Nestle

Stock price: SF52,2
Conclusion: Superior pricing power combined with earnings quality. We reconfirm our valuation range (SF59-SF62 per share).

H1 results: sales up 5.7% to SF55.3bn (food and beverage +5.7% organic)-EBIT up 13.6%-EPS+13.6%. Guidance 2011: around +5% organic growth and EBIT margin improvement.

We expect Nestle to further rerate against peers.

The only large cap combining volume and pricing.
Organic growth reached 5.7%, driven by volume (+4.2%) and also pricing (+1.5%).
-Nestle’s growth drivers include emerging markets (35% of sales) up 11.3% in H1. Nestle’s exposure is even greater in dairy (80%), powdered beverages (65%), infant nutrition (50%), ambiant culinary, soluble coffee and confectionery. Nestle is still under-exposed in certain categories such as ice cream, water, pet care or frozen foods. Management has not seen any indication of any slowdown in any emerging market.
Nestle managed to grow even in Western Europe (+2.5% organic on average in the last five years).
- Solid pricing power in a challenging environment. Unlike peers Danone or Unilever, Nestle preserved positive pricing in all regions, Europe, America and zone AOA. Water was the only division to report negative pricing in H1. Beverages, confectionery and milk products reported above average price increases.

Bottom line reflects a virtuous circle
-Gross margin could be up 80bp in 2010, less than in H1 (+160bp) due to input costs headwind, notably in confectionery, nutrition and water. Nestle expects input costs to rise at the top end of its +2-3% forecast. As result, pricing should stop trending down and stabilize in H2.
-Distribution and administrative costs should continue to benefit from savings (down 40 and 20bp respectively in H1). According to CFO, “the best is still to come from Globe processes and data systems” Nestle expects to save around SF1.5 bn per year vs SF1bn in the past through synergies, increased simplicity, speed and flexibility.
-Innovation will require further increase in marketing spending (up 140bp in H1).
-One should also highlight the absence of major restructuring charges which often pollute competitors earnings (cf Unilever).
All in all we expect sales to reach SF106bn, EBIT margin to reach 13.5% in the core F&B business and net earnings to achieve SF11.1bn-EPS SF3.27.

Nestle has just completed the sale of Alcon to Novartis for $28.3bn.
-We expect free cash to achieve SF8.1bn this year.
-Following the disposal of Alcon and SF10bn projected share buy back, we forecast net debt to fall below SF1.2bn by the end of December.
-Nestle targets a return to F09 debt level of SF18bn by F12, which would imply continuing share buy backs at around SF10bn pa.
-As to L’Oreal, we reiterate our conviction that Nestle would be interested in taking the full control of the company.

Nestle trades at 14.9xP/E and 8.6xEV/EBITDA based on our 2011 estimates, which leaves further upside for such a quality stock. We confirm our valuation range of SF59-62 per share.

Long Nestle at time of writing.

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