagnate as earnings backfill expectations (remember HUL's lost decade!)

But on other side, expensive looking valuations has been reality for long time and reflect business quality and future potential opportunities. Hence it makes sense to hold on even at expensive looking valuations. Past has taught me, if one gets in good business at attractive valuations, time to sell is almost never. 

One may get uncomfortable with lot of one side or other side discussion, when we try to peek into future...but future is inherently unpredictable, with many possible scenarios and as investor our job is to think of most likely scenario and its probability....with advance acceptance that we may be proven wrong.

I hope this discussion, leaves you with better understanding of Nestle's business & stock history over last 20 years, but probably more confused if you are looking for simple yes/no answer on future course of business or stock prices. 

Disclosure- I am not SEBI registered research analyst or investment advisor and blog is written more to educate myself and clarify thought process and should not to be construed as an investment advice. I hold Nestle stock and assume above discussion to be biased.