Nestle’s 2017 Results and 2018 Financial Performance
The climb just got steeper for Nestle chief executive Mark Schneider after only 12 months at the helm of the world’s largest food company. The Swiss giant reported a sixth straight year of slowing organic growth last week, while profits again declined. Simon Harvey goes through the numbers and looks ahead to 2018 and beyond.
Expressing an element of caution on Nestle’s 2018 business outlook after last Thursday’s annual earnings release, CEO Mark Schneider said the “challenge” facing the business “is certainly a harder one than the one we looked at last year”.
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Sanford Bernstein analyst Andrew Wood quantified the closely-watched organic growth rate of 2.4% in 2017 as Nestle’s “lowest this century”, repeating remarks used to describe the fourth-quarter print of 1.9%.
Schneider acknowledged the company’s growth was “somewhat on the softer side” of where he would like it to be.
Bernstein’s Wood opined a turnaround under the new CEO is still a “work-in-progress” and expressed hope the slowdown in Nestle’s growth reached its “nadir” in December.
However, on a brighter note, Nestle achieved a better-than-expected 50 basis-point improvement in the recently introduced target for its underlying trading operating profit margin.
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By GlobalData‘Disappointing’ was the prominent word permeating markets on Thursday
Nestle’s annual sales inched up 0.4% to CHF89.8bn (US$97bn) in 2017 but were still a couple of billion Swiss francs or so below the top-line earnings in 2015 and 2014.
The company’s net profit tumbled 15.8% to CHF7.2bn, more than double the 6.2% drop in the previous 12 months. While those percentage declines pale in contrast to the 36% slide in 2015, note the CHF14.9bn end profit figure in 2014 for some perspective on historical bottom-line earnings.
North America and Brazil, which both fall into the same geographical reporting division, were the culprits for the group underperformance. Weak consumer demand in the former and deflation in the latter were cited by Nestle as the reasons.
In Nestle’s earnings statement, Schneider said: “Our 2017 organic sales growth was within the guided range but below our expectations, in particular due to weak sales development towards the end of the year. Sales growth in Europe and Asia was encouraging, while North America and Brazil continued to see a challenging environment.”
With most market watchers focused on the organic growth numbers, Schneider sought to reassure investors on a follow-up conference call, saying Nestle was still committed to the 2020 growth and margin targets it outlined at its investor day in London last autumn. In the UK capital in September, Schneider underlined Nestle had turned down the dial on its long-running target for sales to rise 5-6% on an organic basis each year, instead setting a broader goal of “mid-single digit organic growth” by 2020.
The company also set a target for its underlying trading operating profit margin to be between 17.5% and 18.5% by 2020 (up from 16% in 2016).
“I know this comes against the backdrop of a softer-than-anticipated fourth quarter, but when I look at all the underlying works that are underway and all of the initiatives that we have picked up and the base development of our business now – at the beginning of 2018 – I actually have a lot of faith and optimism,” the CEO says.
What was behind Nestle’s muted growth in 2017?
While 2017’s sales in the Americas geographical region rose a modest 1.2% on a reported basis, Nestle described the 0.9% organic growth rate as “subdued” or even slightly “negative” amid weak consumer demand, which resulted in what it said was “stagnant” growth in food and beverages.
CFO François-Xavier Roger said weakness in consumer demand in North America affected most of its product categories.
Nestle said Brazil was hit by deflationary pressures, which particularly weighed on the dairy segment, with milk prices falling around 20% in the latter part of the year. However, Schneider says that effect was not unique to Nestle alone and was reflected by “many of our competitors”, but then the company had to “address price levels accordingly”.
Meanwhile, Nestle’s outperformance in emerging markets – 4.8% organic growth compared to 0.7% in developed economies – might be seen as worrisome by some industry watchers given the historical income channels from its traditional markets.
Sales in the Americas region are by far Nestle’s most important, which at CHF28.5bn last year outstripped the CHF16.5bn in Europe, the Middle East and North Africa. Zone AOA – or Asia, Oceania and sub-Saharan Africa – was not far behind with sales of CHF16.2bn.
