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

Hello, everybody. Welcome to the Barclays Consumer Conference. I'm Warren Ackerman, Head of the European Consumer Staples Research team and a long-time follower of Nestlé. It's my pleasure to welcome François-Xavier Roger, Nestlé's CFO; and Steve Presley, Chairman and CEO of Nestlé U.S. We appreciate your support, and hope to see you in person in Boston in 2021. So the format today will be a fireside chat for about 30 minutes, maybe a little bit longer if we run over, where I'll be posing the questions. So with that brief intro, let's get into the session.

So first question for François, and it's just really around the numbers. You delivered 2.8% organic growth in the first half. You're guiding to 2% to 3% for the year, clearly a lot of volatility due to COVID. But maybe, François, could you just walk us through the swing factors for the second half by geography and by category, please?

Good afternoon, Warren, and hello, everyone. Before we go there, I want to just make sure that everybody understand that we wanted to maintain the practice of providing a guidance because many companies in our industry did not do so, but we wanted to maintain the practice of providing a guidance. Given the lack of visibility that we have, especially on what can happen in H2, we decided to go for a conservative guidance between 2% and 3%. So have a look at it with a conservative view. Especially so as we were at 2.8% of organic growth already in H1, you can understand that we were already at the upper end of the range. Rather than providing you some highlight of what could happen potentially by category and by geography in H2, I would rather focus on the channels because actually what does make a difference [Audio Gap] see it in H1, but we continue to see a solid momentum there while we see a sequential improvements since the month of April, which was the worst month since the beginning of the year as far as the out-of-home business is concerned, which accounts for about 15% of our total sales. And in H1, we were at minus 35%. Just for the out-of-home channel, which includes as well the on-the-go consumption and so forth, we don't expect to be back to where we were in 2019, neither this year, probably not next year either. But we start seeing a gradual recovery month-after-month.

Okay. And looking a bit more deeply into the zones, it does seem to me that Zone AOA is a region where to get to the mid-single digit, you'd need to get Zone AOA firing a bit more. Is the issue in AOA portfolio? Is it execution? Is it some combination? How do we get AOA back to the mid-single-digit or even above the average that you need for the medium term?

Now clearly, AOA deserve to be at the level of mid-single-digit growth and we should go there anyway. I would not draw any conclusion from the level where we were in H1 and especially in Q1 because we had some calendar events to start with. With the timing of Chinese New Year, we lost about 3 weeks of preseason shipments this year versus last year. And you can guess, 3 weeks out of 13 weeks in Q1 does make a big difference, which is a reason why, as far as China is concerned, we were at minus 27% in Q1. We did start to recover fairly well in Q2 already. And it was actually positive in Q2. But you're absolutely right, we should be in the mid-single-digit space in AOA. We were already, outside of China, in the mid-single-digit space clearly in H1 2020.

Okay. And maybe moving to you, Steve. I mean, the renaissance in growth in the U.S. in the last few years under your leadership has been really impressive. I'm sure you've had this question often. But it will be great just to get your color on the 1 or 2 things that really been pivotal to that strong turnaround.

Yes. Thanks, Warren. Thanks for having me. And for us, as we look at turning around growth in the U.S., it's really been centered around what we call this hybrid growth model. And it's been a renaissance behind our big brands. Really, for us, when we think about how you grow in this market, no matter how great your innovation is or how strong some of the other things are that we'll come to, you've got to have healthy base business. And reimagining and reinvigorating our big businesses is what we've really focused on. And that's including driving product quality into the product, really focused on consumer-obsessed innovation that's driving big wins in some of our big categories and absolutely just being relentless around this pursuit of what does the consumer need, how do we get it quickly and how do we bring it to our big brands with speed. And so that's really been the focus in the base part of the business. The other part that's been big is portfolio transformation. The second tenet of our growth model is around portfolio transformation. We've been aggressive in the U.S. If you look at our core food and beverage business, we've actually rotated almost half of that portfolio through portfolio transformation. And we continue to be aggressive in that space. I think you saw the Froneri transaction last year in ice cream and recently completed our pasta business on Buitoni. We'll continue to look at that. We'll continue to look to add in this portfolio. And that's been strong. And then the last piece for us is really these new innovation models, how do we find a way to incubate and develop innovation in a different way through open sourcing, tapping into the 40,000 consumers that work for us every day and are passionate about this company. And that's actually brought a good lever of growth for us. And so we've really been focused on that.

