Nestlé S.A. (NESN) Earnings Call Transcript & Summary

It's my pleasure to welcome back to stage, Nestlé, the leading global food and beverage company and a longtime supporter of CAGNY. Over the last 3 years, Nestlé has improved both the top and bottom line with consistency across key metrics. It's been almost 5 years since CFO, François Roger, joined Nestlé and since then, Nestlé has improved both the top and bottom line results, consistency has been broad-based and cash generation and ROIC metrics have improved. Portfolio transformation has been a key driver over the past 3 years as 12% of the portfolio has changed. Nestlé continues to strive for best-in-class, consistent results and continues to be active in portfolio transformation over the coming years. With us today to tell us about the strategy are CFO, François Roger, and Head of Strategy and Business Development, Sanjay Bahadur.

Thank you, Janet. Good morning, everyone. It's a pleasure to be with you today. Let me start my presentation. I'll take the disclaimer as read. I'm sure that you all know Nestlé, so I'm not going to go into too much details. But I just want to do a quick reminder of who we are and what we do, and I'll highlight a couple of points which are relatively new. So Nestlé, largest food and beverage company in the world and sales of almost CHF 93 billion last year. We are operating in 190 countries, a very strong presence in the Americas which accounts for almost half of our sales. We have a well-diversified portfolio of categories, and the 3 largest categories: beverages, which includes coffee; Nutrition & Health Science; and petcare accounts for more than half of our sales. Just want to point out something which has evolved over the last couple of years. If you look at the number of employees we have, we have less than 300,000 today. We used to have 340,000 or 350,000 4 to 5 years ago. The same applies, by the way, to our manufacturing footprint. If you look at it 4, 5 years ago, we had around 450 plants, and even if we kept investing with newer units, especially for businesses like petcare, for Nespresso coffee at large, we are left now with a little bit more than 403 plants. So -- which means that our business is far less labor and capital-intensive than it used to be a few years back in spite of the fact that we have a higher level of sales. And just as a reminder as well, we are the largest spender in terms of R&D in the industry with CHF 1.7 billion a year. You know we have a lot of brands. We actually operate -- have 33 or 34 billionaire brands, which are brands which have more than $1 billion of sales value. And we keep on adding brands to the list. Actually, if you look at illuma, became a billionaire brand last year, quite amazing. I often have the question, but -- "Do you manage to develop new brands?" That's a good example. illuma did not exist 7 years ago, and it's a brand that we have been able to develop to more than $1 billion in 7 years in China alone, which shows you the power of what we can do. We increased the list as well with Felix, which came to the list as well last year. We have a mix of a lot of local brands as well. You see Coffee-mate there, which is obviously very strong in the U.S. 2019 was another strong year with a good set of results. Our organic growth increased to 3.5%. Our operating margin increased by 60 basis points to 17.6%, and we reached our 2020 margin guidance 1 year ahead of time. Our underlying EPS grew, for the second year in a row, at double-digit level to CHF 41. Our return on invested capital, we had 5 years of consecutive improvement in ROIC. Even the underlying return on invested capital last year was at 13.5% if we exclude the impairment that we did at Yinlu and, to a lesser extent, at Hsu Fu Chi, which gives us confidence that we will be able to be at 15% going forward. Free cash flow was at CHF 11.9 billion, or 12.9% of sales, quite amazing to see that we have been able to deliver free cash flow consistently around 12% around the last couple of years, and we expect to be able to deliver the same amount of cash flow going forward. And we returned as well almost CHF 17 billion to our shareholders in the form of share buyback and dividend. This is a record amount that we did. You might have noticed as well that we increased our dividend last year by CHF 0.25, which is more than what we did in the last couple of years. We don't have a dividend policy per se, but we have a dividend practice of increasing our dividend year after year in Swiss francs, which we did over the last 25 years. If we look just quickly at our key growth platform. The U.S., our largest market by far, quite amazing to see that we reached 4.1% last year. We were at 0% growth 2 years ago, so it shows the capabilities that we have to turn around businesses, improve and deliver growth over time. This comes as a result of portfolio management. We disposed of, for example, U.S. Confectionery. We bought Atrium Innovations. We bought the Starbucks rights. But it's very much the result as well of innovation and the drive that we had in e-commerce. Petcare had an amazing year, 7% growth, very happy with that figure. It happened across geographies, across brands and across product segments as well, largely