NSRGY - Nestle: Higher Costs Increasingly Affecting Profitability

Summary

• Nestle has seen rising prices have a significant impact on real internal growth.
• While Purina PetCare has been a strong contributor to sales growth - this could change if rising prices force consumers to re-examine spending habits.
• I see growth prospects in the short to medium-term as being modest.

Investment Thesis: I see growth prospects in the short to medium-term as being modest.

In a previous article back in December, I made the argument that I took a bullish view on Nestle ( NSRGY ) on the basis of strong sales growth in an inflationary environment as well as potential undervaluation on a P/E basis.

Since my last article, the stock had seen a rise in growth in the interim but has largely stabilized at the same price level as that of last December:

The purpose of this article is to assess whether my prior case for taking a bullish view still holds, and whether Nestle could see further upside going forward.

Performance

When looking at Nestle's 2022 full-year results , we can see that real internal growth (or growth excluding the impact of rising prices) was highest for Confectionery and lowest for Prepared dishes & cooking aids - both on a percentage basis.

The RIG of PetCare is down to 4.3% from that of 4.8% for nine-month 2022 results , while overall RIG for the group came in at a very modest 0.1%.

This indicates that organic growth has only slightly outpaced that of pricing growth as compared to that of the previous year.

Moreover, it is also notable that Powdered & liquid beverages (the company's largest segment by sales) has seen full-year RIG fall to 0.2% from that of 0.7% for the nine months of 2022.

For the full-year, pricing was up by 8.2% and organic growth by 8.3% for the total group - while the same was up by 7.5% and 8.5% respectively across nine-month results. In this regard, the gap between pricing and organic growth is narrowing - suggesting that the capacity of customers to absorb further price increases is diminishing.

Moreover, Nestle has been forced to hike prices across some of its product lines once again - with the company recently announcing that it will need to raise KitKat prices once again this year, in spite of an 8.2% increase in 2022.

In addition, the company acknowledged significant pressure on margins across its product lines more generally, with yearly net profits of 9.27 billion Swiss francs coming in well below the 11.58 billion francs that was originally expected.

From this standpoint, inflationary pressures are becoming evident for Nestle - and it is unclear as to whether the company can continue to sustain demand under the current macroeconomic environment.

Risks

From a macroeconomic standpoint, the main risk for Nestle at this time is that a continuation of rising costs forces the company to raise prices across its products further - which could significantly hurt demand.

Moreover, overall sales has been sustained by that of growth across Purina PetCare. However, there is no guarantee that this trend will continue indefinitely. For instance, should inflationary pressure mean even higher food prices going forward - then consumers could choose to lower purchases of pet food in order to afford higher food prices.

Additionally, consumers may decide to increasingly avoid Nestle-branded products in favor of cheaper alternatives if prices become too prohibitive.

Conclusion

To conclude, Nestle SA has seen quite modest sales growth for 2022 when accounting for higher prices. In this regard, the company has become increasingly dependent on the PetCare segment to drive overall sales growth. Should we see demand across this segment start to plateau, then this could impact growth across the stock as a whole.

For these reasons, I see growth prospects in the short to medium-term as being modest.

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