Nestle Builds Momentum in China, 45 Cents at a Time

09/21/2012 2:00 am EST


Jim Jubak

Founder and Editor,

The government-mandated increase in China's minimum wage means a lot more people should be able to afford Nestle's low-cost consumer products, writes MoneyShow's Jim Jubak, also of Jubak's Picks.

Apparently, it makes a difference whether you’re selling $1,000 raincoats or coffee capsules at 45 cents each.

On September 11, luxury-goods maker Burberry (BURBY) announced that same-store sales for the ten weeks that ended on September 8 were flat with the same period in 2011. A slowdown in sales growth in China was a big part of the problem. The stock fell 21% on the news.

Two days later, Roland Decorvet, Greater China Chairman for Nestle (NSRGY), said he expects the company’s sales in China to grow by about 20% in 2012. That would follow 20% growth in 2011. Decorvet projects China sales will grow at a double-digit rate in 2013.

Rising wages in China, a part of the government’s effort to encourage domestic consumption, will increase sales in Nestlé’s coffee and dairy business, as well as at recent acquisitions such as snack and candy maker HSU Fu Chi International and Yinlu Food Group, a maker of ready-to-drink peanut milk and instant canned rice porridge, Decorvet argues.

According to the latest five-year plan, the minimum wage in China is to increase by 13% a year for the next five years. According to Decorvet, that rising income translates into big growth in low-cost consumer goods, such as Nescafe instant coffee or Kit Kat candy bars.

Chinese consumers drink an average of four cups of coffee a year. The average is 150 a year in Hong Kong, 400 a year in Japan, and 600 a year in the United States.

I think you can see the logic behind Nestlé’s thinking.

The problem, if you’re an investor, is that this story isn’t especially cheap. The stock currently sells for 17.2 times projected 2012 earnings per share. That’s roughly a 5% premium to other global food companies.

Furthermore, the sector as a whole isn’t known for rocketing growth rates. Nestlé’s projected 5.3% earnings growth leaves the stock with a PEG ratio (P/E to growth rate) of 3.23.

So let’s be clear what you’re buying for this price: best in class, stable, and predictable growth.

How predictable? From the third quarter of 2009 to the third quarter of 2010, a period when US GDP growth averaged a not-so-robust annual 2.5% a quarter, Nestle averaged organic growth of 4.6%, versus just 1.5% at peers Kraft Foods (KFT) and Unilever (UL), according to Credit Suisse.

What you think that kind of predictable growth is worth depends to a great degree on what you think the US and global economies will look like over the next 12 to 18 months. The more uncertain you think the growth picture is, the more Nestle shares will be worth to you.

I’m relatively pessimistic about 2013, because I think the chance of the US steering away from the fiscal cliff without damage is relatively small, because I don’t see the current austerity plans in Europe producing significant growth in the Eurozone, and because I think China’s transition from a cheap-labor export economy will be long and wrenching.

Nestle closed at $63.78 on September 20. My 12-month target price is just $69 a share, for price appreciation of 8.2%. Add in the current 3.3% dividend, and the total return is just 11.5%.

That’s wouldn't be enough for me in many markets and economies, but I think it is a very solid potential return for 2013 from the conservative end of a portfolio. I’ll be adding shares of Nestle to my Jubak’s Picks portfolio today, September 21, with a target price of $69 a share.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did own shares of Nestle as of the end of June. For a full list of the stocks in the fund as of the end of June see the fund’s portfolio here.

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