Nestle's got a pile of cash, good growth prospects, and a stock price that's a tad too high

09/02/2010 12:56 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Nestle (NSRGY), the largest food company in the world, continues to slice and dice, in an effort to shed underperforming or low margin businesses and pick up higher growth, higher margin opportunities.

Nestle has finished selling its last piece of Alcon, its eye-care business, to drug-maker Novartis (NVS). The sale of the 52% of the company that Nestle sold brought in $28.3 billion.

Nestle will use a substantial part of that to reduce the company’s debt, which stood at $29 billion at the end of June. That should maintain the company’s AA debt rating. (Some will also go to fund a plan to buy back about $10 billion in the company’s shares through 2011.)

Paying down debt doesn’t seem very exciting but it’s essential to the company’s strategy of buying growth opportunities in the nutrition, health, and wellness sectors of the food and beverage market. (A company has to clear room on its balance sheet to finance acquisitions either with cash or new debt) This year Nestle bought a frozen pizza business from Kraft, a United Kingdom nutrition company Vitaflo, and Mivina, a maker of instant noodles in the Ukraine. Expect more deals now that the Alcon sale is done.

Nestle is likely to face a tougher second half in 2010 thanks to rising prices of commodities such as cocoa and palm oil.

But the company finished the first half with good momentum. Revenue grew by 6% from the first half of 2009 including acquisitions and currency effects. (Subtract those and revenue growth came to 5%.) Sales in the Asia, Oceania, and Africa unit grew by 9% and by 6% in the Americas. Europe remained the laggard with just 2% revenue growth.

All the work rearranging the company’s portfolio of brands has paid off recently too. Operating margin climbed in the last 12 months to 13.9% from an average of 11.3% over the last decade.

The shares trade at a price-to-earnings ratio of 18. That’s a bit of a premium to the industry average of 17.2 but I think it’s justified by the strength of Nestlé’s brands.

Still the shares trade near their 52-week high and I’d like to get more of a discount. Anything near or below $48 would be a good price in my opinion. As of September 2, I'm adding the shares to Jim's Watch List.

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