Loeb’s plans for Nestlé are less than radical
Activist should not receive credit for pushing group in direction it was already going
Nestlé is “stuck in its old ways”, with a “staid culture” and a “tendency towards incrementalism”. Some of its brands don’t make sense. Nor does its stake in L’Oréal. It won’t be able to sustain dividend hikes with its current strategy, and it is not nearly profitable enough. These are (some of) the accusations levelled at the Swiss food group by Dan Loeb, the activist investor whose Third Point hedge fund has taken a $3.5bn stake in Nestlé. Is he right?
The stake marks the next step in a newish sortie by Third Point into Europe, where activism — and Mr Loeb — is less prevalent than in the US or Japan. Third Point has directed its ire effectively in the past, whether towards Dow Chemical, Yahoo, Sony, or Sotheby’s. In recent months it has branched out into continental Europe, taking stakes in UniCredit, Italy’s second-largest listed bank, and German utility Eon. But Nestlé is different. Mr Loeb is taking his biggest bet yet, buying up about 40m shares for a 1.3 per cent stake, and devoting 15 per cent of his flagship fund to do so. It is not just his largest bet to date but is against the largest company to date. Both facts suggest he must think there is a good chance he will get his way.
Mr Loeb speaks admiringly of Nestlé. He likes much of its portfolio, and is said to respect its diverse board — although he wishes it had more experience in capital allocation and packaged goods. But he wants to shake up the company. It should, he believes, sell underperforming brands, adopt a formal target to raise operating profit margins from 15 to 18-20 per cent by 2020, and take on more debt to fund share buybacks. The company’s stake in L’Oréal should be swapped via a share exchange offer that would boost Nestle’s return on equity, and it should cut costs. All this would stop Nestlé’s underperformance, which he defines as total shareholder return towards the bottom of its peers over the past five and 10 years.
Much of this makes good sense. Nestlé’s organic sales are rising at their slowest rate for two decades. Operating margins are barely half those of industry leader Kraft Heinz. Nestlé’s balance sheet is under-leveraged, with net debt to earnings before interest, tax, depreciation and amortisation well below 1 times. Valuation multiples are high in the sector, so it makes more sense to sell businesses than to buy. Meanwhile, the L’Oréal stake, while profitable, makes little strategic sense and shareholders should be able to choose to invest in it directly rather than hold a second-hand stake.
However, while the size of Mr Loeb’s bet may be radical, none of his suggestions are. Third Point investors should question why they are paying him elevated hedge fund fees to deploy their money in a manner which barely qualifies as activism. Mark Schneider, Nestlé’s chief executive since January, is already on the path Mr Loeb recommends, and Third Point should not get credit for decisions which management is already contemplating. The announcement by Nestlé on Tuesday that it would buy back CHF20bn of shares appears less a response to Third Point’s demands than the next step in a strategy Mr Schneider has already laid out. Nestlé’s management is already focusing on the right things, investing in the faster-growing parts of the business — nutrition, beverage and petcare — where nearly two-thirds of trading operating profit is generated and underlying return on invested capital is healthy. Mr Schneider has put the US confectionery business up for sale, plans to shift more towards healthier foods and has already hinted he will adopt a profit target.
Investors should be wary of others of Mr Loeb’s claims. For a start, he exaggerates Nestlé’s underperformance. As Bernstein analysts say, shareholder returns and earnings per share have been depressed by currency effects. At constant exchange rates Nestlé’s TSR over the past decade is 85 per cent higher than Third Point suggests, while earnings per share growth ranges from the mid- to high single digits. Secondly, one of Nestlé’s problems is that it has too much cash, rather than too little. Leveraging up would only compound the problem. Thirdly, handing cash to shareholders in the form of a buyback will only improve returns in the short term. Meanwhile, margin targets are all very well, but to get there will require culture change within Nestlé, a far more difficult task.
Whether Mr Loeb’s intervention will help or hinder Mr Schneider in this task is debatable.