No. of Recommendations: 9
Re your Nestle comments. One I've been looking at. Price looks attractive on the surface however revenue is roughly the same as a decade ago as is EPS, some share buybacks however debt levels / liabilities increasing year on year. Screams stagnation to me?
It's a valid point, they are far from being a growth business. The top line isn't growing much, and hasn't in ages. There is no obvious reason to think it will suddenly start to take off. Their products do not do well outside they US, where their penetration has topped out. It's a good part of the way to being a cash cow, in some ways.
But you can still do pretty well with a semi cash cow. Top line sales are up 4.7%/year in the last 10 years, their main sign of stagnation. Net profit margins have risen, so that sales growth became net income growth of 8.3%/year. With share count reductions, that turned into EPS growth of about 9.4%/year, definitely getting to be an interesting number. So the main thing here is to figure out why that has happened, and to what extent it can continue.
Perhaps its biggest charm is that it is a pretty bullet proof business. Their operating margins are holding up well in the 22-26% range, and I expect that to continue, give or take. There has been a small up trend in that figure which may unwind a bit with cost pressures, but I don't see a sign of structural deterioration. They are built to last.
The biggest problem is that the EPS growth over the last decade has come in part from one-time things. Most notably, the net profit margin is up quite a bit--not something you can extrapolate. Part of that is because they were (like Berkshire) very big beneficiaries of the tax cuts. I would say around 2.1%/year of the last decade's increase in net income was from that alone. (in the five years to 2017 the average tax rate was about 32.0%, last 6 years average about 16.4%, meaning each dollar of pre-tax earnings is worth 23% more than it used to be. Spread over the decade I'm talking about, that's an increase of 2.1%/year of the 4.7%/year total net income growth figure)
Still, not a bad record. More "unexciting" than "dead end".
A good part of the investment thesis is the mere quality of the franchise, and the fact that the market generally appreciates it. Like Coke, but more deserved. As a result, I think there is a good chance that valuation multiples may return to their historically pretty generous range (average around 22.5 times trend earnings), giving a nice one time boost in addition to the moderate value growth trend. I hope they are pouring zillions into buybacks today.
If you look at the actual rolling year pre-tax earnings versus its trend, they have had a notable upswing in the last 6-or-so quarters. Frankly I'm not entirely clear on which moving parts are the underlying reasons, I'll have to do more reading on that. That sort of blip needs a bit of an explanation because you need to know if it's just a cyclical upswing (in which case mean reversion of multiples might get you a 15% bounce if/when it happend) or a new level of the longer term trend (in which case valuation mean reversion might get you 28-35%).
Jim
