Nestle (NSRGY)

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Jonathan Sheets

Sar Medoff

Sean Hinton

Nestle SA (OTC:NSRGY) is the world's largest food and beverage company.^[1] Nestle owns several major consumer brands such as Stouffers, Nescafe, Kit-Kat, Carnation, Nestle Water, and many others.^[2] All in all, 30 of Nestle's products earned 1 billion CHF or more during 2010, making Nestle a major force in the global food and beverage industry.^[3] Nestle competes with companies such as Unilever NV (UN), Hershey Foods (HSY), Kraft Foods (KFT), Cadbury Schweppes (CSG), and GROUPE DANONE (DA) in the packaged food market. With only 42% of its food and beverage sales coming from North America, Nestle is one of the most geographically diverse of the major food and beverage companies.^[4] In FY 2010, Nestle generated revenues of CHF 104.6B ($121.1B USD) and net earnings of CHF 9.05B ($10.5B USD).^[5]

Although it already occupies the top spot in terms of sales, Nestle is attempting to continue sales and margin growth by increasing the nutritional value of its products and expanding into new areas of therapeutic foods for people with various illnesses.^[6] The company's stated goal is to transform itself from a food manufacturer to the world's leading nutrition, health, and wellness company.^[3] In 2010, Nestle created a subsidiary that will create food-based products meant to help prevent and treat various medical conditions such as heart disease and diabetes.

Contents 1 Business Segments 1.1 Beverages (CHF 19.27B, 18% of sales in FY 2010) 1.2 Milk Products, Nutritional, and Ice Cream (CHF 19.56B, 18.7% of sales in FY 2010) 1.3 Prepared Dishes and Cooking Aides (CHF 17.2B, 16% of sales in FY 2010) 1.4 Confectionery (CHF 11.8B, 11% of sales in FY 2010) 1.5 Other Food & Beverages (CHF 10.2B, 9.5% of sales in FY 2010) 2 =Pet Care (CHF 9.97B, 9.3% of sales in FY 2010) 2.1 Pharmaceutical Products (CHF 781M, 0.7% of sales in FY 2010) 2.2 Healthcare Nutrition 3 Key Trends and Forces 3.1 Changes in Raw Food Prices put Nestle's Margins at Risk 3.2 Consumers Demanding Healthier Foods 3.3 Strong Swiss Franc Hurts Nestle's Sales 3.4 Nestle Must Capture Growth In Emerging Markets 4 Key Competitors 5 Notes

As retailers push private label products, the ability to earn and maintain shelf space at groceries, convenience stores, and other retail outlets plays a large role in the profitability of packaged food companies. Nestle's large portfolio of prominent consumer brands helps it maintain and increase its shelf space presence despite the growing private label trends, giving it an advantage over competing firms that lack such a strong brand portfolio.^[7] These advantages don't, however, insulate Nestle from the impact of rising raw food prices; as grains and dairy prices rise, so do Nestle's costs of production, which can pressure profits.^[8].

Business Segments

Nestle is divided into eight units, of which at least four contributed more than 10% to annual sales. This speaks to not only the company's diverse interests, but also its strength in each of the respective markets. In FY 2010, Nestle generated revenues of CHF 104.6B ($121.1B USD) and net earnings of CHF 9.05B ($10.5B USD).^[9]

Beverages (CHF 19.27B, 18% of sales in FY 2010)

Beverages is the second-largest segment after Milk Products, Nutritional and Ice Cream. Nestle owns several international beverage brands including Nescafe, Nesquick, Nestea, and Nestle Waters, each of which generated more than 1 billion CHF in 2007.^{[10] [11]} With more than 400 factories around the world, Nestle is able to formulate each product to local tastes; "Nescafe" in Switzerland has a different recipe to the same product sold in the USA.^[3] Nestle's strong brand recognition helps them compete with other brands such as Maxwell House, Lipton, and Evian as well as various store brands.^[12]

The combination of the recession and upper class consumers' increased environmental consciousness^[13] has lead many customers to cut back on bottled water in favor of tap water and reusable containers. Industry experts don't expect bottled water to bounce back anytime soon, and the trend may expand beyond the US.

