Nestlé's performance in 2010 was predictably solid but unexciting. The Swiss consumer staples giant, which makes Kit-Kat chocolate and Maggi noodles, defied weak markets in Europe and the U.S. to deliver 6.2% organic sales growth, in line with its 10-year average, and a 7.4% rise in earnings.
Yet despite a near-flawless record, investors aren't enamored. Its shares have underperformed both the European food sector and the broader market this year.
True, the Nestlé model should purr again in 2011. Sales growth, which accelerated in the fourth quarter, is continuing at a similar pace. Management felt confident to reiterate its long-term target of 5%-6% organic sales growth, something it didn't do this time last year. And while price increases of raw materials are expected to cost Nestlé an estimated 2.5 billion-3 billion Swiss francs ($2.61 billion-$3.13 billion), targeted cost savings will absorb at least half that. Greater operating leverage as volumes rise combined with an improved mix as higher-margin products grow more quickly should offset much of the rest. Price increases where necessary shouldn't be a problem, given Nestlé's innovations and defensive categories like pet food.
Nestlé's balance sheet also offers the prospect of enhanced shareholder returns. Share buybacks worth 10.1 billion francs contributed 0.8 percentage points to underlying earnings per share growth in 2010, and Nestle plans to complete another 5 billion francs of buybacks in the first half of this year. It is also paying out more of earnings in dividends: 55.7% last year. And given that Nestlé is targeting 15 billion-18 billion francs of net debt in 2012, up from 1.3 billion francs in 2010, more buybacks and greater dividends are likely even if it makes mid-sized acquisitions.
Trading on 14 times 2012 forecast earnings, Nestle's valuation looks fair given forecasts of 7% earnings growth again this year. But French rival Danone might offer greater upside. True, Danone is a riskier bet while it digests Russian dairy group Unimilk, and its operating margins will fall in the first half of the year. But 60% of Danone's markets, including the U.S., are increasing sales by double digits, and it reckons group organic sales growth will be between 6% and 8% this year.
Nestlé might be investors' safe, dual-track recovery bet. But trading on roughly the same multiple, Danone could be more exciting for investors looking for a growth stock to play the food sector.
Write to Renée Schultes at firstname.lastname@example.org