Nestle (OTCPK:NSRGY) is not a high-dividend yielder but it is a quality company which offers income investors a safe and predictable income stream for the foreseeable future. Currently, it offers a dividend yield above 3%, which for a mature and resilient company like Nestle is attractive. Moreover, its long history of rising dividend payments makes Nestle a "sleep well at night" type company for income investors. Nestle has a market capitalization of about $230 billion, and is traded in the U.S. in the over-the-counter market.
Nestle is a Swiss multinational food company and the world's leading nutrition, health and wellness company. It was founded in 1866 and has operations in 194 countries and about 339,000 employees. The company operates under various brands, such as Nestle or Nespresso, covering almost every food and beverage category. Nestle has more than 30 brands with more than $1 billion in annual sales, providing a very good brand diversification. Its products include powdered and liquid beverages, water, milk products and ice cream, baby food, pet care, beyond others. Nestle is also one of the safest companies in the world based on its current AA credit rating from Standard & Poor's (S&P), the third-highest credit rating on S&P's scale.
Nestle has a very good geographical diversification which is clearly a positive factor, given that it doesn't expose the company too much to consumer demand from specific geographies. For instance, its main competitor Danone (OTCQX:DANOY) has been negatively affected by its relatively large exposure to Southern European countries, which over the past two years have suffered from weak economic conditions impacting consumer demand and therefore Danone's sales growth. As Nestle's sales are much more spread around the world, weakness in a few markets should have little impact on the company's overall sales.
Nestle has operations worldwide but generated around 57% of its sales in developed markets during the past year, and the remaining 43% in emerging markets. The weight of emerging markets in the group's sales should continue to increase over the next few years due to stronger economic growth and improved eating habits in emerging markets. Nestle has a target of a 50/50 split in 2020, but it could get there sooner especially through acquisitions. In 2012, emerging markets reported 11% organic sales growth, which was above the group's average of 5.9%. By geography, the Americas were Nestle's largest single market in 2012, representing around 31.4% of its sales. Europe was the company's second-largest market with a weight of 16.7% on sales.
Regarding its financial performance, Nestle has a very good history of growth, strong profitability and business resilience over the economic cycle. Compared to its closest peers Danone and Unilever (NYSE:UL), one of Nestle's big advantages in the past few years has been less volatility in volumes and prices, within its organic sales growth. Even during the global financial crisis of 2008-09, its pricing wasn't negative for organic growth as it did for both its competitors and volumes have also been more steady. This proves Nestle has a superior business model, which is quite resilient to economic cycles.
In 2012, Nestle's sales were about $102 billion, an increase of 5.9% from the previous year. Nestle has a long-term 5-6% organic growth rate target, which is in-line with its average annual growth rate over the past ten years. However, going forward this target is more demanding as Nestle's sales base is larger which may lead the company in some years to miss this target. For 2013, Nestle's top-line growth should be at the bottom of its guidance, impacted by weak demand in Europe.
Its profitability has improved over the past few years, with an EBIT margin expansion from 12% in 2002 to about 15.2% last year. During the first six months of 2013, Nestle was able to continue its margin expansion despite a challenging operating environment across several of its businesses, mainly in Europe and Asia, Africa and Oceania.
Regarding its dividend history, Nestle has an impressive track record given that it has paid annual dividends since at least 1959. It has paid rising dividends since 1995, showing very good growth rates for a mature company like Nestle with its CAGR of 10% from 2008 to 2012. Its last dividend payment was CHF 2.05 ($2.27) per share, an increase of 5.1% from 2011. Its dividend payout ratio was only 62%, which is acceptable for a stable company like Nestle. On the other hand, Nestle only makes one payment per year and the Swiss withholding tax is high at 35%, reducing a little bit of Nestle's dividend appeal.
Nestle's capital expenditures (capex) amounted to $6 billion in 2012 representing about 5.8% of its sales. This ratio is way above its closest peers Danone and Unilever, showing it has room to decline over the next few years which will be a boost to the company's free cash flow generation. Nestle's cash flow from operations was $17.7 billion during the past year, which was more than enough to finance capex and dividend payments. Its free cash flow after dividends was $4.66 billion, showing how safe the dividend is and its growth potential if Nestle's management decides to take a more aggressive stance regarding its shareholder remuneration.
Moreover, Nestle is L'Oreal's (OTCPK:LRLCY) largest shareholder with an equity stake of 29.8%, which at its current stock price is worth about $31 billion. L'Oreal is a French beauty company offering product mainly for women, such as cosmetics and perfumes. Therefore, this stake is not a core holding and Nestle may decide to monetize it over the next few months. If the company decides to dispose its stake, it will most likely increase its shareholder remuneration through special dividends and perform share buybacks, which is clearly another positive factor for income investors.
Nestle purchased Pfizer's (NYSE:PFE) baby-food business in 2012 for $11.9 billion. This has led to slightly higher debt levels, but its current credit rating should not be at risk. According to S&P, Nestle has about $5 billion to make debt-financed acquisitions without putting its credit rating at risk. At the end of the second quarter of 2013, Nestle's net debt amounted to about $24 billion, or a net-debt-to-EBITDA ratio of only 1.3xx showing the strong balance sheet. This strong balance sheet and its strong cash flow generation that should lead to lower leverage over the next few years is another positive factor for Nestle's dividend sustainability over the long-term enabling it to raise its dividend continuously unless it performs a major acquisition.
Nestle is a quality company, with a resilient business model and a remarkable dividend history. Its dividend is not among the highest on the stock market, but regarding its sustainability is clearly among the best. Moreover, its growth prospects are good and a special dividend may come if it decides to sell its non-core stake in L'Oreal. All these positive factors justify why it is relatively highly valued given that Nestle is trading at more than 18x its estimated 2013 earnings, which is not particularly cheap but should not dissuade income investors to grab this safe dividend machine.