Danone

Stock price: €44.1
Conclusion: As expected, Danone is revising its sales growth guidance to 6%+ this year. However, negative pricing coupled with higher input costs prevent Danone from raising margin expectations. Assuming a return to double digit growth next year, CAGR in EPS between 2008 and 2011 should not exceed 5%. We find Danone fairly valued in light of such growth rate.

H1 results: Sales up 11.2% to €8.3bn (+7% organic-+6.9% organic in Q2).EBIT +6% (+2% organic) EPS -2%. Guidance 2010: sales up 6%+, margin stable, Free Cash Flow up 10%+

Solid growth, still driven by lower pricing
-Volume grew 9.8% in H1 (+8.9% in Q2). All businesses reported high single digit growth in Q2 (+8 to +10% volume). Dairy growth is driven by new markets (US, Latam) and a return to growth in Europe except Southern Europe. Water is also boosted by developing markets and improved demand in Europe. Japan and Spain remained tough. Infant milk is up double digit while weaning food is flat. Medical keeps growing double digit.
-Pricing remained negative in Q2 (-2% vs -2.8% H1), notably in dairy (-2.7%) and in water (-3%), while baby food and medical remained flat.
-We are surprised by the magnitude of pricing decline in Europe (-3.7% Q2 almost unchanged vs -4.3% in Q1 ) at a time when large markets such as France or Poland, according to management, returned to positive numbers. We think of two probable reasons, first Spain where the crisis deepened, second a negative mix in water . The good news comes from the return to positive pricing in Asia and in the Rest of the World.

No leverage, volume is not enough
-We estimate the underlying decline in margin at -134bp vs -74bp reported given the 60bp decline in A&P spending in H1. The decline results from higher Input cost (94bp), negative country mix (15bp) and pricing, partly offset by savings.
-Stable margin for the full year will require +70bp gain in H2. We find the target challenging given the further increase in input costs in H2, above 10%. It will depend on pricing which has to turn positive, and also on costs savings (€500m) skewed towards H2.
All in all we look for €16.9bn sales-stable margin at 15.3%-€1642m net profit-EPS +6% to €2.73.
-Beyond 2010, Danone needs to come back to positive pricing. Much will depend on brand equity at a time when health claims become harder to defend (cf our April 15th comment). We will also look at the integration of Unimilk in Russia which will initially weigh on Danone’s margin. Last, it remains to be seen whether margins will take off in water following years of steady decline.

Danone trades at 16.3xP/E and 10.5xEV/EBITDA based on our 2010 estimates. We think the stock looks fairly priced in light of its EPS growth track record since 2008 and the challenges for H2 and next year. Our valuation range of €48-€50 remains unchanged.

Danone

Stock price: €44.5
Conclusion: We slightly raise our valuation range up to €48-€50 per share on forex coupled with the positive impact of the merger with Unimilk in Russia. We feel that Nestle continues to offer better value.

Expanding in Russia: reasonable price but high execution risks.
-Danone will merge its Russian dairy business (€500m sales-12% margin) with Unimilk (€1bn sales-6% margin). Following €120m cash contribution, Danone will control 57.5% of the JV, while the Unimilk shareholders will hold 42.5%. Unimilk shareholders have put options to sell their stake between 2014-2022 for €1.3bn. Russia will account for 10% of sales (second largest market after France).
-10.5xEBITDA looks moderate for a deal supposed to (1) give Danone the leading position in the CIS area and in Russia with a 21% share (2) accelerate Danone top line growth by +50-100bp (3) provide cost synergies accounting for 200bp over 4 years.
-One should not underestimate execution risks attached to the deal. First, the complexity of Unimilk’s industrial platform (28 facilities in Russia, Ukraine and Belarus making €1bn sales comparing with 55 plants for Danone worldwide accounting for €8.5bn sales). Second, the target of 20% growth pa for the JV looks demanding in light of the long term mid single digit volume growth recorded for the dairy market in Russia, even assuming increased value combined with market share gains. We think that shedding a light on Danone’s recent track record in Russia would have been useful. Thirdly, it might take longer than expected to transform Unimilk business into a high value added business with superior margins.