the result of innovation in that case. E-commerce grew 18.5% and reached 8.5% of our total sales, very happy with that as well. And premium products, I'll come back to that a little bit later, grew by 7.4% last year. We value shareholder return. We have returned to our shareholders almost CHF 110 billion, and it is in Swiss francs, currency that tends to revalue against most currencies. We returned that amount over the last 10 years as a combination of dividend and share buyback. Dividend accounted for about 60% of it and share buyback, 40% of it. The share buyback, as you know, we completed a CHF 20 billion share buyback program last year in December, and we started a new one for the same amount at the beginning of this year. Net-net, with all these financial results for the year 2019, we had a strong TSR in under any time frame, 1 year, 3 year, 5 year, 10 years, we exceeded the stock food and beverage index significantly. Looking forward, we expect to see organic growth, gaining some further momentum in '20, 21, '22, so as to reach a mid-single digit level on a sustainable basis, which is what we are targeting. We are a little bit late versus our original target for 2020, given that we may not necessarily reach the mid-single digit level in 2020, but we expect to reach it a little bit later, a small function of time. And the underlying trading operating profit, as I said earlier, we reached the 2020 target 1 year ahead of time, and we expect to see our margin -- operating margin to continue to increase. For the rest of my presentation and Sanjay presentation, we wanted to walk you through the way we create value through portfolio management. I will cover only the part that has to do with our current portfolio and the way we manage our current assets, while Sanjay will show you how we create value through portfolio management externally, essentially through M&A. You know that our portfolio is essentially geared towards growth, which happened -- didn't happen by chance, it happened by choice and by design. If we look at our high-growth categories: petcare, Water, Infant Nutrition, coffee and consumer health care, they account for 57% of our sales, and they grew faster than the group average in spite of the fact that we were underperforming. And clearly in Water last year because we were flat with water -- without water, actually, we're already at 5% there. Emerging markets, which accounts for 42% of our sales, grew by 4.7% last year, and premium products, which account for 26% of our sales grew by 7.4%, 2x faster than the average of the group. And the beauty of the exercise is that all of these growth drivers, individually and combined, have a better margin, which is above 18.5% to be compared with the average margin of 17.6% which means that not only do they drive the top line, but they drive the bottom line as well through a mix impact. Beyond the number of -- in terms of growth, what matters is the quality and the sustainability of the growth. You know that we report our growth with RIG and OG, the difference between pricing, and I know that there was some interest and some appetite from many investors and many analysts to better understand what RIG is about, so as a combination of mix and volume. And I'm happy to share this analysis which covers 90% of our business, which shows that over the last 3 years, actually, 2/3 of our growth came from mix, which is quite interesting. This is really where we create value, and let me take you through each and every component individually. Pricing is relatively limited at a time when we see commodity pricing at a relatively low level in terms of cycle. To start with, at a time when we see deflation or no inflation in most of the world, pricing does not really exist anymore. Pricing is limited to the passing through of commodity and packaging cost inflation as well as the impact of foreign exchange. If you look at it last year, for example, we had an input cost increase for commodity and packaging material in the range of CHF 350 million, and we increased our prices by about CHF 500 million to CHF 600 million. So we did a little bit more than what we had, but we don't expect a lot in terms of pricing even if we could probably do a little bit more. Volume matters, volume is important. Last year, it was about 1 percentage point of growth out of the 3.5% that we had. Volume matters because this is about share of stomach, this is about share of shelf space in the trade, online, off-line, in consumer table. So we value a lot volume, and we had a positive contribution from volume. And mix is actually -- so as I said, 2/3 of our growth over the last 3 years on average. Within mix, we can itemize category and geography mix, which is a mix of our geographies and the mix of our categories, which is slightly positive in both cases. But the bulk -- the very vast majority of this mix is actually coming from product mix, which is clearly about premiumization, and we are very, very happy with that. If we look at it even over the last 3 years, we see that volume has increased year after year, which we are pleased by. We see that pricing is relatively flat to slightly declining, reflecting, once again, commodity cycle and the global deflationary or noninflationary