Overreaction to Results Offers Opportunity

Source: Adrian Day 07/31/2024

Global Analyst Adrian Day reviews quarterly results and other developments at several companies on his list, mostly his global holdings.

Nestlé SA (NESN:VX; NSRGY:OTC) stock fell sharply after it reported first-half results, with analysts and investors calling them “disappointing” as the company adjusted its annual forecast downwards. I think the market is overreacting.

As Switzerland’s leading newspaper Neue Zürcher Zeitung put it: “The figures are actually good, Nestlé is growing again.”

The company reported organic growth (adjusted for currency impact) of 2.1%, with the second quarter better than the first. Underlying earnings (again, in constant currency) rose 3.3%. Margins are strong at over 17%, and free cash flow rose Chf 0.6 billion to Chf 4 billion. All regions and categories saw improvements. CEP Mark Schneider proclaimed, “Positive real internal growth is back.” All in all, then, these are perfectly respectable results.

Pricing Power Diminishes, Causing Reduction in Guidance

However, the growth was less than had been expected, which the company attributes to slowing price increases, up 2% in the first half. Volume growth, however, helped to offset the smaller price increases. As a result of smaller price increases, the company slightly lowered its full-year guidance, though it said it was still looking for earnings per share to increase at a mid-single-digit rate.

Coffee was the largest growth contributor, followed by strong performance once again from pet foods, led by premium brands. Importantly, the Health Science division, which has been a drag on earnings, “is recovering as planned,” according to Schneider, who said it was set for a strong second half. The company has also introduced a new food line called Materna, specifically designed with the nutrients women need before, during and after pregnancy.

Company Continues To Buy Back Shares but at the Cost of Higher Debt

The company continued its large buyback program, repurchasing Chf2.4 billion of shares in the first half. The program, which commenced at the beginning of 2022, aims to buy back Chf 20 billion of shares over three years. The company’s net debt increased by just over 20% since the end of the year.

Once nearly debt-free, Nestlé’s debt has grown steadily over the years. Its debt-to-equity ratio, for example, has more than doubled over the past three years to 170%, while its quick ratio (ratio of liquid current assets to current liabilities) has declined from a respectable 0.56x to a weak 0.16x. To make matters worse, most of their debt maturities are this year and the next few years, meaning they will be rolling over debt at significantly higher interest rates. With most of its debt in dollars and Euros, future rate cuts in Europe and particularly the U.S. will help them going forward. I am not concerned about the ability of Nestlé to meet its obligations, given its very strong cash flow generation, but I would like to see the debt come down again. In my view, this would be a good time to reduce its 20% stake in the French cosmetics company L’Oreal further, which is worth Euro 43 billion.

Dividend Increases Again, for 28th Straight Year

Importantly, internal growth is accelerating in all sectors and with strong margins. Nestlé has the ability, should it care to, to eliminate most of its debt. Though not undervalued on headline metrics (price to earnings or price to NAV), it is selling now at pretty much its lowest price-to-free-cash-flow ratio in more than a decade, with, after another dividend increase, its highest yield (at 3.4%) in a dozen years.

It has increased its annual dividend every year since 1996, when it held it flat. Nestlé is a cornerstone, global blue-chip holdings for us, and the exaggerated drop from over Chf94 in the last three days to its lowest price in over five years is a good opportunity to buy or add to positions.

Orogen Has Seven Drill Programs Underway

Orogen Royalties Inc. (OGN:TSX.V), in an update on its partner-funded exploration programs, said that seven properties were planning or had just completed drill programs, mostly in Nevada and British Columbia. This is a very active program for a junior company. Among these, Headwater and Newmont are planning a 7,000-metre drill program at Spring Peak in western Nevada, on which Orogen retains the right to ongoing cash payments and a 1% royalty.

Also, Nevada Gold Mines is following up on last year’s drill program at the Maggie Creek project in northern Nevada, with exploration, including a test of the lower plate rocks, currently underway. Orogen receives ongoing payments as well as a 2% royalty. At the MPD South project (formerly Axe) in British Columbia, Kodiak is planning a 10,000-metre drill program. Most exciting are the “Silicon analogs” with geological similarities to AngloGold’s fabulous Silicon-Merlin discovery, on which Orogen holds a 1% royalty and is already up to over 13 million ounces.

An update from Anglo is expected in early August. This is clearly the foundation of Orogen’s current valuation and the main driver in the foreseeable future. However, the work, including drilling, being undertaken on multiple other projects serves to emphasize that there will be life after Silicon when (assuming) that royalty is eventually sold.

There Is More to Orogen Than Silicon!

