We think Nestle's (NSRGY) announcement it is to undertake a strategic review of its U.S. confectionery business is more significant for its implications regarding a potential portfolio realignment than it is for its financial significance. We are reiterating both our wide moat rating and our CHF 79 fair value estimate for the ordinary shares. Nestle will remain a highly entrenched consumer product manufacturer in the U.S., even if it disposes of this unit, because its portfolio will remain very broad and the firm will still be a leading supplier in several categories.
Nestle is not at a competitive advantage in the U.S. candy industry, where Mars, Hershey and Lindt collectively control over half of the market. According to Euromonitor, the company has a value share of 8% and its portfolio generated sales of CHF 900 million last year, or just 1% of Nestle's consolidated top line. Globally, confectionery is a low margin business for Nestle, and its 2016 EBIT margin of 13.7% was the lowest of all the reported segments except bottled water. With pricing power and volumes both appearing to be softening, we have little hope that Nestle can reignite the unit's growth in the near term.
Investors, therefore, are unlikely to shed any tears at the disposition of this business. In fact, many will be optimistic that the announcement may signal the beginning of a more significant portfolio repositioning, amid a prolonged period in which Nestle has failed to hit its former organic growth rate of 5% to 6%. The company recognizes that long-term growth is likely to come from healthy food categories, and hopes to eventually double its sales in this area to CHF 10 billion. However, it has simultaneously retained a presence in unhealthy categories such as confectionery and frozen foods. Though small, this deal may be the first sign that new CEO Ulf Mark Schneider is willing to refocus the portfolio, and shed low-growth businesses that do not add to the companies nutritional credentials.
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Philip Gorham, CFA, FRM does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.