2nd UPDATE:Nestle Warns Of Tough 2nd Half As Raw Material Costs Rise

Nestle SA (NESN.VX) Wednesday warned of a "more challenging" second half as higher raw material costs are set to dent business, reflecting the bearish mood in the food and beverages industry that has worsened amid a recent sharp spike in commodity prices.

Even as the Swiss food and beverages giant, which owns household brands such as Perrier mineral water and Dreyer's ice cream, improved first-half net profit and sales and reiterated its full year targets, Chief Executive Paul Bulcke said in a letter to shareholders that the second half will be more difficult due to "a more challenging input cost environment".

The warning about a harder second half comes as food companies around the world are struggling with higher raw material prices and slow consumer demand in Europe and the U.S., which prevents food firms from raising retail prices to balance higher costs.

Costs for powdered milk, cocoa, coffee and wheat have risen at double-digit rates over the past few months, prompting food majors such as Danone SA (BN.FR), Unilever Plc (UL) and Kraft Foods Inc (KFT) to turn more cautious for the next few quarters.

Premium chocolate producer Lindt & Spruengli AG (LISN.EB) said Wednesday that cost cuts were needed to balance the recent 30% spike in cocoa prices but that retail price increases were difficult to hammer through and would depend on inflation and currency development.

Nestle's Chief Financial Officer James Singh, who described the current economic climate as "one of the most difficult periods in decades," said the company will avoid price wars but would stay competitive by increasing the quality of its products.

Still, he added that Nestle's global geographic presence as well as super-selling products such as ice tea Nestea and pet food Dog Chow, which each generate more than CHF1 billion in annual sales, should help the company gain market share going forward.

Nestle also expects that cost cutting, efficiency improvements and investments in its distribution network and marketing should help support its full-year organic growth rate as well as its operating profit margin.

"We have increased investment in our brands, people and capabilities and have prepared the company for a more challenging second half," CEO Bulcke said. "Our focus is on winning in all markets," CFO Singh said, adding that "Nestle will perform irrespective of market conditions."

As a result of these efforts, Nestle expects a full-year organic growth rate--which strips out the foreign exchange and acquisition impact but includes price changes--of about 5%, up from about 4% a year earlier, while the operating margin should beat last year's results when the figure stood at 14.6%.

Cost cutting and investments in its distribution network paid off in the first half as Nestle posted a 7.5% rise in net profit to 5.45 billion Swiss francs, or about $5 billion, from CHF5.07 billion in the year earlier period. Revenue, which was helped by continued strong growth in Asia, increased 5.9% to CHF55.34 billion from CHF52.27 billion a year earlier as the company also benefited from strong demand for its pet food products and its Nescafe coffee system.

Analysts welcomed the strong set of results and said that despite the more difficult economic environment in Europe and the U.S. Nestle is likely to excel in the months ahead as the company also stands to get a $28 billion cash inflow from the sale of its stake in U.S. eye-care company Alcon Inc (ACL), which is expected to be finalized in the third quarter.

"Nestle's figures are very strong and with the company's focus on cost cutting and its push in advertising spending, it is set to outperform the food and beverages sector," said Jon Cox, analyst at brokerage Kepler Capital Markets.

Analysts expect Nestle to continue to expand its market presence through small to medium-sized acquisitions. Nestle recently took over U.K.-based clinical nutrition firm Vitaflo and bough a majority stake in Guatemala-based food and drinks producer Malher, helping it to broaden its presence in fast-growing markets.

Shares in Nestle, which have advanced about 2.5% this year so far, were unchanged in an overall lower Swiss market.

-By Goran Mijuk, Dow Jones Newswires, [phone]; [e-mail]