And just tapping into U.S. pet food, I mean it's, by far, your biggest piece. I think it's 30%, just under your U.S. business. The growth there has been phenomenal. I remember a few years back, you were struggling for growth. You were underweight in e-commerce. We were worried about Blue Buffalo and General Mills. And here we are with stellar growth. What's driving that? And how sustainable is that?

Well, we believe it's absolutely sustainable. When you look at the category, it's a really structurally attractive category with a lot of things leading towards long-term growth. Even in COVID -- pre COVID, this category was very strong going into the crisis. It stayed strong through the crisis. And I think with the increase in pet adoptions through the crisis, that actually bodes well for the future as we move ahead on pet care. And when you look at it, we've really been focused around these tenets of premiumization, personalization and innovation, an innovation like the Pro Plan LiveClear, which is the allergen-reducing pet food, which has really been a breakthrough for us. And those -- as we think about it, that's driven this just really strong growth in the category to push pet food forward. And then the second piece is, for us, e-commerce has exploded. We've really invested into building our capabilities, changing the things necessary we need for our brands, and we continue to be near triple-digit growth in e-com on pet food.

Wow, amazing. Maybe moving back to François and talking a bit about margins. You've been pretty clear with us, underlying margins will be up this year. But beyond that, I'm interested in how much has been done on structural costs. I mean a few years ago, you talked about all these different structural buckets that you had. It'd be interesting to know where we are at in terms of improving the asset intensity of the portfolio and what's left, not just on the EBIT margin but also on the gross margin looking forward.

Okay. So we are basically done what we expected to do back in 2017. You remember that we established a saving program to take about CHF 1.7 billion, CHF 1.8 billion initially out of our P&L. We even raised it to CHF 2.5 billion. By now, we have done most of it, so -- which is really what we addressed as well as in terms of structural cost, which is the nonconsumer-facing activities, which is made of fixed industrial costs, fixed distribution costs and G&A, which is a bucket of about CHF 17 billion. The objective was relatively simple, to reduce this cost in absolute value in Swiss francs each and every single year. We managed to do it over the last 3 years, we will do it again this year. And when you take that against the operational leverage with a growth of 3%, 3.5%, we managed to get as a consequence of that, 50 to 60 basis points of margin improvement each and every single year over the last 3 years. We will continue to get these efficiencies. We will continue to reduce our structural costs. This is not over as a program. So we found new ways to get there. And we are confident that the program can continue for a couple more years, so which mean that in theory, we should be able to generate 50 to 60 basis points of margin improvement, except that there is a big difference in the future. In the past, we let that flow entirely to the bottom line, which is the reason why we increased our margin by 50 to 60 basis point. In the future, there will be some margin improvement but not to the same extent. Because part of the savings, part of the cost efficiencies, we will use them to support our growth, which means essentially potentially marketing spend. And we will use a significant portion as well to finance the sustainability cost, which is going to raise in the future.

Okay. Very clear. And just turning to the question on everybody's minds on M&A. Obviously, we had the news yesterday on the NHS acquisition. We'll come to that in a moment. But before that, there's been a lot of disposals on the ledger, not many acquisitions. And I think Mark said in the past, there's been concerns around valuation levels. You've looked at lots of things but turned down lots of things. I guess why haven't we seen -- is it valuation? Why haven't we seen you transacting more? Is it because the WACC crossover is tough to reach? Any kind of thoughts around that? Because people are a bit worried that actual reported revenue number is going down in Swiss francs.