environment, and we see that mix contribution is increasing year after year. Once again, this is a result of what we do in terms of premiumization overall. So as a consequence of that, our premium products now account for 26% of our total sales, while it was 11% in 2012. So we are -- they are, again, very happy with it. Premium products bring growth, as I showed earlier. It brings profits. On average, with premium products, we have about 4 percentage points higher margin overall. It's -- we are working away from commoditization and we are really building brand equity. Premiumization as well works across categories, across geographies without any problem whatsoever. If you take coffee, you take -- you have the example there of Blue Bottle. I could mention Nespresso, I could mention Starbucks, which are really premium products. If we take illuma in Infant Nutrition, we take KitKat in Confectionery. And even in categories where we have been disappointed by the results of geographies like -- take Water. Water, we were flat last year, but premium products, most specifically, the 3 beverage that we have: San Pellegrino, Perrier and Acqua Panna, they grew between 8% and 9% last year worldwide. If you -- and the mainstream offering that we had in water was actually declining. If you take even China, we had a disappointing year in China. No drama as well, we grew by 1.5% last year, which is pretty much in line with the food and beverage market growth last year. So 1.5% is lower than where we were the year before, we were at 5%. But if we look more specifically at our premium offering within China, I'm talking of Nespresso, I'm talking of petcare, I'm talking of illuma -- even on the large base, illuma, it's a $1 billion base, all of these products grew double digits. And most, not all, but most of our mainstream offerings in China were flat to declining. So it was really across categories and markets and countries. Just to give you a little bit of flavor to finish my presentation on what premiumization means. We are really leveraging on 2 trends. One of them is key consumer trends. So there, we are pushing hard with consumer demand. There is a pent-up demand for natural products. Naturalization is something which is important. Take the example of Coffee-mate. It's a $1.7 billion business here in the U.S. We started with the mainstream offering, moved into natural, even developing a new brand, a sub-brand, which is called Natural Bliss, moved into plant protein-based products into premium artisan products. Take the example of vegan and plant-based food where there is a pent-up demand for these products, we have been in that business for quite some time already. We already have about CHF 200 million of sales, growing double digit. Take organic. Very strong momentum. I just took the example of Garden of Life, which we bought, which is part of Atrium. Very differentiated products in the vitamin, mineral and supplement space. Differentiated in terms of offering organic, GMO-free, different distribution channel as well, growing double digits. And sustainability is something that the consumers are demanding very strongly as well, so we are moving with less plastic, more carton, more paper, different ways of distributing our products as well. So we are really accelerating on key consumer trends. And the other way to drive premiumization is through differentiation. What we do is to push as much as we can as well in direct-to-consumer, DTC, that's what we do, obviously, with Nespresso, but we go beyond that. That's what we do here in the U.S., for example, with Ready Refresh, which is growing very nicely. We move as much as we can, not only for petcare, but for food as well in the business of solution beyond the mere supply of food. If you take the example of petcare, we need to bring solutions to pet parents or pet owners which is, for example, aging for dogs, which is -- or basically for dogs and cats, which are issues. "Our dogs are barking too much because they are stressed." for example. So we developed a product called Calming Care, which reduces barking for dogs, which is not a sleeping pill, but it's a probiotic that reduces their stress level. And these are examples. Research and development, as I said earlier, we spent about CHF 1.7 billion a year in R&D. That does make a difference, especially in some categories like Infant Nutrition. You heard about what we have done in HMOs, reaching CHF 850 million of sales in year 2. I could mention as well this hypoallergenic infant formula that we developed, which is a sizable business as well with high single-digit growth, and personalization is another way to drive premiumization. That conclude the part of my presentation. So really, I would say, to summarize, a good year 2019. But beyond the number, what is important is the quality of what we do and the sustainability of what we do and I wanted to show you through the example of the breakdown of our RIG, the breakdown of our growth and through the premiumization effort that we embarked upon, that we are really creating value beyond the raw number. Thank you very much. I pass on the mic to Sanjay. Sanjay is a newly appointed member of the Executive Board in charge of M&A, Partnership as well as the strategy. Thank you.

