Size No Longer a Barrier to Waking Nestle From Slumber

For all its recent underperformance, we still regard Nestle as having a wide economic moat, and even in the event of material asset sales, the business will likely remain highly entrenched in retailers' supply chains because its portfolio is very broad and the firm is a leading supplier in several categories. However, in this note, we prescribe several strategic options that would probably make us review our long-term assumptions for the business and our fair value estimate.

Nestle has failed to keep track of the changing environment in the consumer product manufacturing industry, in our opinion. The company's size, once the key source of leverage in its operating model, is now a double-edged sword. Nestle--which generated CHF 90 billion in sales last year, more than any other consumer product company--has not achieved its self-described "Nestle model" organic growth rate of 5%-6% since 2012. This can be partly attributed to the fairly low inflationary environment in recent years, and with pricing pressures appearing to creep back into Europe, we estimate this could add 100 basis points to the 3.2% organic growth rate achieved last year.

However, it also reflects structural changes within the industry, in particular the growth of unbranded competition in the hard-discounter channel and the potential disintermediation of mainstream grocers by e-commerce. We think Nestle must take steps to address these changes in order to kick-start sales growth and improve the business' margin and return profile.

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