But then Roger did not seem to be fazed by the divergence in geographical numbers. He says: “Looking now at our performance split between developed and emerging markets, both met a positive contribution to our overall growth. In the developed markets, we had broadly stable organic growth throughout the year. Pricing stabilised and was flat for the first time in a number of years.”
And he saw EMENA as an overall positive last year, a region he says “sustained good momentum”, with prices in western Europe stabilising after two years of “deflationary pressure”.
Still, the spin-off of Nestle’s ice cream business into the Froneri joint venture with the UK’s R&R Ice Cream in 2016 continued to bear on EMENA revenues, contributing to the 1.9% shaved off sales from net divestments.
Meanwhile, Nestle said the performance of its nutrition division, which the company views as one of its high-growth areas, was “soft”, with organic growth of 1.1% and sales of CHF10.4bn.
When questioned on whether he was happy with such a levels of growth, and how the company planned to address it, Schneider said: “For a category that we see as a growth category, we cannot be happy with our growth rate, absolutely not. We have already taken fairly energetic action when it comes to giving this business a new structure, which I believe gears it up for much better growth.”
What’s on the organic growth horizon?
In London in September, Schneider set out five ways he believed Nestle could achieve its new target for organic sales growth: invest selectively in fast-growing categories and regions; address the “under-performers” in its portfolio; innovation; “embracing digital opportunities”; and ongoing “active portfolio management”.
Nestle forecasts a 2% to 4% range for organic growth in 2018, which would see it anchored around the same levels of the previous four years.
On an earnings call this time a year ago, Schneider made the same organic growth projection of 2% to 4% for that year, saying it was “prudent” to offer conservative guidance.
Bernstein’s Wood expressed disappointment with the current outlook numbers, particularly after the 2.4% growth rate in 2017 missed analysts’ forecasts, with his company putting the consensus estimate at 2.6%.
“We had hoped for optimistic 2018 organic growth guidance (3-5%), so we are disappointed that management only indicated that growth would improve,” he notes.
Meanwhile, a separate real internal growth metric also remained weak. The RIG, an internal metric referring to organic growth that strips out the impact of pricing, slowed to 1.6% last year from 2016’s 2.4% pace and 2.2% growth in 2015. Bernstein’s consensus view was 1.9%.
Yet Schneider said on Thursday’s conference call: “There’s also good news on the organic growth side in that I think our real internal growth has held up really strong.”
But will investors anticipate more muted growth this year?
Martin Deboo, an analyst at Jefferies, says: “The statement doesn’t beat around the bush on the sources and causes of weak growth and has the hallmark of CEO Mark Schneider’s trademark candour and straightforwardness. It reads to us as much a message to the internal organisation as it does to the market, with more restructuring to come. But FY-18 feels like a further year of a slow top line, with pricing weak and volumes decelerating.”
It will, of course, be some months before Nestle’s recent M&A activity feeds into its organic growth rate. Last year, Nestle bought US-based Sweet Earth in September and in December announced it had acquired Canadian vitamins and supplements group Atrium Innovations. Early this year, Nestle also sold its US confectionery business to Italy’s Ferrero.
Schneider said: “A lot of the actions that we kicked off in 2017, over and above what you can see in the organic growth number, will actually benefit us in 2018 and 2019, because many of our actions invariably are linked with time lags when it comes to actually feeding into organic growth.”
He made reference to three areas where Nestle expects to generate growth – portfolio management, efficiencies and organic growth – and added in a related comment: “We’ve laid out a few specific actions that we have now implemented in the year 2017. And I’m taking great hope from those that when it comes to 2018 and 2019 and beyond, you will see those kick-in and naturally help us towards our mid- to single-digit target.”
On a breezier note for margins
Nestle is targeting for its underlying trading operating profit margin to reach 17.5% to 18.5% by 2020.
That metric, which filters out restructuring costs, edged up 50 basis points to 16.4% in 2017 – an increase of 40 basis points on a reported basis from 2016’s 16% – which the CEO said was supported by operating efficiencies and the execution of ongoing restructuring initiatives.