Absolutely. So first of all, we do not want to deleverage the company and we don't want to reduce our scale either. So clearly, which is a reason why Mark said it during our call at the end of July and he said it at the beginning of the year as well, we want to be much more on the acquisitive side now. Especially so that over the last 18 months, we have clearly disposed of more asset than we have bought assets. That being said, it's not just about going shopping because we have a strong balance sheet or we have a credit card or whatever, we want to be disciplined in what we do as well. So we want to make sure that when we go for acquisition, they meet our 3 main criteria. Strategic fit with what we want to do, which is essentially around nutrition, health and wellness or high-growth categories but not on an exclusive basis, we can invest even outside of these high-growth categories if we find the right opportunities. Then cultural fit, we want to feel like managing these assets. We want to feel to share the same values as well with these businesses. And the third one is we want to make sure that we get a proper financial return, which one of the KPI is exactly what you said, which is make sure that over time, which we define as 5 to 7 years, we can get a return on invested capital, ROIC, superior to the WACC, not necessarily the WACC of Nestlé, by the way, the WACC of this specific acquisition. This has been a limitation somewhat for some of the assets. But looking forward -- looking backwards at what we did not take over the last couple of years, I'm quite happy we didn't go there. I think we have been very disciplined. That did not prevent us from doing sizable acquisition, Starbucks rights, Atrium, now Aimmune. And then there will be probably more in the future as well because we really want to go there. And I can tell you for these 3 assets, for example, we will reach a return on invested capital above the WACC probably before 5 years. So this is absolutely feasible, but we need to be selective and disciplined in what we do.

And what WACC should we be thinking about for Nestlé?

Well, for Nestlé, it's around 7%, 6.5% to 7%. But it depends. I mean if it is a WACC in an emerging market -- if it is an acquisition in an emerging market, obviously the WACC is higher. So it depends very much on it. Because we apply the specific WACC for this specific asset. If it is in a different industry, in a different category, so we are applying a specific WACC of a given asset.

And just the -- you mentioned the 15% ROIC target. I mean going back a few years, it seemed like Nestlé's ROIC was going down every year. And you put this measure in place to try and move it the other way. And what I like about that is it's a fully loaded number, including M&A. So I think the number today is around 12%, 12.5%, 13%. It was slightly impacted by some write-downs. Just interested in when we might achieve that 15%? And kind of how much are you baking in for dilution from goodwill? So how much underlying ROIC improvement do you see mid-term?

So indeed, we have made some significant improvement because we were around 10% in 2014. Last year, underlying, we were already at 13.5%. And there will be some further improvement this year. So you know we are clearly on the journey to 15%. We didn't want to provide a specific timeline for the 15% because it depends precisely on what we will do in terms of M&A. Obviously, any acquisition that we do, even -- and especially medium-sized acquisition, they will be dilutive at the beginning because we expect to reach the WACC around probably 5 to 7 years or even before in most of these instances. But so in the meantime, we are using all levers in the best business to really increase the ROIC, accelerated growth in terms of organic growth; accelerated margin, we talked about it, 50 to 60 basis points of margin improvement over the last couple of years; reduction of working capital, better management of our asset base as well. We reduced our tax rates. We incentivize as well, in the softer part of it, we incentivize the top management on return on invested capital for the long-term incentive plan as well. So we really use all levers with a lot of success. And in addition to that, as I mentioned earlier, we have been very disciplined in terms of acquisitions as well.

Okay. And maybe back to you, Steve. Again, you mentioned the portfolio change in the U.S. as a driver for the accelerated growth. Just interested, given what's going on with your distribution, particularly the move on DSD to third party, the decision to exit U.S. water. I know that's moved from a globally managed business to a regionally managed business, now you're looking to sell that. Could you maybe give some of the background behind that? And U.S. frozen, people ask me all the time, could that be next? Given you've changed your distribution, you've got more optionality around that. Or what does that need to do to remain in the portfolio? I'd be interested in your color on that.