Danone trades at 16.5xP/E and 10.8xEV/EBITDA based on our 2010 estimates (EPS €2.69 in 2010-€3.06 in 2011) implying a slight premium to peers. We expect Danone to revise its long term growth target from 5%+ to 6%+ sooner or later. Nonetheless, the stock offers less upside potential than Nestle for the nex 12 months.

Danone

Stock price: €46.0
Conclusion: Strong top line in Q1, but at the expense of pricing. Management confirmed flat margin this year implying no leverage. We reiterate that the stock looks fully priced based on our valuation range of €46-€49 per share.

Sales Q1: €3.978m, up 8.2% (+7% organic). Confirming guidance for 2010: sales growth above 5%, stable margin, FCF up 10%+

Strong start in Q1.
-Organic growth was broad based in dairy (+7.6%), baby (+8.5%) and medical (+9.3%) driven by strong volume (+10.8%)
-Water lagged behind with only 2% growth, despite solid volume up 8%.
-Asia and the Rest of the World driving sales thanks to double digit growth.

…driven by pricing cut.
-Negative pricing impacted sales by 3.8%, notably in dairy (-4.9%) but also in water (-6.2%) and baby food (-0.4%).
-Europe is the most impacted (value down 4.3%).
-Comps will turn positive in value in H2 but will become tougher in volume, leading us to expect organic growth to slowdown.
-Management is expecting flat margin for the year, which means that the gains from higher volume are offset by the negative leverage coming from pricing.

Withdrawing claims before European Food Safety Authority (EFSA) ruling.
According to Danone, “the lack of clarity and visibility regarding the application of the European regulation on health claims” justifies its withdrawal decision. Danone is waiting for clarification which might or might not come from a new meeting early June. We feel that Danone’s claims for Activia and Actimel were increasingly at risk following the recent issue of negative opinions on probiotics by EFSA. Short term, management is saying that the absence of claims does not prevent Activia and Actimel from growing in France and the UK. Longer term however, we think this is clearly bad signal sent by Danone which used to say that “building credibility in health is crutial to our mission”..

Danone trades at 17.7xP/E and 11.6xEV/EBITDA based on our 2010 estimates, implying 25% premium to Nestle (9xEV/EBITDA). We think the stock is fully priced and we continue to prefer Nestle.

Danone

Stock price: €41,9
Conclusion: Back to growth but not at the EPS level… We raise our valuation range up to €45-€47 per share to account for improved cash generation. Nonetheless, Danone remains expensive vs peers and offers lower near term upside potential.

2009 results: in line with expectations. Sales down 1.6% reported to €15bn (+3.2% organic)-Net earnings +11% to €1412m, EPS down 3% to €2.57. Guidance 2010: sales growth above 5%, stable margin.

We might have to wait until 2011 to see a return to EPS growth
-Top line growth is back but at a huge cost. Sales in Q4 rose by 5.5% (+3.2% full year) with pricing down 3.4%. The dairy division recorded -5.3% value impact in Q4. According to Danone, consumption in 2010 should not rebound and one might see even more pressure. Danone forecasts another negative pricing impact of -2-3% in H1 this year, only partly offset by positive mix impact in H2. Management implied that we will have to wait next year to return to positive pricing territory.

-2010 headwinds. First, margins in dairy (up 30bp in 2009) will be under pressure due to continuing pricing decrease in H1 at a time when milk costs are expected to bounce back (+5-7%). We forecast input costs impact to turn negative this year (-70bp vs. +250bp excluding productivity gains last year) Second, Danone said that the geographic diversification in baby and medical should impact the margins by around 10bp. Last, notwithstanding a 35bp gain in “underlying” margins in water last year, Danone’s track record on the reported front (margins which drive EPS declined for the third consecutive year) leads us to remain cautious for 2010.

-We feel more confident on the financial expenses side. Net debt went down by €4.6bn last year to €5.7bn (1.9xEBITDA). In addition to the capital issue, Danone increased FCF by more than 20% to €1.3bn. We project +18% increase this year to €1.53bn, driven by further improvement in working capital inflow, notably for baby food and medical.
However, EPS could remain stable (around €2.55), impacted by the higher number of shares.