François, thank you very much. So good morning. As you know, my name is Sanjay Bahadur. I'm the Head of Group Strategy and Business Development at Nestlé. I'm a long time Nestlé employee, been with the company more than 37 years. I'd like to take this opportunity to talk to you a little bit about the role that portfolio management plays in our value creation strategy, how portfolio management has been used to drive growth at Nestlé, and to give you some insights into our processes and our strategy. Portfolio management is a very important driver of our growth. Growth is what motivates Nestlé employees, and of course, it's very, very good for our shareholders as well. A few years ago, we realized that growth was not meeting the expectation level that we had set for ourselves, and we decided to focus on 3 key pillars, one of them being fixing underperforming businesses, portfolio management and investment in our high-growth categories. As you will see from the attached chart, growth increased from about 3% in 2018 to 3.5% in 2019, which is an improvement of 50 basis points. Of that, 35 basis points or 70% came from portfolio management. So you can see that portfolio management is indeed contributing to growth at Nestlé. There's also been a step change in the level of activity that we have at Nestlé. 2018 and 2019 were very busy years for us as we worked hard to reshape our portfolio, and we recently announced divestitures of our Skin Health business, of our Herta charcuterie business in Europe and also our U.S. ice cream business. Recent activity has been biased towards divestitures, which is really in 2019. And for 2020, we'd like to bring the focus back onto acquisitions and to have a better balance between divestitures and acquisitions. The start in 2020 has been good. We acquired a business called Zenpep. Zenpep is actually a series of -- or a combination of enzymes. It's classified as a drug, but it's really just enzymes, and this is to help people to digest their food better. And it's really a very, very good supplement and a very good complement for our Nestlé Health Science business. We have completed more than 50 transactions since 2017, which seems like a very large number, and in fact, it's helped to contribute to change about 12% of our portfolio. And if 12% doesn't sound large, think of this in absolutes. That's more than CHF 10 billion in sales. Most of these transactions have been more small and mid-sized, which is really the sweet spot for Nestlé. We do see more transactions coming up in 2020 as we progress. We divested businesses which were noncore to Nestlé, such as Gerber Life Insurance business and our Nestlé Skin Health business, Herta charcuterie and at the same time, we focused on acquiring businesses in our high-growth categories. And as François mentioned, these are coffee, petcare, Nestlé Health Science, Infant Nutrition and Waters. And we also obtained access to new trends in the market and new areas such as personalization. At Nestlé, we have 3 main criteria when we look at acquisitions. The first, not very surprisingly, is a strategic fit with our company. We really want to sharpen our focus on Nutrition, Health and Wellness and focus on food and beverage business. We want to access new consumer trends and to build capabilities in areas that were there. And in general, what we want to do is to invest in categories where we benefit from tailwinds, whether it's a category, geography or a channel. Second criteria, also not very surprisingly, is financial return. We'd like businesses to be both margin accretive and growth accretive. Not very easy always, but that's certainly our objective. And in terms of financial return, we'd like the businesses to achieve a ROIC, return on invested capital, in excess of our WACC, in about 5 to 7 years. The third criteria is something that people often underestimate, which is the cultural fit. Assessing the people who would join our organization, their mindset and their thinking is very, very important part of our acquisition process because this is what leads to a successful integration within Nestlé. Assets have been very expensive in our core categories, our high-growth categories, and as you can see from the chart, the multiples have been very, very high, and some of them may have been at levels which we did not think is meaningful for us and we walked away from some of these transactions. The transaction that we made -- that we did do in this space was our major transaction with Starbucks. It's a $7 billion transaction, where we paid a multiple of 15x. And given the business that we acquired, we are very, very confident that we earned a very good return for our shareholders for this transaction. And once again, this also points out that we focus more on midsized acquisitions rather than on very large ones. Disciplined M&A, as François also pointed out, is very important for us to protect our return on invested capital. We've improved our return on capital -- invested capital every year for the last 5 years, and we have no intention of changing this, and our medium-term goal remains to get to about 15%. ROIC is now in the management incentives of our senior management, and this obviously also helps to drive ROIC agenda. Given that prices are very high, we've also focused on innovative business models and creative transactions to help us to create value and to accelerate growth. I'll talk about Froneri and Starbucks separately in a minute, but I'd like to mention 2 other transactions that we've done in recent times. One was the acquisition of Atrium, which took us into a new space for Nestlé, which is vitamin, minerals and supplements. This is not the generic or the commoditized space, but this is really the high-end, value-added VMS space which also enabled us to access new channels in health -- in the health care channel and health care stores. And we've found that to be a very good acquisition so far. We also invested in Persona, which is a relatively small acquisition, but it's opening up the window towards personalized nutrition. I'd also like to mention the minority stake that we took with the IVC Group. The IVC Group is the largest vet clinics business in Europe with more than 1,100 veterinary clinics all across Europe. This is part of building an ecosystem for our pet food business where we