Thanks. Yes. And if you look at -- I'll take them in buckets. But if you look at any of the moves we make, it's really around this portfolio transformation that sets us up for future wins in the marketplace. And as we look at water specifically, I think the opportunity for us to become more focused in the premium space in water with premium mineralized and functional water, it's a far more structurally attractive space. The base water business is an attractive category. But as we look across the investments required to -- and our ability to win there and really the organization's focus and prioritization across the portfolio, it pushes us into this much more sharpened focus on the premium space in water. And so that's what led to the decision to kind of exit the mainstream portion of the business in the regional spring. And as we look at that, the review is going very well. I think we're well underway. I think we hope to have it completed early 2021. And then it will allow us to really focus on that space. And as you -- and then if I shift to frozen, right, the exit on DSD was really around going after efficiencies in the business to simplify the business, really get focused on what's important to the consumer, unlock resources in the business that then you can turn around and drive growth with on those businesses. The DSD was a very expensive path to market. It was a difficult, complex project to unravel. But we did it successfully. We did it 6 months early, unlocked the margin creation from that move and invested that in growth on those businesses. And you see both frozen and our pizza business and our ice cream business have performed quite well through the transition and now after the transition. And so -- and as we look at frozen food or the idea, would it be next in the portfolio transformation? Frozen is actually a structurally attractive category, high cash flows, high ROIC and really strong growth. And you've got to -- as you think about frozen, it's important that you break it into buckets. There's no such thing as a monolithic frozen category. Stouffer's, which is a very big business for us in the U.S., has been growing for multiple years now, delivering strong margin accretion and winning share actually on that part of the business. And so you think of it in meals, you think of it in pizza, I think the DSD was a critical move to unlock the growth and the potential of that business. So pizza, I think, is on a very good path. And then you go to our snacking portion of the business, which is primarily Hot Pockets. And that one actually has been a growing business and growing share prior to the crisis on COVID. So we've really been focused on the turnaround in the nutritional meal segment, which is our Lean Cuisine business, where we've struggled on the personalized meals. We've just reimagined that business, relaunched Life Cuisine, which is underneath Lean Cuisine. And that business shows really good early signs that we'll be able to turn that business around as well. So for us, it is a structurally attractive space. It is consumer-focused. Consumers actually have come back to the category in a big way pre COVID, through COVID and we think post COVID. It offers a convenience and a taste that just -- and a value that can't be beat in their meal offerings. And so we feel really strong about our frozen portfolio right now. Still work to do, we always have work to do in the space in all of our businesses. But it's an attractive business for us.

Okay. Now back to François. And a question on coffee, specifically Starbucks. I mean when you bought it, about $3 billion of revenues. You rolled it out incredibly quickly. I mean what is the real potential for this brand? And maybe -- I mean, Steve, maybe you can touch on it in the U.S. as well, which is its heartland. But François, also when I look at the availability now in the U.K., you can see it everywhere. I mean you're starting to capture some of that Nespresso compatible market yourself. So compared to the acquisition criteria you set out, are we ahead of that? I mean could this be a bigger brand than Nespresso in time?

So first of all, we are very happy with this acquisition. It was not $3 billion in size when we bought it, it was $2 billion. But last year, we have added another $300 million of sales, which is very good. This year, we are very happy, we are growing at a strong double-digit level for Starbucks. We gained about already around 10% of the Nespresso compatible capsules in Europe in 1 year. So very, very happy with what we have seen so far. There is -- on the other hand, I mean, Nespresso -- don't forget Nespresso is 2 -- more than 2x bigger than Starbucks. So -- and it continues to grow. I mean it's amazing to see that 34 years after the launch with a limited patent protection, in spite of compatibles and so forth, we still grow double digit. And we don't have any such objective for Starbucks to exceed in sales, for example, Nespresso. I think that they both complement and help and support each other as a brand. So it's much more about the complementarity of the different brands with a different architecture, with their own personality, their own positioning, might be a little bit of cannibalization here or there but very limited. So we -- between our 3 brands, Nescafé, Nespresso and Starbucks, excellent complementarity. So we have no objective necessarily for one to exceed the other one in terms of sales.

Okay. And Steve, Nespresso over in the U.S.?

Yes. So for us, I couldn't agree more with François. I think the stratification of the category in terms of consumption occasions is really important to understand. And the ability for Nespresso, Starbucks and Nescafé to play really complementary with each other across that stratification is a core driver for growth. And your ability to win in all of the segments of the category with leading brands is powerful. For us, in Starbucks, the business has done really, really well. We've transitioned it over -- actually have been able to significantly accelerate the growth rate pre deal in the traditional CPG business, the traditional grocery part of the business. Obviously, COVID has hurt the out-of-home portion of the business that came to us some, but it's a much smaller piece of the part of the business that we acquired. But that business continues to accelerate. And what we've really been pleased with in the U.S. is the ability to extend it into Starbucks by Nespresso. We launched Nespresso compatible pods under the Starbucks name. And we've also launched a Starbucks creamer. We've got a really strong leading position in creaming in the U.S. And we're able to extend, again stratify that category, find a new opportunity through kind of SRM and stratification that allows us to find new growth levers by bringing Starbucks to the creamer category and work in complementary with our other creamer brands to further grow our share in that space. So that's been really, really big success for us in the U.S. for the Starbucks acquisition. And it continues -- the business continues to perform well. We acquired a great brand, obviously, but also a really strong team that executes well for us in the market.