Our DCF model leads to €47 per share. However, the comparison with peers shows that Danone continues to trade at a premium (16.4x P/E and 10.5xEV/EBITDA based on 2010 estimates). We have been prefering Nestle last year, today’s presentation leads us to stick to our view.

Danone

Stock price: €42.5

Conclusion: Sharp downgrade of medium term annual sales growth target. We stick to our valuation range of €40-43 per share. Stock seems fully priced

We felt that the objectives of +8-10% growth that where annonced in 2008 following the acquisition of Numico to justify the premium paid were not sustainable. We were expecting the group to cut its medium target, but we are surprised by the magnitude of this downgrade. +5% growth corresponds more or less to the objectives of Danone peers in the food sector. The new objectives for the medium term is even below the former target including the slow growing biscuit business, which looks clearly disappointing for a group supposed to be smaller, leaner and more focused on the fastest growth segments in the food industry (dairy, baby food and water). Danone is acknowledging that new consumer behavior might prevent it from boosting revenues and margins through highly priced innovative blockbusters. As a result, Danone is moving from a value to a volume driven strategy.

The objectives of €2bn of free cash flow by 2012 implies a 2010-2012 CAGR of 17% which looks ambitious compared with the revised expectations for top line growth.
The absence of guidance on the margin front is reducing bottom line visibility. We believe that management will more focus on capex and working capital release than margin improvement to get there.

The good news is it will be easier for management to meet sales growth expectations in the future. Nevertheless, Danone trades at 15.5x P/E and 11x EV/EBITDA, which implies more than 10% premium to peers, more difficult to justify today. We continue to prefer to buy Nestle which offers compararable growth and margin improvement at a discount vs Danone.

Danone

Stock price: €42.5
Conclusion: Rebound in volume at a huge cost. Waiting for revised medium term guidance. Valuation looks full in light of our estimated range (€40-43 per share)

9 months: Sales down 2.2% reported, up 2.4% like for like (Q3 up 4.1%). 2009 guidance: 4% growth in H2, EBIT margin improvement 60-70bp in constant currencies. +10% EPS growth but meaningless as it is ex right issue and forex impact…
Including both, we expect EPS to be down by 6% this year.

We are still waiting to see the right balance between volume and pricing. Q3 was marked by a spectacular rebound in volume, up 7%, but also by negative pricing, down 3%. Although we understand that this was the price to be paid to restore growth in yoghurts, we lack visibility regarding medium term guidance. Interestingly, the CFO said he was confident about the growth drivers (innovation and new markets in dairy products) but he did not confirm medium term guidance of +8+10% growth . Last, we feel that Danone will need to adapt its health claims to the new regulation, which might take some times.. and adjustments (cf settlement in the US and stricter regulation in the UK)

Growth in water (+9% in volume) is also held back by a structurally negative geographic mix, as emerging markets should continue to drive future expansion. In addition, margins keep going down in water and we don’t know when they should start to stabilize.

Visibility looks better in baby foods and medical nutrition.
Baby foods is slowing down, but this is mainly the result of slower demand in prepared foods,more affected by the economic downturn, and a tough comparison base in infant milk in China. Danone keeps gaining share in infant formula outside of China.
Medical nutrition should also benefit from long term growth visibility at a time when baby boomers are ageing.

In conclusion, we expect management to revise down its medium term guidance which look too agressive, notably for dairy and water. The stock trades at 16.2x and 15.2x P/E based on F9 and F10 estimates and 10.8x EV/EBITDA, which looks generous considering EPS expectations for this year and next year (-6% and +7% respectively).

Danone

Stock Price : €37,4
Conclusion: Lack of clarity in the guidance. We thought that the stock was fully priced before the rights issue, it is still the case following H1 results.

H1 sales up 1.6% like for like, down 2.2% reported. Net income up 7.6% like for like, 3% reported. Management confirmed guidance of sales growth “a few points” below the medium term target of +8-10% and +10% growth in EPS.

