Nestlé’s organic growth estimate for the new year suggests the food giant will need to increase prices again to recover a decline in gross margin.
The KitKat maker raised prices in 2022 by less than some of its international peers, with CEO Mark Schneider insisting today (16 February) that Nestlé “didn’t see any volume impact at all”, unlike some of its global counterparts.
While the gross margin declined a hefty 260 basis points in the year to 31 December, the actual print remained equally hefty at 45.2%. However, Nestlé’s real internal growth, or RIG metric that strips out the effect of pricing from organic growth, registered a meagre 0.1%.
Nestlé increased prices last year by 8.2%, driving 8.3% organic growth and 8.4% in reported terms, with sales reaching CHF94.4bn (US$102bn). Its peer Unilever, meanwhile, upped prices by 11.3% with a 2.1% loss in volumes while Kraft Heinz hiked its prices by 13.2% and saw volumes decline 3.4%.
Schneider said today, on a follow-up media call, that volumes were protected by a continuing rationalisation programme – cutting SKUs in a “portfolio rotation towards items that are in better demand, higher growth [and] higher margin”. That policy, also aided by a rebound in foodservice from the depressed realms of Covid, was “ramped up” in the fourth quarter.
“When you compare our pricing to our industry peers, I think it doesn’t stand out as something that has been going above and beyond,” Schneider argued in today’s Q&A session. Nevertheless, he added: “We still have some repairing to do because the pricing done to date is not fully repairing the gross margin.”
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Schneider was coy in revealing Nestlé’s pricing plans for the new fiscal year for reasons he put down to “competitive signalling”, but insinuated further action will be dependent on the trajectory of input-cost pressures following a year of “significant” inflation.
“There are a number of price increases that we have announced, even late last year, that will go into effect during the first part of this year, and so they will provide for some additional pricing,” he said. “And then obviously, we will have to stay flexible throughout the year as we see a number of our input-cost factors develop and then see how to reflect that.”
Nestlé’s organic growth estimate of 6-8% for 2023 suggests prices may have to rise again given the top-end is just shy of the pricing-led print last year. And similarly for the closely-watched underlying trading operating profit margin, pitched at 17-17.5% for this year - fell 30 basis points in 2022 to 17.1% and was down 40 points on a constant-currency basis.
Martin Deboo, a UK-based analyst at US investment bank Jefferies, agrees: “FY-23 organic growth guidance is for 6% to 8% [Jefferies 4.7%] and would appear to imply further significant price (and hence cost) inflation in 2023,” he wrote in a follow-up research note.
“We expect a negative reaction this morning and a debate around the RIG impact of planned optimisation measures and capacity constraints versus negative underlying price elasticity,” Deboo added.
Indeed, Nestlé’s share price was down more than 2% at 3:21pm UK time today.
For 2022, underlying earnings per share rose 9.4% in constant currency and 8.4% in reported terms to CHF4.80. However, EPS dropped 43.5% to CHF3.42 "mainly reflecting the 2021 gain on the disposal of L'Oréal shares".
Nestlé retained its longer-term 2025 targets. "We expect sustainable mid single-digit organic sales growth and a return to an underlying trading operating profit margin range of 17.5% to 18.5% by 2025. We expect annual underlying earnings per share growth to be in the range of 6% to 10% in constant currency."
Schneider explained the dynamics around organic growth and RIG in today’s introductory remarks: “The nature of that growth has changed. In ‘21 it was more volume- and mix-led. Now in the year 2022, obviously in the face of inflation, it was more pricing-led. Nonetheless, very positive news that we came out ever so slightly with a positive RIG.”
Pressed during the Q&A, he added with respect to the outlook: “While we believe that most of this growth is going to be pricing-led, we are not providing a specific breakdown between the pricing and the real internal growth. I think at a turbulent time like this, to provide a specific breakdown of organic growth into pricing and real internal growth ahead of time, is probably not credible.”
RIG was negative in both the fourth and third quarters - minus 2.3% and 0.3%, respectively - leading Bruno Monteyne, a senior food analyst at US asset management firm AllianceBernstein, to write: “The debate on the analyst call will likely be on how long the negative RIG is likely to last,” he said, referring to a latter conference with financial professionals.