get access to information, which we would normally not be able to get. In this case, we have access to all the veterinary clinics, the advisory panels of these veterinary all over Europe, and this is really helping us to work on our product portfolio, making it both therapeutic, more value-added and more premium which we can see the benefits in our petcare business in Europe already. Moving on to Froneri. Froneri presented a unique opportunity for Nestlé in 2016. It was created by the combination of our branded European ice cream business with the largely private label business of a company called R&R. It's a unique ownership structure with a 50% ownership by Nestlé and 50% by our partners, which is PAI Partners based in Paris. Froneri itself has a very unique product portfolio. They have their own brands. They have license plans, largely Nestlé, but also Mondelez, Disney and other companies. And they have also private label contracts with many of the key customers. This has enabled them, really, to be category captains and become leaders in the ice cream space. They have an amazing management team, agile, nimble, entrepreneurial, which have moved really, really fast with their specific category knowledge to transform the business and to create value for us and also for our partners. If you look, track record has been really strong over the last couple of years. The business has grown by 6% CAGR in the last couple of years. The EBITDA margins have increased very significantly by almost 600 basis points, or in absolute terms, more than EUR 200 million, and we have gained market share against the competition by about 130 basis points in the markets where we compete with each other. The additional profit has, of course, significantly increased the value of the Nestlé stake during this period. Froneri now has moved on to the next stage in its journey where Nestlé has contributed or divested its U.S. ice cream business to Froneri. We call it Froneri 2.0 and this will take the business and the turnover of Froneri from something like EUR 2.8 billion to EUR 4.3 billion, and the margins from around EUR 500 million to close to EUR 800 million on a pro forma basis. This gives Froneri real scale, geographic diversification and the ability for the management team to once again execute and to bring value for us in terms of accelerated growth, procurement synergies and also manufacturing synergies. Moving on. Wanted to also mention our transaction with Starbucks, which has attracted quite a lot of attention over a period of time. This deal was done in 2018. We acquired Starbucks' very, very successful North American CPG business. And at the same time, we entered into a global and perpetual license for the brands in the CPG channel all over the world. And this led to the creation of the global coffee alliance between Nestlé and Starbucks. With this transaction, Nestlé now markets the 3 most iconic coffee brands in the world, which is Nescafé, Nespresso and of course, Starbucks. The initial prognosis and execution has been very good. We started to launch products 6 months after completion, which is very, very quick, and by the end of 2019, we had launched products in 40 countries all over the globe. This includes countries in Europe, in Latin America and also in Asia. We had CHF 300 million incremental sales delivered in 2019, and we expect and hope that this trend will continue and even accelerate in 2020. Staying with the theme of innovation, but in a different way. Nestlé has also been investing in venture funds in the last couple of years. The first investment that we made was in something called -- in a fund called Flagship. Flagship's a Boston-based biotech fund and they're investing in companies with breakthrough technologies in the area of nutrition and nutrition science. This is a very, very good fit with our nutrition, with our Nestlé health science business. We also took a stake in a fund called Five Seasons, which is a European fund, and it focuses on nutrition science, food and food tech as well. And just recently, we also took a stake in the U.S. in a fund called Power Plant Ventures. Power Plant Ventures, as its name suggests, only invest in plant-based food and beverage companies. And this brings us access to all the innovation, the deal flow that's happening in this space. And as you know, it's a very high-growth area, and we are very pleased with this initial investment. We also believe at Nestlé that business is a force for good. Our CEO recently announced that we would spend up to CHF 1.5 billion in creating a market for food-grade recycled plastics. There's quite a lot of recycled plastics going around, but very little of the food-grade quality. So by paying above-market prices, we intend to create a market and to ensure that there is enough supply and make our contribution to a better planet. Similarly, we also announced an initiative to invest CHF 250 million in venture fund in the sustainable packaging area which will focus on 2 aspects. First, to invest in companies, which provide innovative technologies for packaging and recycling. And secondly, in larger enterprises, which will actually help us to get better supply of food-grade plastics and materials. In summary, just a few key takeaways for you. Nestlé has sharpened its focus on food, beverage and nutritional health products to help to accelerate our journey towards a more nutrition, health and wellness company. M&A and portfolio management has been an important part of strengthening our portfolio, creating value and accelerating growth. We have 3 main criteria when assessing acquisitions, which is the strategic fit, financial return and the cultural fit. We have been disciplined in the price that we have paid. We do not intend to change this, but at the same time, we remain very open to innovative business models and creative deal structures, wherever it can create value for Nestlé. We've improved our governance for acquisitions, put solid acquisitions plans in place with a greater follow-up to make sure that the deals that we do, do are successful and create value for our shareholders. M&A will continue to be an important part of our value creation model. 2020 has started well, and we expect that this will be another busy year for us with both acquisitions and divestitures coming up. Thank you. Q&A?

