NSRGY Nestle SA (PK)

By Saabira Chaudhuri 

KitKat owner Nestlé SA is upping its game in high-end chocolate to chase revenue growth as overall chocolate volumes decline.

Global chocolate volumes will be flat this year from a year earlier and fell 1.1% last year, according to Euromonitor. In the U.S., the world's largest chocolate market, consumption peaked in 2005 and has declined 3% on average over the past 10 years, according to UBS. But revenue has grown by 3% a year on average since 2001, the firm said, as companies have sold health-conscious shoppers pricier offerings with complex flavor profiles, organic ingredients and less sugar.

That is forcing mainstream chocolate companies like Nestlé to shift gears.

On Thursday, Nestlé reported 3.1% organic growth from a year earlier in its confectionery business for the six months ended June 30, below growth in categories like water, pet care and coffee. François-Xavier Roger, Nestlé's chief financial officer, called confectionery "a difficult category," noting that growth was down year-over-year with "no category growth overall in the U.S."

Overall, Nestlé reported first-half net profit of 4.1 billion Swiss francs ($4.3 billion), down 8.9% from 4.5 billion francs over the same period in 2015. Revenue of 43.2 billion francs was equivalent to organic growth--which strips out the effects of currencies changes, acquisitions and divestments--of 3.5%, aided by strong sales in North America. The company has missed its sales target of organic growth of 5% to 6%--dubbed the "Nestlé Model"--for three years running, raising questions about its long-term growth prospects.

The chocolate industry has been consolidating over the past decade, delivering efficiencies to a handful of big players that have helped them battle falling volumes. Mondelez International Inc.'s recent $23 billion bid for Hershey Co. failed, but analysts expect further consolidation. The top six players control 60% of the market, according to Euromonitor.

Nestlé, which bought 60% of Chinese candy maker Hsu Fu Chi in 2011, has largely stayed away from making big acquisitions in confectionery. The company has showed interest in buying Ferrero International SA but has been unsuccessful so far, leaving its chocolate portfolio skewed toward mainstream chocolate with brands like KitKat, Crunch, Butterfinger and Smarties.

As consumers have displayed a taste for upscale chocolate, Nestlé has worked to position some of its existing brands as premium offerings in certain markets. KitKat runs stores in Japan that last year sold a limited-edition version of the chocolate wafer covered in a layer of real gold foil for Yen2,016 ($20).

More recently, Nestlé has moved to take some of its local chocolate brands international, highlighting their provenance and heritage. Consumers, particularly millennials, have an increasing desire for products with strong local stories.

Nestlé in March said it would invest EUR60 million ($67.9 million) over three years to take its Italian chocolate brand Baci Perugina global. It agreed to sell six other Italian chocolate brands to fund its focus on the hazelnut-studded bonbon.

Valeria Norreri--a Nestlé brand manager who worked on the international rollout of its San Pellegrino water, which now sells in 145 countries--is heading a new international confectionery unit that aims to turn Baci Perugina into a global name.

"Sales results of several countries confirm that the product has the potential to win in foreign markets," she said in March.

Nestlé last year decided to take its almost-200-year-old Swiss chocolate brand Cailler international, in a bid to enter what it described as "superpremium chocolate," traditionally the province of names like Lindt, Godiva and Ferrero. The hazelnut-and-almond chocolate, made with milk collected within 20 miles of the Cailler flagship store in Broc, Switzerland, now sells through Amazon.com Inc. in the U.S., the U.K., Germany and China, and at airports in Dubai, Singapore and Switzerland.

In February, Nestlé said it was taking its pistachio-laden Turkish chocolate brand Damak to the U.S. The company described Damak--which uses pistachios from the Gaziantep region of Turkey--as "an adventurous taste experience not found in any other chocolate."

Analysts have criticized Nestlé for its chocolate performance in recent years, noting its laggard position in the category relative to its dominance in coffee, water, infant nutrition and other businesses. The Swiss company's confectionery business, along with frozen food, also increasingly looks at odds with its ambition to become a health and nutrition behemoth, leading analysts to suggest it could eventually look to exit U.S. chocolate. Nestlé didn't immediately respond to a request for comment.

Hershey, Mars Inc. and Chocoladefabriken Lindt & Spruengli AG all have bigger U.S. businesses than Nestlé, and Hershey and Mars have also been pushing into high-end chocolate of late. Hershey last year launched a deluxe version of its Hershey's Kisses brand, featuring a hazelnut in the middle and rice crisps. Mars earlier this year completed a deal to buy Mexican chocolate maker Grupo Turin, which makes brands like Turin and Conejos and distributes Lindt in Mexico.

Brian Blackstone contributed to this article.

Write to Saabira Chaudhuri at saabira.chaudhuri@wsj.com

(END) Dow Jones Newswires

August 18, 2016 09:22 ET (13:22 GMT)

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