BUY OR SELL-Has Nestle got further to run on Alcon sale hopes?
* Recent broker upgrades drive stock rally
* Alcon sale could prompt further buybacks
* More buybacks priced in? M&A seen as risk
ZURICH, Oct 28 (Reuters) - Shares in Nestle SA (NESN.VX), the world's biggest food group, have rallied in recent weeks on hopes it will sell its stake in eye care firm Alcon (ACL.N) and return the proceeds to shareholders.
Have the shares run out of steam or are they still undervalued?
BUY
Nestle shares broke out of their recent trading band after UBS upgraded the stock to "buy" due to hopes it will sell its remaining 52 percent stake in Alcon, potentially raising up to $28 billion.
The 9 percent rally of the last two weeks in Nestle's stock compares to a 3.7 percent rise in the DJ Stoxx European food and beverage index .SX3P. The shares were trading up 0.2 percent at 47.30 Swiss francs at 0949 GMT.
Nestle said last week it was likely to exercise its option from January 2010 to sell its Alcon stake to Novartis (NOVN.VX) as it announced in-line third-quarter sales. [ID:nLM416716]
Nestle, which makes Nescafe coffee and KitKat chocolate bars, also said it was speeding up its 25 billion Swiss franc ($24.53 billion) buyback programme, prompting analysts to speculate it might launch another next year if it sells Alcon.
In a note entitled "Fifty Billion Dollar Baby", Deutsche Bank analysts Jamie Isenwater and Harold Thompson said that prospect had prompted them to up the stock to "buy" from "hold" and hike its price target by a third to 60 francs.
"Nestle is on the verge of a transformational event in our view. We believe the likely disposal of its Alcon stake in 2010 could catalyse the start of a circa 50 billion franc buyback over the next five years," they wrote. [ID:nN27273258]
Despite its diverse product range and geographical reach, Nestle has underperformed the food and beverage sector this year, partly due to questions over what it plans to do with its stakes in Alcon and French cosmetics giant L'Oreal (OREP.PA).
The sale of the first Alcon tranche sparked speculation last year Nestle might use the proceeds to seek a full takeover of L'Oreal, but many analysts now say Nestle would be better advised to focus on its core food business. [ID:nL9655831]
"We ... believe that Nestle is a seller, not a buyer of L'Oreal and see potential for buybacks or acquisitions to increase earnings per share growth from 8 percent to 12 percent per annum until 2015," said Deutsche's Isenwater and Thompson.
Analysts said stripping out Alcon would expose Nestle's relatively cheap valuation compared to food and beverage peers.
Nestle is trading at 15 times forecast 2010 earnings, in line with the world's third-biggest food and consumer goods group Unilever (ULVR.L) (UNc.AS), but at a discount to French food group Danone SA's (DANO.PA) 16 times. [ID:nLN229250]
"We think the Alcon disposal could be a revaluation catalyst early next year," said Helvea's Andreas von Arx, who rates Nestle "accumulate" with a price target of 51 francs.
SELL
SNS Securities analyst Richard Withagen argues that the market's focus on the Alcon proceeds has pushed the share up too much, noting Nestle's price/earnings ratio of about 15 times for 2010 compared to about 14 times for its peer group.
"Valuing the food and beverages business in line with the industry leads to a target price of 44 francs," he said, cutting his rating to "reduce" from "hold".
Deutsche's Isenwater and Thompson admitted a major risk to their optimism would be a "value-destructive" acquisition.
Nestle has declined to comment on any possible counterbid for Britain's Cadbury (CBRY.L) against Kraft (KFT.N), though it said it was always open to purchases of the right kind.
J.P. Morgan analyst Pablo Zuanic cut his price target to 42 francs from 45, saying he does not see volume growth speeding up in the fourth quarter and while Nestle has good emerging market potential, they are offset by its uncertain L'Oreal intentions.
"Although far from certain, the scenario of all Alcon proceeds being allocated to share buybacks is priced in already, in our view, and hence news flow contradicting that view should generate downside," he said. (Editing by David Cowell)
