I have always regarded Nestlé as a high quality company. They have a broad portfolio of high quality brands like Nespresso and a significant stake (20,1% as of this writing) in L’Oréal, which is a high quality company in its own right. That’s why I was perplexed when I read the following in the 2024-half-year-report:

Net Debt
Net debt increased to CHF 59.5 billion as at June 30, 2024, compared to CHF 49.6 billion
as at December 31, 2023. The increase largely reflected the dividend payment of CHF 7.8
billion and share buybacks of CHF 2.5 billion.

In what universe does it make sense to borrow money, which costs money due to interest rates, to pay a dividend, which costs money due to taxes? In Switzerland the dividend tax is a whopping 35%, this amounts to 2,73 billion CHF. Paying taxes is unavoidable, that is not the problem.

What is worrisome is the 9,9 billion CHF increase in net debt. Nestlé’s average interest on debt is 2.6%, that is an extra cost of 257,4 million CHF. Unless Nestlé pays down their debt, this 257,2 million CHF cost will repeat itself annually. Which means they need to use their expected 10 billion CHF to pay down their debt. But they likely won’t do that, since their current actions have shown that they rather pay a dividend.

Repeat this behavior a couple of years and you end up with a compounding annual interest expense that will cost shareholders north of 2.5% of annual free cashflows. Which over time can significantly drag on performance.

I believe it is never worth borrowing money to pay a dividend. Borrowing only makes sense when the return on the borrowed capital exceeds the interest expense. Which given the 35% tax is highly unlikely.

In the Netherlands we have a saying that goes:

Een sigaar uit eigen doos.

A cigar from your own box.

Which means giving someone a gift they themselves have payed for. In this case Nestlé shareholders bought themselves quite an expensive cigar.

In my opinion, the better course of action is to withhold dividends when liquidity is insufficient. I understand this is unpopular for a number of reasons and it might cause the stock to go down. Well, for long-term shareholders, this could be a blessing in disguise. This opens up the possibility for doing buybacks at value-adding prices. Buybacks are a great, tax-efficient tool to increase shareholder value. The lower the stock price, the more efficient the buybacks. I believe every company should have a flexible capital allocation strategy: First, (re)invest in high-return projects; secondly, use the remainder to distribute in the form of dividends or buybacks, depending on the share price. This approach, when executed correctly, will yield the best long-term results for shareholders.