Nestle also proved correct in its previous assessment made in September for the separate trading operating profit margin to fall by 40 to 60 basis points in 2017. However, the magnitude of the drop was at the top-end of its forecast, coming in at 14.7%.
Schneider says: “We’re seeing a very solid improvement of the underlying trading operating margin. In fact, we’re slightly ahead of our expectations. And that puts us well on our track for the 2020 margin target.”
But exactly what those expectations are is unclear in terms of the annual percentage point increase in the underlying margin. Roger would not be drawn into giving a specific yearly estimate on the analyst conference call.
He pointed out the difficulties in making such an estimate given the swings in the operating environment each year, and noted the CHF900m hit Nestle took from rising commodity prices last year.
Commenting on the 2020 margin target, Roger said: “So I think you’ve seen from our focus in 2017, we’re well on our way and there is going to be continued focus on this, but, at this point, bearing in mind also how much these margins are being whacked around not just by our own internal efforts, but also by where raw materials prices are going, I think it is better to leave ourselves some flexibility here. But again, I can assure you we feel good about our efforts here and feel strong about it.”
Alain Oberhuber, an analyst at Switzerland-based financial services firm MainFirst, issued a revised outlook for Nestle after the earnings, with a positive slant on the trading margin but less so on growth.
MainFirst now envisages an organic growth rate of 3.4% in 2018, instead of 3.9% previously, and an improvement in the underlying trading operating profit margin to 16.9% versus a prior forecast of 16.7%.
Oberhuber says: “We expect that underlying operating margins will improve faster than expected due to heavy restructuring in the last two years, a higher volume growth rate, and [the] positive mix from scope changes of US confectionery out and Atrium in.”
Nestle sees recent M&A boosting organic growth
In January, after Nestle completed the deal to sell its US confectionery assets Third Point activist shareholder Daniel Loeb, who invested in the company in June, said he now expects the “decisive disposal of other ill-fitting businesses” and expressed the need to “move with greater urgency to complete its targeted level of portfolio adjustments”.
In June, just days after Loeb’s investment was made public, Nestle outlined where it plans to focus its resources on trying to drive growth. The company said it had decided to focus its “capital spending” on “advancing high-growth food and beverage categories such as coffee, petcare, infant nutrition and bottled water” and would look to invest in the consumer health sector.
The acquisition of Atrium underlined Nestle’s interest in consumer health, although that deal was subsequently questioned by Loeb.
Speaking on Thursday about Nestle’s recent M&A activity, Schneider said: “All of these companies are really high-growth businesses that will, over time, contribute in some cases meaningfully to our organic growth, and the disposal of US confectionery would also lift up our average organic growth because its organic growth profile had suffered in previous years.
“When these two transactions [Atrium and US confectionery] are completed it will be a net benefit after that year lapping time that I talked to you about earlier, or about 20 basis points when it comes to organic growth, so this is clearly a benefit and there’s also margin benefits since the Atrium business is higher margin than our US confectionery business.”
Loeb, meanwhile, has also called for Nestle to sell off its 23% stake in L’Oreal. In a development that might be applauded by Loeb, Nestle said last week it would not be renewing its shareholder agreement in the firm when it expires on 21 March, which some market watchers interpreted as a precursor to the potential sale of the stake.
MainFirst’s Oberhuber said: “We read this as supporting no imminent desire to liquidate the stake, but leaving a door open for the future that was previously closed.”
Nestle is also exploring “strategic options” for its Gerber Life Insurance operations, which may include disposing of a business acquired from Novartis in 2007 and which generated sales of CHF840m. However, the Swiss giant said it “remains fully committed to retain and develop the Gerber baby food business, which is an integral part of our infant nutrition growth platform”.
In all, the jury is still out as to whether Nestle can inject some notable growth in 2018 and continue to improve its margins and investors may have to wait until 2019 before they see some success from Schneider in turning around the company’s fortunes.
Deboo at Jefferies summed it up: “While welcoming the candour and intent in the statement [Nestle’s earnings], the big picture for us is one of continuing structural growth challenges for Nestle.”
