With the first Danone yogurt created and sold 100 years ago, Danone is now a multinational consumer food company listed on the Euronext Paris (the second largest exchange in Europe). It is also a constituent of the CAC 40, a benchmark French stock market index, representing the 40 most significant stocks within the Euronext Paris.
With Danone products available in over 120 countries, the business employs more than 100,000 people and generates c. 66% of revenues outside of Europe. Danone has a number 1 market position in fresh dairy products and plant based products worldwide. It has a number 2 market position in early life nutrition and packaged waters worldwide and a number 1 market position in Advanced Medical Nutrition in Europe. So how has all of this been achieved and what is the strategy behind it?
Danone has built one of the biggest global food and beverage businesses by acquiring key players in markets outside of Europe and growing Danone and other brands within the European market. By identifying key trends outside of dairy, Danone has built a diversified revenue base in both specialised nutrition and waters. The company prides itself on research and innovation, keeping their brands ahead of consumer trends. Its latest move is into plant-based products, which should provide a growth platform for the group going forward.
Danone operates across three defined segments: essential dairy & plant-based products (EDP), specialised nutrition (SN) and waters.
EDP is Danone’s core offering and represents 53% of sales, the segment includes dairy-based products such as yogurt, milks, probiotics and flavoured coffee creamers with which many consumers will be familiar. In 2017 Danone purchased WhiteWave, a US based consumer group operating in organic foods and plant-based milks. In April of this year, and in line with capital allocation priorities, it sold the loss-making organic salads business Earthbound Farm as it sought to focus its strategy on alternative milks and health foods.
Specialised nutrition (SN) encompasses Danone Early Life Nutrition and Advanced Medical Nutrition, both of which aim to improve the health and wellbeing of vulnerable individuals. This division looks to capitalise on health and nutrition focused consumer trends, as well as tapping into the ageing population trend and the increased role of nutrition in managing health issues.
Danone markets a range of packaged water brands globally, with its largest markets in China, Indonesia and France, as consumers make the transition from sugary carbonated drinks to more natural products. Two thirds of the segment’s revenues are generated from natural waters and one third from flavoured waters.
Strategy & Targets
Danone’s strategy is focused on staying ahead of consumer trends and delivering premium products to market. It is capitalising on a pivot towards nutrition and health focused consumer decisions.
Danone’s financial targets include an efficiency programme on its selling, general and administrative expenses, aimed at strengthening the company’s competitiveness by generating cost savings of €1 billion by 2020. Danone will reinvest a significant portion of the gains in growth, to support the implementation of its strategy and mission.
FY18 delivered €300m in cost savings, while management have guided €350mn in FY19. Plant-based products incorporate a significant aspect of management’s strategy as it expands the footprint of Alpro, its alternative milk brand, in additional European markets. Expanding the market, along with the secular tailwind can provide sustained growth for Danone.
In addition to its financial strategy, Danone has made significant progress towards both nutritional and environmental targets, which should help it to sustain superior premium pricing as well as continuing to gain share from the conscientious consumer. 78% of products are in line with its nutrition standards (with a target of 100% by 2020), which look to lower sugar, saturated fats and salt content. On the environmental front, 87% of packaging is recyclable, reusable or compostable (with a target of 100% by 2025).
While the European consumer staples and food sector is more expensive than its US equivalent, we see this premium as justified considering fundamental performance of the underlying companies. We prefer European foods because of their superior earnings growth, stronger margins and cash flow. European foods also tend to have a more diversified revenue footprint and are less reliant on their home markets, or on the US. We do not expect the premium that European names enjoy to diminish in the medium term. While the sector might not include the most exciting names, these businesses are less cyclically exposed, and their performance is more consistent throughout the business cycle. They deliver a strong yield underpinned by robust operating performance. Given the increasing concerns regarding global growth and bond yields, valuations across the sector have increased.
Danone has traded at a discount to its European peers for several years, mainly due to concerns regarding strategy and lagging profitability. Management’s 2020 strategy has begun delivering efficiencies and improved underlying performance. We believe that, if management can continue to deliver on this strategy, Danone can close the valuation gap and generate relative outperformance against its peers.
The investment case for Danone begins from our top down sector allocation. Our preference for increasing defensive allocations is predicated on weaker economic data, indicating that global growth is likely to continue to slow. We expect European consumer foods and staples to outperform, with robust revenue streams, strong margins and cash flows. Within the sector, Danone offers the most attractive risk/return profile. While headline sales growth is expected to be flat, reoccurring sales growth is expected to be 3% and to expand to 4-5% by 2020. Margins continue to improve as management cut costs and pivot the business to higher margin products. With a yield close to 3%, the current depressed interest rate environment is likely to continue to be supportive for Danone.
In addition to its strong operating results and attractive valuation, Danone’s strategy should be supported by a structural growth trend. Consumers are increasingly assigning value to the health and nutritional benefits of food. Management’s acquisition of Whitewave gives it a strong footprint in plant-based products, a segment which can support growth over the medium term.
There are of course a number of risks to the investment case including the failure of management to deliver cost cuts, resulting in weaker margins. Continued inflation in input costs could also erode margin gains. Slowing growth in major markets such as the US, Russia and Emerging Markets would have a direct negative impact on group revenues.
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Warning: Past performance is not a reliable guide to future performance. The value of your investment may go down as well as up.