NSRGY - Nestlé: More Globally Diversified Than Most Funds

2023-10-03 09:18:58 ET

Summary

• Nestlé's global revenue balance looks better balanced than the geographic allocation of the Vanguard Total World Stock ETF.
• While VT is over 60% concentrated in just US stocks, only 32% of Nestlé revenue comes from the US, with relatively more coming from Asia, Africa, and Latin America.
• This geographic balance, combined with Nestlé's recession-resistant profits, is why I see this name as an attractive dividend-growth-at-a-reasonable-price investment.
• The dip in Nestlé stock this year, which I see as driven by a strong Swiss Franc, seems to be like the best buying opportunity in years.

Since moving to Switzerland almost two years ago, one stock I have spent more time looking at than most others is global food and beverage giant Nestlé S.A. ( NSRGY ), which is by far the top holding of the iShares MSCI Switzerland ETF ( EWL ) at 19.4%. One reason this one stock has deserved so much of my attention is forced exposure: pension funds here have limits on how much can be invested outside Switzerland, which means that few, if any, equity-heavy pension funds here have less than 7% allocated to Nestlé. This is even higher than the 6.4% position total US stock funds have to Apple stock . While at first, I found this top-heavy exposure to Nestlé uncomfortably high, but the more I look at Nestlé's mix of brands and geographic exposures, the more comfortable with this name providing me exposure to not only developed markets, but many emerging markets I have interest in as well. In this article, I wanted to compare the single stock of Nestlé versus one of the most globally diversified of benchmarks: the Vanguard Total World Stock ETF ( VT ). I first compare the geographic diversification of the two, arguing that Nestlé revenues are even more balanced than the geography of VT's holdings, and then see how Nestlé compares with this benchmark on a few other key metrics.

Nestlé vs VT on Global Diversification

Although Nestlé is a Swiss company, by far its largest single market by revenues is the United States, which made up 32% of its 2022 sales. I find this number attractive because it is about half the level of US exposure reported by VT, with the difference mostly meaning Nestlé has relatively more exposure to emerging Asia, Africa, and Latin America, which I want. China exposure is about the same ~5% for both Nestlé and VT, and by this crude measure, VT's 2.2% allocation to Switzerland is even greater than the ~1% of Nestlé's sales that come from within Switzerland. This is of course not an apples-to-apples comparison, since I am drilling into the revenue source geography of Nestlé, while treating the 0.44% position VT has in Nestlé as 100% Swiss, but I think gives a decent first-order approximation of geographic diversification, given that Vanguard does not provide this revenue breakdown.

The table below is my brief summary of this comparison based on the geographic regions reported on page 47 of Nestlé's 2022 annual report , compared with the reported geographic breakdown of VT's holdings .

Source: Nestlé 2022 Annual Report, Vanguard, Author's Calculations

Nestlé vs VT on Business Diversification

Besides the risk associated with allocating too much to any one company, the second main reason I don't think anyone will be selling all their VT holdings to put it all in Nestlé stock is industry concentration risk. That is, with VT, you profit not only from food and beverage businesses, but also from technology, transportation, banking, lithium mining and dozens of other diverse businesses. While I agree that this is why Nestlé's weight in my overall portfolio will probably never exceed the ~7% weight we are forced to accept in our pensions, and in fact I still think a 2% weight is more prudent, I do think the risk of concentrating on staples is one of the lowest of any sector, especially given Nestlé's extremely diverse brand portfolio . Unlike iPhones, new cars, new business loans, or metals, coffee, breakfast cereal, and pet foods are not things people tend to cut back on much in recessions. In that way, I see Nestlé's business as being far more resilient against the many different shocks that might disrupt a business like Apple's over the course of this decade .

Nestlé vs VT on Dividends

Although Nestlé's 2.9% dividend yield may not seem significantly higher than VT's 2.1% , Nestlé is still a stock I would mostly buy for its dividend and expected dividend growth. My current "hurdle rate" for any dividend stock I buy is that it needs to at least have a dividend yield greater than the 2.3% yield on long-term TIPS ( LTPZ ), PLUS an expected dividend growth rate exceeding that of inflation. In the case of Nestlé, I expect dividend growth to continue at a rate above the rate of global food inflation, given the premium margins its brands continue to command in markets around the world. While VT's dividend growth rate has averaged 3.5% over the past 10 years , one might argue VT's dividend has more business cycle risk, as 13.7% of VT is allocated to financials, some of which may cut their dividends in their next recession. By contrast, Nestlé has a long history of steady dividend growth , through boom and bust cycles, going back at least as far as 1959.

Nestlé vs VT on Profitability and Valuation

Nestlé generally deserves to trade at some premium to broad market benchmarks because it is a simple, robust, and very profitable business, with an A+ profitability rating on Seeking Alpha . The most apples-to-apples metric we could compare here to VT is Nestlé's 24% return on common equity ratio, versus the 16.5% portfolio return on equity rate reported by Vanguard for VT. I see Nestlé as having an even greater profitability premium than this, because Nestlé has the ability to borrow money in Swiss Francs, where 10-year yields remain only around 1% , in contrast with many VT components who would mostly borrow in dollars at a rate of >5%. The current mark-to-market yield on the single 2027 Nestlé bond in the iShares International Aggregate Bond ETF ( IAGG ) is currently 1.68%, implying Nestlé has quite a bit of room to continue levering up and continue harvesting a hefty rate of return for equity holders over this cost of funding. In other words, Nestlé not only looks far more profitable than the weighted average company in VT, but it has a much fatter margin of profitability over its benchmark interest rate than VT.

By non-dividend valuation metrics like the Price/Earnings ratio, Nestlé's 20x forward P/E, is notably higher than the 17.1x earnings VT currently trades at, though in my view, this is a relatively minor premium given the difference in profitability, dividend growth, and recession resistance noted above. Nestlé's TTM P/E ratio is a much higher 28x, due to a significant dip in earnings over the past year, and this dip paired with a strong Swiss Franc ( CHF:USD ) are my two main explanations for why Nestlé stock is down about 20% in Swiss Franc terms since the end of 2021. For an American shareholder, it shouldn't really matter whether Nestlé's dividend doubles and the exchange rate remains the same, or the Swiss Franc doubles in value against the dollar and the dividend remains the same, as either day, Nestlé's return in dollars would remain the same over such a scenario. That said, I see the currency effect as a relatively short-term shock, and the long-term growth of my dividend, in whichever currency I measure it, is simply driven by this company's ability to profitably sell its products around the world. In the beginning of this article, we established that Nestlé collects revenues in a very well balanced global mix of currencies.

Conclusion

While many investors wouldn't consider it crazy to allocate 100% of a portfolio to VT, many of those same investors probably would consider it crazy to allocate even 10% or more of a portfolio to a single stock, even if that stock is Nestlé, and even if that stock's geographic exposure may be even more diversified than VT's. That said, I am increasingly getting comfortable with the idea of switching over at least 2%, and perhaps as much as 5% of a portfolio from a fund like VT to a stock like NSRGY. I find this year's dip in the price of Nestlé shares, especially in Swiss Franc terms, as providing one of the most attractive entry points to this stock I've seen since the COVID-19 pandemic. Until fund management companies start providing better reporting on the revenue and profit breakdowns of the companies they hold, I'll continue finding it worthwhile to continue looking for many more world-class and globally diversified brand portfolios like Nestlé's.

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