Milk Products, Nutritional, and Ice Cream (CHF 19.56B, 18.7% of sales in FY 2010)

Milk Products, Nutritional, and Ice Cream was Nestle's largest segment. It includes the Carnation, Coffee Mate, Dreyer's, and Edy's brands among many others. Nestle's milk and ice cream brands compete with products such as Breyer Ice cream and store brands. Their nutritional products include Gerber Brand baby food and Nestle brand yogurts. Nestle's nutritional products compete against brands such as Dannon Yogurt and store brands. The company's Nutrition segment became part of Nestle HealthCare Nutrition in early 2011 and will report under this wholly owned subsidiary in the future.

Prepared Dishes and Cooking Aides (CHF 17.2B, 16% of sales in FY 2010)

Nestle's Prepared Dishes and Cooking Aides segment consists mostly of products that are designed to be ready to eat very quickly, such as microwave lasagna.^[14] Nestle owns brands such as Stouffer's, Lean Cuisine, Hot Pockets, and Maggi. Nestle has increased the nutritional value of its prepared dishes in order to compete with products such as DiGiorno, Bertoli, and Kraft Macaroni and Cheese.^[15] In 2010, Nestle bought Kraft's frozen pizza business for $3.7 billion.^[16] The purchase added the DiGiorno, Tombstone, Jack's and Delissio brands to Nestle's stable of products, as well as the license to sell California Pizza Kitchen frozen pizza. With this acquisition added to Nestle's existing product line, the company increased its market share to 33% from 17% of North American frozen foods.^[17]

Confectionery (CHF 11.8B, 11% of sales in FY 2010)

Nestle's Confectionery segment includes confectionery brands include Kit-Kat and Nestle Chocolate. The Nestle Chocolate brand produces famous products such as Baby Ruth and Nestle Crunch.^[18] Nestle's confectionery products compete with chocolates and candies from Hershey Foods (HSY) and Cadbury Schweppes (CSG) (recently purchased by Kraft Foods (KFT) and snacks from manufacturers such as Kraft Foods (KFT), as well as various store brands. With Kraft Foods (KFT)' purchase of Cadbury in January 2010, Nestle dropped to the third largest chocolatier.

Other Food & Beverages (CHF 10.2B, 9.5% of sales in FY 2010)

This group consists of "Nespresso", "Nestlé Professional", and "Cereal Partners Worldwide". Nestlé Professional, previously Nestlé Food Services, provides food supplies to the food service industry. Cereal Partners Worldwide has ongoing operations in more than 130 countries and account for nearly 25% of all cereal sales outside of the United States and Canada.^[19]

=Pet Care (CHF 9.97B, 9.3% of sales in FY 2010)

Nestle's Pet Care group contributed 12% of the company's total 2009 Sales.^[20] Nestle owns several pet care brands that produced more than 1 billion CHF in 2007 such as Purina, Dog Chow, and Friskies. Nestle's pet care products compete against brands such as Iam's and store brands. In 2009, Pet Care generated revenues of 12.9 billion CHF with organic growth of 7.9% from 2008. In particular, Purina outperformed the other brands in its market with mid-to-high single digit growth around the globe.^[21]

Pharmaceutical Products (CHF 781M, 0.7% of sales in FY 2010)

Nestle's Pharmaceutical Products division segment consists of pharmaceutical and cosmetics brands. Nestle owns 30% of L'oreal (LRLCY) and recently sold its controlling stake in Alcon Inc. (ACL), an eye care product manufacturer, to Novartis AG (NVS).^[22] Nestle also participates in two joint ventures with L'oreal (LRLCY): Galderma and Laboratoires innéov. Galderma produces the topical acne medication Differin and Laboratoires innéov produces several cosmetics-related nutritional supplements.^[23]

Healthcare Nutrition

Using funds from its sale of eye-care company Alcon to Novartis AG (NVS) in 2010, Nestle created the Nestle Health Science company.^[24] This wholly-owned subsidiary will create food-based products meant to help prevent and treat various medical conditions such as heart disease and diabetes. The company will also oversee the Nestle Institute of Health Sciences which will undertake research aimed at bridging the gap between pharmaceuticals and food and unraveling the web of connections between food, drugs, and disease. Nestle's existing Healthcare Nutrition segment will now become part of the new subsidiary.^[25] The majority of the company's brands were acquired from Novartis AG (NVS) in 2007.^[26]