As discussed previously, Orogen, in any sale of the Silicon royalty, wants to keep its other assets, including the cash-flowing royalty on First Majestic’s Ermitaño; the multiple other royalties and option earn-in projects; the portfolio of projects available for option and sale, mostly in Nevada; and the over $19 million cash balance.

The next steps, we believe, will be a resolution of the arbitration between Anglo and Altius over the extent of the latter’s royalty on the district, Anglo’s update, specifically on drilling to the west of Merlin, and the sale of Altius’ royalty.

As discussed previously, we do not believe that Orogen’s royalty will be sold before Altius has sold its larger royalty. Orogen has upside on the sale of Silicon, in which, it is envisioned, shareholders will receive directly cash or (more likely) shares from the acquirer, while retaining shares in the rump Orogen. While, as we have said, the immediate upside on a sale may not be a large multiple from the current share price — but large enough — the upside is both fairly certain and fairly near term, while the downside is very low.

Continue to buy.

Hutchison Cuts Distribution Even as Revenue Is Up

Hutchison Port Holdings Trust (HPHT:Singapore) cut its interim distribution to shareholders to HK$0.05 from HK$0.055 despite an increase in revenue during the first half. Costs rose 4% compared with a 3% increase in revenue. The revenue increase was mainly due to a large increase in container throughput at its Yantian Terminals in China.

Overall, throughput rose 4% year on year after two successive years of declines. Hutchison’s ports are also benefitting from the Red Sea ship attacks, with a diversion of ships from nearby ports. One significant risk ahead relates to its debt. Since about two-thirds of the debt is at fixed rates, the Trust will see a large increase in interest rates when it refinances debts in the months after November when nearly US$1 billion of its debt matures; this debt was largely drawn four to five years ago when rates were far lower.

Most of its debt is in U.S. dollars. Capital spending, however, is budgeted to be down 27% this year. The other risk is the threat of a deepening trade war between the U.S. and China, which is a known risk and, to some extent, already priced into the unit (stock) price. Assuming a comparable reduction in the Trust’s final distribution in February (it pays twice a year), the forward yield is 9.5%.

For income investors, it’s a Buy.

New CEO at Kingsmen

Kingsmen Creatives Ltd. (KMEN:SI) announced the retirement of its Chief Executive Officer, Cheng Oon Teck, at the end of the year to be replaced by Chong Siew Ling, currently the Group Managing Director for Exhibitions & Thematic.

Kingsmen is seeing growth in contracts across the board after a slow recovery from Covid lockdowns, and now pays a 3.6% yield.

Buy.

BEST BUYS this week, in addition to the above, include Fortuna Silver Mines Inc. (FSM:NYSE; FVI:TSX; FVI:BVL; F4S:FSE), Metalla Royalty & Streaming Ltd. (MTA:TSX.V; MTA:NYSE American), and Fox River Resources Corp. (FOX:CNSX).

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Important Disclosures:

1. As of the date of this article, officers and/or employees of Streetwise Reports LLC (including members of their household) own securities of Orogen Royalties Inc., Fortuna Mining Corp., Altius Minerals Corp., and Metalla Royalty & Streaming.
2. Adrian Day: I, or members of my immediate household or family, own securities of: All. My company has a financial relationship with: All. I determined which companies would be included in this article based on my research and understanding of the sector.
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Adrian Day Disclosures

Adrian Day’s Global Analyst is distributed for $990 per year by Investment Consultants International, Ltd., P.O. Box 6644, Annapolis, MD 21401. (410) 224-8885. www.AdrianDayGlobalAnalyst.com. Publisher: Adrian Day. Owner: Investment Consultants International, Ltd. Staff may have positions in securities discussed herein. Adrian Day is also President of Global Strategic Management (GSM), a registered investment advisor, and a separate company from this service. In his capacity as GSM president, Adrian Day may be buying or selling for clients securities recommended herein concurrently, before or after recommendations herein, and may be acting for clients in a manner contrary to recommendations herein. This is not a solicitation for GSM. Views herein are the editor’s opinion and not fact. All information is believed to be correct, but its accuracy cannot be guaranteed. The owner and editor are not responsible for errors and omissions. © 2023. Adrian Day’s Global Analyst. Information and advice herein are intended purely for the subscriber’s own account. Under no circumstances may any part of a Global Analyst e-mail be copied or distributed without prior written permission of the editor. Given the nature of this service, we will pursue any violations aggressively.

( Companies Mentioned: HPHT:Singapore, KMEN:SI, NESN:VX; NSRGY:OTC, OGN:TSX.V, )