Back in April, I made the argument that while Nestlé S.A. (OTCPK:NSRGF) had seen strong performance in 2019, I was cautious on further growth prospects due to the effects of the COVID-19 pandemic as well as controversy surrounding Nestlé Waters as well as food labeling practices.
With that being said, we have seen healthy growth in the stock price since April:
On an earnings and free cash flow basis, we can see that the stock is trading at roughly in the middle of the five-year trend on an EV/EBITDA basis, while the price to free cash flow ratio is at a five-year high.
EV to EBITDA
Price to Free Cash Flow
Based on a quick visual inspection, the stock would appear to be fairly valued on an earnings basis yet overvalued on a free cash flow basis.
With that being said, there are growing indications that the stock is rising in anticipation of future earnings growth.
For instance, when looking at half-year 2020 performance for the company, we can see that margin growth (excluding the divestiture of Nestlé Skin Health) is still up on that of last year – in spite of costs arising from COVID-19.
Additionally, underlying EPS is also up on that of last year. While the increase is slight, it still marks impressive growth given the underlying financial strains caused by COVID-19:
Putting aside the effects of the pandemic on the business, Nestlé has continued to take steps to increase its focus on its most profitable business segments.
For instance, I had previously remarked that Nestlé Waters has seen controversy in recent years due to perceived exploitation of low-cost geographies whereby water is extracted and then sold at a higher price in other markets. This, among other factors saw RIG for Nestlé Waters drop by 1.9%.
However, after having divested of its Canadian Nestlé Pure Life business pending a deal closure, along with placing North American Waters under strategic review, the company has recognized the need to reassess its position in the bottled water market. Granted, the company still continues to see downward pressure for this segment in terms of growth:
However, with Nestlé now considering selling North American Waters, this would allow the company to refocus its efforts on more profitable segments, which is to be welcomed.
Additionally, Purina PetCare – arguably the company’s flagship offering at this time – continues to perform strongly. For instance, the North American market saw organic growth of 5.3%, led by Purina PetCare, as well as coffee and frozen food.
On a more holistic basis, Nestlé has seen strong growth across developed markets more broadly:
Looking forward, should Nestlé continue divesting of unprofitable segments or at least reducing exposure to the same (namely its water business), while concurrently bolstering sales for profitable segments such as PetCare, then I take the view that this company will become a lot more focused going forward and overall profitability will continue to grow.
As someone who is long the stock, I am impressed by Nestlé’s growth during the pressures of COVID-19 and its efforts in refocusing on higher-profit segments. For this reason, I intend to stay long.
Disclosure: I am/we are long NSRGY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Additional disclosure: This article is written on an “as is” basis and without warranty. The content represents my opinion only and in no way constitutes professional investment advice. It is the responsibility of the reader to conduct their due diligence and seek investment advice from a licensed professional before making any investment decisions.