“At group level, the miss was at RIG (volume) level with a -188 bps miss on RIG, offset by +84bps beat on pricing. Top-line softness is offset by organic growth guidance of 6% to 8%, materially ahead of visible alpha consensus of +4.7%.”
CFO François-Xavier Roger implied much of the gross margin decrease materialised in the second half “as inflation was higher than we anticipated in the summer, primarily due to energy, as well as labour costs”.
Schneider suggested forward hedging materials and other costs creates price pressures in itself, particularly if input expenses start to come down.
“In some cases, you have forward contracting that then creates cost pressures going forward. In other cases, you still have catching up to do because on a full year-over-year basis, even though the price may have eased a little bit over the last few weeks and months, you're still north of where we were a year ago and the pricing so far has not fully reflected that," he said.
Portfolio trimming as another means to counter rising costs has seen Nestlé complete 22% of its product “rotation”, Schneider said, adding that in 2023 the company will be “working very hard on protecting our volume growth, which is an important driver of long-term market shares”.
He added: “Originally, this initiative was born about a year ago under the impact of some of the supply chain constraints that we saw around the world. And when you had these constraints, we were forced to think about where we channel and focus our resources to be sure that we serve our consumers and reach our partners the best way. And that led to this whole notion of SKU rationalisation - we labelled this ‘cutting the tail to push the head.’
“We're working on continued cost efficiencies in order to shield our consumers around the world from the impact of inflation, and of course, after tactically adjusting our marketing expenses.”
"Value" still in frozen
That rotation has culminated in the termination of Nestlé’s frozen food business in Canada, as announced earlier in February, and given the CEO’s comments today other similar decisions may follow.
Schneider explained that decision was based around importing into Canada from the US, given the operation has no local manufacturing, and the consequent cost impact of fluctuations in currencies. It means the loss of a business estimated by the CEO at CHF150m.
“It was not a business that was separately sellable,” he said during the Q&A, noting the withdrawal was representative of Nestlé’s “willingness to walk away from business” in pursuit of longer-term benefits for growth and profitability.
“As we go through the year, you'll see more of these examples,” Schneider added. “We will do that going forward to all categories, and that is, we will have a very targeted review SKU by SKU, brand by brand, where we have a good chance to win and what the size of the prize is at the end of the day. But this is not a reflection on the frozen category overall.”
His last reference was batting away the prospect fielded to the CEO that Nestlé might exit the frozen-food category altogether, not just in Canada.
“This is clearly a tactical move under this [optimisation] programme. We see value in the frozen sector, we believe in that sector,” Schneider stressed. “But having said that, like any other sector, like any other category, you have to be very targeted on where you have the best chance to win.”
The question of Russia also came up on today’s call in the wake of Unilever’s recognition of the potential costs of writing down assets in the country.
Unilever still has a physical presence in Russia, despite halting imports and exports the month after Vladimir Putin’s troops entered Ukraine in February 2022. Investment, and media and adverting spending, were also suspended in March last year.
However, Unilever continued to supply what it called “everyday essential food and hygiene products made in Russia”, drawing widespread criticism as some of the company’s food manufacturing counterparts withdrew.
Nestlé took the same stance. In March last year, the company said it would cut the number of products on sale in Russia after previously suspending all capital investment and advertising spending in the country. However, it would continue to supply essentials such as baby food and nutritional products for hospitals.
Schneider reiterated the stance today when asked about Nestlé’s intentions in Russia: “We have done exactly what we announced late March last year. We have significantly reduced our number of SKUs in this market by about two thirds and we're focusing on basic and essential food and beverage products.
“Demand of course, for food and beverage products is still very strong. Volumes also have been increasing on some of these essential and basic brands as some of the others were discontinued.”
CFO Roger chimed in on the impairment and write-down proposition: “We did some adjustments and some impairments last year for some assets that we are not using given the fact that we reduced the number of SKUs and the number of products that we use, but this was a relatively limited amount.
“But we have no plans to write-off our entire operations in Russia for the time being.”