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Chart Of The Day: Too Late To Ride Third Point's Nestle Shake-Up?

Published 06/26/2017, 10:00 AM
Updated 09/02/2020, 02:05 AM

by Pinchas Cohen

Shares of Nestle SA (SIX:NESN, OTC:NSRGY), Europe’s largest company and the world’s biggest food company—with revenues upward of $80 billion—jumped 4.7 percent in early Zurich trading today, setting off a broader rally in European equities. The bounce occurred on the news that US activist investor Daniel Loeb, founding CEO of New York-based hedge fund Third Point LLC, had 'targeted' the company, amassing 40 million shares for a $3.5 billion stake in Nestle’s $254 billion market cap. This gives Loeb 1.3 percent ownership in the food and beverage multinational and makes him Nestle's sixth largest shareholder.

When the news became public, Third Point issued a statement:

“It is rare to find a business of Nestle’s quality with so many avenues for improvement.”

How's that for a backhanded compliment? The company has tremendous potential, but it hasn’t been managed very well. Of course, the hedge fund has a point. Nestle’s stock has underperformed most of their US and European consumer staple counterparts in various measures over the last decade.

Among Third Point’s suggestions to Nestle management: sell the company's 23% stake in cosmetics maker L’Oréal SA (PA:OREP); increase leverage for share buybacks; and adopt a formal profitability target.

Too Late To Get In?

Nestle Daily

Now, that the stock is up 4%, is it too late to ride the Nestle gravy train?

No. The supply/demand dynamic suggests another rise of at least an additional 4.5 CHF per share toward 90.00, or 5%.

While a reversal H&S is common among published articles, consolidation H&S seems to escape most, and that is exactly what today’s leap completed.

The left shoulder was formed in the 81-83 range between May 22 and June 6, on a successful rally after March’s 77.5 peak, within an uptrend. The head was formed in 80-83 levels between June 7 and June 16, as a correction off the rally.

The right shoulder was formed in the 81-84 price area between June 19 and June 23, as a mostly failed rally in advancing the uptrend.

The breakout on the upside breakout of the neckline completed the consolidation pattern, which suggests a resumption of the trend prior to the interruption. It therefore acts as a continuation pattern.

This type of breakout has an impact on the pattern’s completion. Although the volume was low, which doesn’t strengthen the case for any upside momentum, the gap does. A gap, in general, demonstrates that there were only buyers but no sellers at those prices.

While that sounds bullish, it isn’t always. It depends on the type of gap, based on its place on the price map.

This gap of 4-percent—from Friday’s 82.10 close to today’s 85.38 open—is very much a bullish “breakaway” gap, because it broke out of a consolidation and therefore acts as a support, suggesting a further advance. One question analysts want to determine is whether a gap is a meaningless “common gap," which occurs amid price congestion, or a "breakaway gap," that cleared out of that congestion.

That's easy to distinguish now that the stock has registered a fresh all-time high. The fact that this breakaway gap, which suggests further advances, happened on a completion of a continuation pattern, which itself suggests a further advance, bolsters the case for additional upward momentum.

The Relative Strength Index, a momentum oscillator that measures the speed and change of price movements, confirmed the price consolidation breakout with a breakout of its own. However, as a leading indicator for momentum it already provided a heads up when it crossed above its neckline on June 16, ten days ago.

Trading Strategies For Nestle SA

Minimum Target Price: $89, and since we’re carving out new price territories, there are no resistances.

Conservative traders would wait on a long position for a correction, as both gaps and H&S patterns often have one. Although it is a highly contested myth whether gaps must fill, they generally do, at least in part, as a gap is by definition an emotional expression. Traders experience buyer's remorse, because they become concerned they may have gone too far. As such, they immediately take profit, tipping the supply side of the scale. Since a rising gap’s support is at its bottom, Nestle’s would be at yesterday’s high of 82.30.

Moderate traders would wait for a correction before buying on a return move to the H&S, which is at 84.

Aggressive traders would jump in with a stake now, since there might be no return move, and they will then have missed a reliable opportunity. However, they should be aware that any certainty provided by being in the position is offset by a proportionately elevated risk of a pullback. Thus, they should input that into their capital management.

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