Thank you, Sanjay. We can move to the Q&A session now.

So you mentioned another year or potentially another year for -- a busy year for acquisitions and divestitures. Can you talk a little bit more about -- give some color on your perspective on kind of where the market is for valuations, both in terms of buying like emerging growth businesses, where it just seems like valuations are pretty high. And then how that stands relative to the market for divestitures because it's -- what's transacted in -- at least in the food industry in terms of divestitures of like noncore assets, the valuations have been relative low. So just how you think about those 2 things in context of the value model you have in terms of assessing M&A.

So you're right, the market is indeed the kind of -- dichotomy kind of situation. The market for good quality assets with good brands, good business models and good management teams remains very, very solid in the low interest rate environment. This actually helps us in divestitures because we've been achieving very good prices, such as, for example, for our Nestlé health -- Skin Health business and U.S. Confectionery and others. On the other hand, it is more challenging when we are buying assets, and when valuations exceed the level which we think will create value for our shareholders based on our criteria, we would walk away from those acquisitions. We've done that in the past, and we'll continue to do that in the future. At the same time, this also enables us to be creative, and that's why I pointed out the example of Froneri and Starbucks, where we think we did very creative transactions which helped to create a lot of shareholder value without basically risking our return on invested capital.

You've -- as you've noted, you've been very successful in coming up with creative ways to do either M&A or partnerships and JVs and such. And as we know, those can also come with pretty significant challenges if they're not structured right or if both parties don't go in on the same page and what have you, and we've seen plenty of examples of that over time. So I'm curious, how do you ensure, as you go into some of these more creative partnerships and I assume you look to do more, that everyone is on the same page? What are those key sort of factors that you take into account before you can really feel good about that type of structure?

Yes, I think that's a very good question and a very important one. That's -- again goes to the cultural fit that I talked about when we looked at acquisitions. For example, when we did the transaction with Froneri, this is with PAI Partners, it's a private equity company, quite different in outlook from Nestlé, more short term-oriented. We are more long term-oriented. Before we actually signed up, we spent 2 days with the board. It's a joint board between Nestlé and PAI and also the CEO. We spent 2 full days before we signed up deciding what we're going to do, what we're going to agree to do, and what we are -- more important, agree not to do. Similarly, when we've done the transaction now recently with Herta, with a very distinguished Spanish family in the charcuterie business, we spent a lot of time with the family. I, myself, spent days with them deciding what we should do together what -- and once again, what we should not do. So we haven't had the bust-ups or blow-ups, and that's because we invested a lot on the cultural side of these acquisitions. If we felt the partnership was not good, we wouldn't do it.

Yes, I'd like to come back to the Water category. I mean you decided to integrate them in the Water category into the existing geographic businesses -- business units you've got. The challenges being that, I mean, you've got on one hand, a premium sparkling or premium water that's doing very well, but the mainstream business is challenged by product label and buying at a lower price. So should we think about the -- this business as also a temptation to divest from a -- from the mainstream business? Or could you expand more of on just the organization change, what you're planning to do with the water category.