Soup it up

Nestle's rich valuation needs recipe to match

Fast-moving consumer goods companies, as the likes of Nestle are known, aren't so fast moving these days. The Swiss kibble-to-Kit Kat maker reported sales growth of 3.5 per cent before currency movements for the first half of 2016, far below its own target, and said that its pricing power was "historically low". A shame, then, that Nestle's valuation of 22 times next year's forecast earnings, like many of its peers, is at a decade high.

Pricing is a drag on growth, but not the only one. Nestle is struggling to get consumers paying more because of persistent deflation in the West, and relatively low commodity prices. A rise in the cost of commodities like sugar, coffee and palm oil will help, but hasn't yet. Besides, when the cost of what's on the supermarket shelf goes up, shoppers often buy cheaper products instead.

A more troubling issue is that rising emerging-market prosperity, while still important, is no longer such a reliable formula for growth. China, for example, is down to what Nestle characterised as "basically zero growth" for food and drinks, even though GDP and disposable income continue to grow at almost nine per cent in nominal terms. Competition and disruptive online retail haven't helped. It's discouraging in a market that has gone from just 2.5 per cent of Nestle's revenue in 2010 to almost eight per cent now.

There are two things Nestle and its peers can do to keep investors keen. One is to squeeze cash out of the business, which the Swiss group is doing by wringing out its supply chain. Working capital amounts to below five per cent of sales, better than rivals Danone, Unilever and Reckitt Benckiser. Capital expenditure is also flat, which helped Nestle's free cashflow increase by 41 per cent in the latest six months, year on year.

The other thing is to think more disruptively, which means more than just marketing products differently and creating new flavours of Kit Kat. Unilever is experimenting with direct-to-consumer razor delivery, and just bought a maker of air purifiers. Its shareholder return over the last year is triple Nestle's. It's timely that the Swiss group's new boss, Ulf Mark Schneider, comes from the pharmaceutical industry, because the old consumer-goods formula needs a shot in the arm.