During the past few years, the Swiss equity market has been forsaken by many investors due to the weak performance of its healthcare and financial sectors, but is that still the case?
Swiss equity market outlook
Swiss companies have made some interesting profits recently with net earnings yield that have constantly increased during the past 20 years.
Even if interest rates have decreased recently, Swiss companies have not increased their indebtedness and did not use a higher debt-to-equity ratio to boost the return on equity.
Overall, Swiss companies are some of the most international companies in the world as they earn just 10% of their profits in Switzerland and 90% abroad. Also, the current weakened franc benefits Swiss companies as global earnings are worth more in francs (companies exposed to the euro could benefit largely from it). This currency exchange rate factor is expected to increase profits in the next months/years.
Even if there are many positive indicators showing that the Swiss equity market is healthy, it is important to look at the risks that could hurt the Swiss and global economy. In Europe, for example, it is important to keep an eye on Brexit and to a lesser extent, the different elections scheduled in the next months that could threaten the EU. In case of a black swan event, the Swiss equity market could be weakened by a damaged global economy or/and a revalued Swiss franc that would be considered as a safe-haven currency (i.e global earnings worth less).
Nevertheless, the historically high risk premium (6%) and the estimated 3.1% average dividend returns make Swiss equities attractive for investors in comparison to Swiss bonds. In fact, dividends are an essential component of the Swiss equity market as they accounted for over 50% of the total return of the Swiss equity market during the last 20 years, the rest coming from stock price increase. Also, for home investors (i.e Swiss private investors), distributions not subjected to withholding tax are income tax-free.
Review of the largest Swiss market cap: Nestlé
Nestlé is the world’s 1st food and drink company in terms of sales with a leading position in the coffee market (Nescafé), bottled water market (Nestlé Waters), frozen pizza market and pet food business (Friskies, Purina). Nestlé operations are divided between different product categories, including powdered and liquid beverages (22%), nutrition and health sciences (17%), mild products and ice cream (16%), dishes and cooking aids (14%), pet care (14%), confectionery (9%) and water (8%).
Nestlé is operating in 190 countries, North America being its most important market with 45% of total sales in 2016, then EMEA accounts for 30% and Asia for 20%. As a result of the US Tax Reform, Nestlé expects a reduction in its US corporate tax expenses of around CHF 300 million per year.
Sales growth in Europe and Asia was encouraging while North America and Brazil continued to see a challenging environment. In 2018, Nestlé expects sales to grow by 2% to 4%. After a decrease in net profit in 2015 – 2016 (i.e adjustment to deferred taxes), a strong net profit increase is expected in 2018. In fact, net profit decreased by 15.8% to CHF 7.2 billion and earnings per share decreased by 15.8% to CHF 2.32 mainly due to an impairment of goodwill related to Nestlé Skin Health. The Group’s net debt also increased from CHF 13.9 billion to CHF 17.9 billion in 2017 due to the share buy‐back programme launched in 2017.
Nestlé could also face risk factors affecting future results, for example a major event triggering food safety that would hurt Nestlé brand image, a negative perception of processed food or capacity constraints resulting from raw material issues (e.g water shortages).
In term of corporate governance, BlackRock (US) holds 4.7% of Nestlé share capital and The Capital Group Companies (US) also holds 3.55% of the 3 112 160 000 outstanding shares currently priced at CHF 76.
Nestlé could also use acquisitions to reposition itself away from processed foods as the packaged food industry faces competitive pressures and health concerns, the strategy would be to focus on both healthy products and the others divisions (water, coffee, pet care, …) by investing in high-growth businesses. As part of that strategy, Nestlé recently agreed to sale its candy business to Ferrero for $2.8 billion in response to declining sales in the unit.
To conclude, it could be useful to add some Swiss equity to a portfolio in order to benefit from the global exposure of its constituent, the relatively satisfying average returns in comparison with bonds, and the weaken franc that benefits to Swiss companies vis-à-vis other European companies. Diversifying geographically the portfolio by adding Swiss stock to it could also benefits to the investor in case of an euro-appreciation that would weaken the Swiss franc and reveal hidden value as described before. Finally, in case of a portfolio invested outside Switzerland, expanding the asset universe with international diversification to the Swiss equity market would generally reduce the risk and maximize the return, on the other hand, a Swiss investor with a portfolio already largely allocated to Swiss equity should definitely consider diversifying outside of his homeland to benefit from diversification gains and avoid the so called home bias.
Mattis Maurinier
Sources:
- UBS House View 2018
- Nestlé Annual Report