Key Trends and Forces

Changes in Raw Food Prices put Nestle's Margins at Risk

The price of raw foods such as corn, wheat, and dairy can change due to factors such as weather and demand from other industries. Nestle's ability to pass cost increases on to consumers will play a big role in their ability to maintain their current profit margins.^[27] Commodity prices have not yet stabilized and continue to rise. The company has been gradually increasing prices since 2005, foreseeing the major rise in commodity prices, however it has been combating higher input costs by reducing the cost of packaging, increasing efficiency, and introducing high-end products with higher price points.^[28]

Consumers Demanding Healthier Foods

Nearly all of Nestle's revenues come from sales of food and beverage items. Thus, changing consumer demand for different types of food and beverage items can have an impact on Nestle's sales. These changes can be seasonal; for example, consumers tend to demand more hot beverages such as coffee during the colder winter months.^[29] Long term trends also affect consumer demand. For example, the National Restaurant Association says that consumers have been demanding healthier food options when dining out, which reflects the larger trend of growing public concern for health and wellness in general.^[30] Nestle is attempting to take advantage of trends such as these by putting the "Nutritional Compass", which prominently displays nutritional information, on over 90% of its products' packaging, and repositioning itself as a nutrition and health company.^[31]

Nestle's creation of the Nestle Health Science company illustrates their commitment to nutrition, health, and pharmaceutical foods.^[32] This wholly-owned subsidiary will create food-based products meant to help prevent and treat various medical conditions. The company will also oversee the Nestle Institute of Health Sciences which will undertake research aimed at bridging the gap between pharmaceuticals and food and unraveling the web of connections between food, drugs, and disease. Nestle's existing Healthcare Nutrition segment will now become part of the new subsidiary.^[33]

Strong Swiss Franc Hurts Nestle's Sales

Nearly all of Nestle's sales happen outside of Switzerland, but the company reports its income in Swiss francs.^[34] As such, changes in the exchange rates between the Swiss franc and other world currencies can greatly impact Nestle's revenue. When foreign currencies depreciate relative to the Swiss franc, any transactions denominated in those currencies will convert to a smaller number of francs, meaning less revenue for Nestle. The opposite is true as well, with a weak franc boosting Nestle's international sales. In order to help minimize the effect of fluctuating exchange rates, Nestle purchases currency futures, swaps, forwards, and options.^[35]

Nestle Must Capture Growth In Emerging Markets

Recognizing the important of emerging markets, Nestle is investing heavily in production capacity in new markets, such as South Africa, Brazil, Russia, and India. Nestle's expects emerging markets to account for 60% of future growth.^[36] Additionally, company has introduced its "Popularly Positioned Products." These products are lower cost and are priced at a level where poor consumers in the developing world can purchase them every day. With the explicit goal of having emerging market sales account for 45% of revenues by 2020, Nestle is heavily investing in Brazil, Russia, and India from 2010-2012, and encouraging local acquisitions by their geographic subsidiaries.^[37] The company has also expanded its manufacturing facilities in Africa with new/expanded factories in Kenya, Zimbabwe, Angola, Mozambique, and other countries. The company plans to increase sales of locally made products in Africa to 52% in 2012 and 76% by 2016.^[38]

Key Competitors

Nestle competes with other packaged foods companies as well as store brands from retailers such as Safeway (SWY), Wal-Mart Stores (WMT), Walgreen Company (WAG). Nestle's major competitors are:

• Unilever NV (UN) - A Dutch company that produces packaged foods and products for the home and personal care markets. Unilever is one of Nestle's largest international competitors.^[39]
• Kraft Foods (KFT) - A U.S. company that produces packaged foods products. Kraft is one of Nestle's largest U.S. based competitors.^[40] In early 2010, Kraft bought Cadbury Schweppes (CSG), creating the largest candy company in the world and strengthening Kraft's international presence.^[41] Cadbury Schweppes (CSG) is a U.K. company that produces products for the confectionery and non-alcoholic beverages markets; they compete with Nestle's beverage and confectionery products internationally and in the U.S.
• GROUPE DANONE (DA) - A French company that produces packaged foods and beverages. Groupe Danone competes with Nestle internationally and in the U.S.^[42]
• Hershey Foods (HSY) - A U.S. company that produces chocolate and sugar confectionery products. Hershey Foods competes with Nestle's confectionery brands mostly in North America.

