Never before have Nestle SA (NESN) bulls paid as much as they are now for options, convinced the food company will buy back shares and boost dividends after it sold a portion of its stake in L’Oreal SA.
The cost of calls that profit should Nestle climb 10 percent is near the highest level ever relative to bearish wagers, according to three-month data compiled by Bloomberg. Call prices linked to the stock that has risen 13 percent since June reached a record versus puts on Feb. 26.
L’Oreal’s agreement to purchase 8 percent of Nestle’s stake in February for 6 billion euros ($8.2 billion) won the support of Nestle’s biggest owners in part because it freed money to return to shareholders, a person familiar with the matter said last month. About 3.4 billion was paid in cash.
“Buybacks and an improved dividend are on investors’ minds,” said Manish Singh, who helps oversee $2 billion as head of investments at Crossbridge Capital LLP in London, adding that he plans to buy more of the company’s shares. “The cash from the L’Oreal stake sale answers that wish.”
Chief Financial Officer Wan Ling Martello said on Feb. 13 that Nestle will use the cash proceeds to start a stock-repurchase program. The company’s dividend yield will rise to 3.2 percent in the next year from 3.1 percent in the last, according to Bloomberg Dividend forecasts. Following the completion of the transaction, the world’s largest food company will own 23.3 percent of L’Oreal, down from 29.4 percent.
As part of the L’Oreal transaction, Nestle gained full control of its Galderma skincare joint venture, boosting Nestle’s focus on nutrition and health products.
“Nestle getting control of Galderma means the company moves further into the health and wellness sector,” Singh said. “So it’s not just food, but health and wellness as a long-term play, where investors see great potential for the future.”
Galderma, which makes treatments for acne and psoriasis, will become part of a new division known as Nestle Skin Health SA. It’s the latest push by Nestle into health care, a sector that promises faster growth and wider profit margins than the company’s main food business, according to Oru Mohiuddin, an analyst at Euromonitor International in London.
Revenue will rise about 5 percent this year excluding acquisitions, disposals and currency shifts, with the second half of the year stronger than the first, the Vevey, Switzerland-based company said last month after posting a 4.6 percent sales increase for 2013.
“The outlook for a continuation of dividend growth and share buybacks support the bullishness we’re seeing,” Konstantin Giantiroglou, head of investment advisory at Neue Aargauer Bank in Brugg, Switzerland, said in an interview on Feb. 28. “They will manage it in the best interest for the company and thus for its shareholders.”
Chris Hogg, a spokesman at Nestle, declined to comment on the options trading.
Craig Sterling, managing director and global head of equity research at EVA Dimensions LLC in New York, advises clients not to buy shares in Nestle, citing its high valuation.
“Nestle is a great company, but it’s expensive,” Sterling, who had the equivalent of a sell rating on Nestle, said in a phone interview on March 3. “Especially relative to its peers. You need to pick your spots and decide when you want to buy it, and it’s not a compelling valuation. I’d take a step back for now. I’d like to see it a bit cheaper.”
Nestle trades at 18.9 times estimated earnings, 2.7 percent more than food and beverage companies in the Stoxx Europe 600 Index, according to data compiled by Bloomberg. That compares with 17.7 for Danone and 17.8 for Unilever NV.
The VSMI Index, the measure that tracks prices of options on the Swiss Market Index, slipped 1.9 percent to 13.87 yesterday. Europe’s VStoxx Index dropped 4.2 percent to 17.91.
The number of bullish Nestle options outstanding was near its highest level since July 2011 relative to puts, data compiled by Bloomberg show.
There were 969,824 calls for 1 million bearish contracts as of March 3, according to the data. Among the five most-owned contracts, four were bullish. June 70-Swiss franc calls, with an exercise price 4.7 percent above yesterday’s close, had the largest open interest among bullish options, followed by June 84-franc calls, the data show.
“Investors are looking at Nestle as a package, and it’s a good-looking one,” said Gillian Hollenstein, who helps oversee 100 million Swiss francs ($113 million) as chief investment officer at Labha Investment Advisors SA in Zurich. “The L’Oreal stake reduction, return of capital via buybacks and market opinion that the guidance given by the company could be conservative all contribute to investors being inclined to buy the shares.”
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