Danone, the French food giant, came to the market this week in cautious mood.
The Activia manufacturer does not expect trading conditions to get easier in 2012. It forecasts its sales will grow more slowly this year than they did in 2011 and predicts its margins will be flat year-on-year.
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However, when the company issued its outlook for the year ahead on Wednesday, its shares rose. Danone’s shares climbed in part because of a what one analyst called a “creditable performance” in 2011 but the market is broadly upbeat about the outlook for the business. It may be watching the horizon carefully, and it may face challenges in the fresh dairy sector, but investors and analysts, even if some have immediate concerns, are confident about Danone’s medium-term prospects.
After reporting its financial results for 2011, Danone forecast that its sales would increase by 5-7% this year, a decent level of growth but lower than the 7.8% it enjoyed last year. The company added it expected to maintain its trading operating margin of 14.72% this year.
Danone CFO Pierre-André Terisse said he did not expect the economic environment to improve and acknowledged that low consumer confidence meant Danone had to stay competitive, which would have an impact on margins. After a challenging year, the company will also look to invest behind its fresh dairy brands in Russia and the US – two countries Danone deems as emerging markets in the sector.
“We basically want to maintain our margins. The existing difficult consumption context in Europe and the potential of our business in the emerging markets is going to require that we have a good level of support for our brands. We think it’s important we avoid any compromise if we want to keep delivering and building,” Terisse said.
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By GlobalDataSanford Bernstein analyst Andrew Wood said he was “surprised” by Danone’s margin forecast. He predicts a 15 basis points increase in margins, although this is lower than his previous prediction of a 25 basis point rise. “The main reason for our reduction is our view that management will use as much ammunition as it has on re-investment, particularly in Russia and the US, in 2012 to regenerate volumes and still leave some modest margin growth. Our 15 basis point increase is ahead of management guidance but we believe management is being prudent on this,” Wood said.
ING analyst Marco Gulpers also believes Danone’s margin forecast is “conservative”. Gulpers predicts a 15-20 basis point increase and argues that, with pressure from commodity costs expected to be lower than last year, Danone can invest in growing its top line and still increase margins.
However, there is some concern about the near-term prospects for Danone’s fresh dairy business, which had a challenging 2011. Much of the questions over Danone’s performance in 2011 centred on its dairy business, with its waters and baby food operations driving its top line.
Within dairy, margins improved as the company benefited from cost savings from the integration of 2010 Russian acquisition into Unimilk and its moves to improve the mix of the portfolio. On the other hand, volumes fell due, Danone said, to its decision to no longer sell certain products in Russia. Without Unimilk, Danone’s fresh dairy volumes increased in 2011, although Wood said growth slowed quarter by quarter throughout the year.
Russia, southern Europe and the US were three markets in which Danone’s fresh dairy business struggled in 2011. “The fact is that after years of being the growth engine for
Danone, the fresh dairy business has become the laggard and a drag on operating performance,” Wood said. The Sanford Bernstein analyst predicted Danone’s fresh dairy sales would increase 4.3% in 2012 (below the 4.6% recorded in 2011) but said that would be dependent on a “strong bounce” in the second half of the year from the company’s operations in Russia and the US.
In Russia, Danone has been reshaping its business in the wake of its acquisition of Unimilk in 2010. The management team was changed, the portfolio was revamped and unprofitable lines discarded. “We are on track,” Danone CEO Franck Riboud said. “The first [aim] was to focus on how to restore margins. We did it. Now, it’s time to build the right platform and growth. We have had some good results from local brands, which are starting to grow again. We have huge potential in the country, perhaps not in 2012, but I’m sure that within the next five years it will help us deliver the expectations we have for the company.”
Riboud noted Danone’s main competitor in Russia, PepsiCo-owned Wimm-Bill-Dann, discounted heavily in the last quarter of 2011 “because they need basis points”. However, Riboud said market share in Russia was “not an issue” for Danone “for the time being”, pointing to the decision to cut SKUs from its portfolio. He argued Danone’s plans for milk production in Ukraine had given it a “competitive advantage” in Russia and, above all, the company, which has faced criticism over the Unimilk venture, had created a “platform that will really develop”.
At ING, Gulpers plays down the threat from Wimm-Bill-Dann. “Wimm-Bill-Dann is a tough competitor but it’s not tougher than anywhere else. It’s quite rational at the moment. Wimm-Bill-Dann is not the feared competitor it was thought to be.”
Danone’s position in the US, a country it describes as an emerging market for yoghurt, has been under scrutiny over the last 12-18 months. Greek yoghurt has taken the sector by storm and, according to Wood, the segment now accounts for “over a quarter of the market”. Danone was slow to respond – even CEO Franck Riboud admitted he had been “angry” with the company’s performance in the sector – but, in the last six months, it has opened an R&D centre in the US and relaunched its Greek line as Oikos, a brand it advertised during the Super Bowl earlier this month.
Riboud said on Wednesday that he is now “smiling again” about Danone’s operations in the US. The Danone brand was set to take Yoplait’s mantle as the “strongest” yoghurt brand in the country because, Riboud claimed, General Mills had “missed” the launch of a Greek line. Furthermore, Riboud said new production capacity coming on line in June should enable to secure more listings and boost its Greek yoghurt business in the country.
However, as in any emerging market, there are challenges suppliers will have to surmount to drive sustained growth. Riboud spoke at length about the importance of category captains or advisors in the US retail trade. At present, Yoplait is the category captain in the yoghurt sector, a position Riboud said Danone “expected” to take. “Everything is decided by the category advisor,” he said.
Riboud said Danone was working hard with the likes of Wal-Mart Stores to see yoghurt given more space in store. He warned: “With the way the shelf is organised right now, we will not develop the category. Greek is cannabalising everything.”
The Danone chief said Greek yoghurt was having some benefits on the sector as a whole in the US. He said the emergence of Greek yoghurt meant the new technology the company was installing to cater for consumer demand would also be able to improve the quality of other products in its portfolio. Greek yoghurt was also leading to demand for “indulgent” products, which, he claimed “will help extend the shelf”.
That said, Riboud said yoghurt manufacturers faced a problem in selling not just “single cup” products but also multi-packs. Yoplait, he claimed, was acting as a brake on that development as “they don’t have the facilities to deliver packs”.
What is clear is that boosting sales in Russia and the US is key to the performance of Danone’s fresh dairy business in 2012. “We need a recovery from the US and Russia to make this a normal growth year of around 5% growth,” Gulpers explains.
However, despite the challenges facing Danone, particularly in the fresh dairy sector, analysts are broadly positive about the value of the business and about its long-term strategy. Gulpers, for one, says the price of Danone’s shares is a favourable multiple when compared to the likes of Nestle.
Kepler Capital Markets analyst Jon Cox, who is based in Zurich, raised his target price for Danone’s shares from CHF52 to CHF55. “At our CHF55 target, the stock would trade at 17x 2012 estimated earnings and 15x 2013 estimated earnings, which we believe is justified by its superior growth and cashgenerative dynamics in the big food space,” Cox says.
And, over at Sanford Bernstein, Wood, despite his short-term concerns over Danone’s fresh dairy business, believes the company will see the fruits of its work in Russia and the US by 2013 or 2014. He argues that, “in a nutshell”, he “likes the Danone strategy”.
Wood adds: “Management has done a good job of positioning it to be a good, stable and consistent top and bottomline grower…with huge potential for cash generation and a manageable balance sheet.”