Notes

1. ↑ Nestlé 2009 Financial Statement
2. ↑ NSRGY 2007 Management Report: Nutrition, Health and Wellness across the product portfolio, pg 33
3. ↑ ^{3.0 3.1 3.2}
4. ↑ Nestle Management Report 2007
5. ↑ NSRGY 2010 Annual Report, p.44
6. ↑ NSRGY 2007 Management Report: Leadership in Nutrition, Health and Wellness, pg 16
7. ↑ NSRGY 2007 Management Report: Nutrition, Health and Wellness across the product portfolio, pg 33
8. ↑ NSRGY 2007 Consolidated Financial Statements, Consolidated Income Statement, pg 3
9. ↑ NSRGY 2010 Annual Report, p.44
10. ↑ NSRGY 2007 Management Report: Nutrition, Health and Wellness across the product portfolio, pg 33
11. ↑ 2004-2008 Sales.
12. ↑ Nestle 2009 Full Year Results Conference Call Transcript, 2/19/2010, p. 7
13. ↑ A Fashion Trend Meets A Watery Grave, Wall Street Journal, 8/6/2009
14. ↑ NSRGY 2009 Full Year Financial Results
15. ↑ NSRGY 2007 Management Report: Nutrition, Health and Wellness across the product portfolio, pg 36
16. ↑ Frozen Pizza A Sizzling Investment, Investopedia.com, 1/13/2010
17. ↑ Frozen Pizza A Sizzling Investment, Investopedia.com, 1/13/2010
18. ↑ Nestle USA: Our Brands
19. ↑ Nestle 2009 Full Year Financial Results Conference Call Transcript, 2/19/2010, p. 7
20. ↑ NSRGY 2009 Full Year Financial Results
21. ↑ Nestle 2009 Full Year Financial Results Conference Call Transcript, 2/19/2010, p. 8
22. ↑ NSRGY 2007 Management Report: Pharmaceutical and cosmetics activities, pg 48
23. ↑ NSRGY 2007 Management Report: Pharmaceutical and cosmetics activities, pg 48-49
24. ↑ NSRGY Q3 2010 Press Release, 10/22/10
25. ↑ Nestlé Chief Looks to Science to Make Healthier Profits, Wall Street Journal, 12/19/10
26. ↑ Nestle Buys Medical Start-up CM&D Pharma, MSN.com, 2/2/2011
27. ↑ NSRGY 2007 Consolidated Financial Statements, Financial Risks: Commodity Risk, pg 65
28. ↑ Nestle's Recipe for Juggling Volatile Commodity Costs, Business Week, 3/17/11
29. ↑ Spectrum Commodities: Coffee Seasonal Chart
30. ↑ Consumer Demand for Ways to Fit Quality Meals Into Hectic Schedules Shape Restaurant Trends in 2008, According to National Restaurant Association
31. ↑ NSRGY 2007 Management Report: Leadership in Nutrition Health and Wellness, pg 31
32. ↑ NSRGY Q3 2010 Press Release, 10/22/10
33. ↑ Nestlé Chief Looks to Science to Make Healthier Profits, Wall Street Journal, 12/19/10
34. ↑ USD to CHF Exchange Rates
35. ↑ NSRGY 2007 Consolidated Financial Statements, Financial Risks: Foreign currency risk, pg 62
36. ↑ Nestle CEO: Growth, More Influence From Emerging Markets, Capital.gr, 5/7/10
37. ↑ Battle Brews As Nestle Prepares to Push Coffee Brand, TradingMarkets.com, 7/6/10
38. ↑ Nestle to Increase Local Output in Equatorial Africa CEO Says, Bloomberg, 2/10/11
39. ↑ Google Finance: Unilever NV
40. ↑ Google Finance: Kraft Foods
41. ↑ Kraft Buys Cadbury for $19.5 billion, Business Pundit, 1/19/2010
42. ↑ Groupe Danone SA