Based on our full year forecast (like for like growth of 3.6%, implying +5.6% in H2), we feel that the wording of the guidance could have been changed from “a few points” to “well below”…
As to the EPS guidance, although we understand the measure at constant scope of consolidation and constant exchange rates, we wonder why it is excluding the effect of the rights issue, which makes it almost meaningless for the shareholder.
The fact is our EPS forecasts for 2009 and 2010 are respectively 10% and 14% lower than our March estimates.

Fundamentally, we believe that the mid term guidance of 8-10% revenue growth is too high in light of the durable pricing pressure in the dairy business and volumes decline in water in developed markets. In addition, the recent pricing pressure in Germany indicates that the highly profitable medical nutrition business is not immune to the economic crisis.
In conclusion, at a time when consumers are less willing to pay a premium for health benefits, Danone offers a medium term growth scenario of +5-6% in sales and +9-10% increase in earnings.

The stock which was fully priced before the rights issue is down 13% YTD. Danone still trades at 14.7x 2009 and 13.6x 2010, which implies a 12% premium versus Nestle adjusted for Alcon (13.1x-12.3x). Our long term DCF based valuation suggests no significant upside.

Danone

Stock price: €37
Conclusion: Stock down 6,5%, but still at risk.

Rights issue of approximately €3bn

Danone announced its intention to raise €3bn of equity capital through a Right issue in order to optimise the capital structure of the company. CFO estimated the dilutive impact at around 10%. Net debt will come down from €10.3bn to €7,3bn, implying 2,6x EBITDA vs 3,7x before the right issue.
Management stressed that there is no immediate plan to buy back minorities in Spain (valuation range estimated between €2-2.4bn) following the death of Daniel Carasso.
Management reiterated guidance for 2009, adjusted for forex and excluding the right issue.

We said in our last comment that the stock was fully priced at €37,4 (April,16).
Notwithstanding today’s fall , we are still seeing further downside risk.

First, we feel that the current difficulties of Danone Spain might incite minority shareholders to exercice their put option, which would leave little room for manoeuvre for bolt-on acquisitions.

Second, we wonder whether reiterating a guidance of 10% in EPS this year, but adjusted for currency impact and also excluding the right issue still makes sense for shareholders !

Third, we think the mid term guidance of 8-10% underlying growth coupled with margin progression becomes increasingly questionable at a time when management looks for a durable economic downturn. We believe that 2010 guidance might be, again, below target.

In conclusion, 14.2x P/E and 8.6x EBITDA looks expensive in light of the lower EPS growth visibility.

Danone

Stock price: €37,4 

Conclusion: Fully priced.

Q1 sales down 2.3% (reported), up 1% like for like.

• Danone posted 1% underlying growth in Q1, thanks to double digit growth in the businesses acquired from Numico, baby food  and medical nutrition, which helped to offset lower sales in fresh dairy (-1.2%) and in water (-3.9%). Management reiterated guidance for the year: like for like growth “a few points below medium term target (8-10%), margin improvement, EPS growth +10% adjusted for forex .
• We think that only 1% growth in Q1 does not bode well for the rest of the year. Top line in 2009 could be “well ” and not just “a few points” below target. Danone struggles in the  fresh dairy division, with sales down 1.2%. Fresh dairy account for almost 60% of  Danone sales. Q1 numbers imply that the business model which used to rely on double digit growth in the blockbuster (Activia, Actimel..) categories is no longer working in a tougher economic environment. Management did not comment on France and Spain which are key markets for the dairy division, which is also worrying.
• Management continues to expect margin to improve, which we think is feasible considering the positive impact of lower input prices this year coupled with superior growth in the highly profitable baby and medical categories. However, price reductions associated with promotions in fresh dairy and declining consumption in water in developed markets should hold back the expected gain in profitability.
• As a result, 10% growth in EPS (adusted for forex) this year might be difficult to achieve. According to our estimates, such a guidance would require almost 100 bp gain in EBIT margin, which seems too high in the current environmemt.  The risk exists to see management revising down guidance in the coming months. 
• The stock seems to be fully priced. We forecast 4% EPS growth this year on a reported basis, implying +7% on an underlying basis. The stock trades at 13x earnings, which is generous considering the low visibility in the dairy division. Our DCF valuation,based on a 9% Wacc, is close to the current stock price.