Nestlé forges healthy premium to Danone

Nestlé shares are winning a higher rating than arch-rival Groupe Danone and are set to stay ahead at least for 2009 as investors warm to the Swiss group's wide range of reliable businesses in recession.

The world's biggest food group posted solid first-quarter sales last week, helped by its range of interests in coffee, chocolate and pet food, while Danone suffers in a competitive yoghurt sector and may have to cut prices to generate growth.

The Vevey-based maker of Nescafe coffee, KitKat chocolate bars and Friskies cat food reported underlying sales growth of 3.8 per cent in the first quarter, pretty resilient put against Activia and Actimel yoghurt maker Danone's one per cent.

Although Danone's share rating outshone its Swiss rival through 2008, driven by innovations at its fresh dairy side, Nestlé is doing better as the slowdown grips, moving to a premium and is many analysts' preferred European food stock.

"We believe that Nestlé is the strongest and most balanced company in the European food group. We have seen excellent operating results from Nestlé in 2006, 2007 and 2008 and we expect this to continue throughout this year," said Bernstein's Andrew Wood.

The two stocks traded on similar ratings earlier this month, but now Nestlé shares have edged ahead to trade on about 12 times forecast 2010 earnings, compared with Danone on 11.4 times, according to Reuters data.

"It (Nestlé) has the strongest balance sheet, the lowest cost of debt, offers the lowest concentration of risk and a management team that appears not to be distracted by a big restructuring programme or acquisition integration," said UBS's Alan Erskine.

Both groups have their origins in the milk industry, but while around 17 per cent of Nestlé's sales now come from milk products, including ice cream, Paris-based Danone sees nearly 60 per cent of sales coming from its dairy division. Danone's first-quarter group underlying sales growth of one per cent undershot already low forecasts with dairy particularly disappointing for investors with underlying sales there down 1.2 per cent with both volume and pricing negative.

"Dairy remains 58 per cent of group sales, so effectively defines the group and where there has been volume growth it appears to be the result of aggressive price cutting," said Collins Stewart analyst Rob Mann.

"This to us represents further evidence that yoghurt as a category is ultra-competitive and that Danone will over time have to sacrifice margin and return to sustain volumes," he said, adding he considers Danone to be in the midst of a permanent de-rating to a sector discount rather than premium.

Danone's Evian and Volvic bottled water business saw first-quarter sales off 3.9 per cent, so with dairy also down it had to rely on growth from its fast growing but smaller baby nutrition and medical nutrition divisions. Although Nestlé has gained a premium over Danone, some believe a further re-rating is unlikely. Pablo Zuanic at JP Morgan said Nestle faces a low-quality 2009 with sales largely price driven rather than led by volume rises.

"The quarter supported our belief that a re-rating of the Nestlé valuation multiple this year is unlikely," he said.

Nestlé's 3.8 per cent first-quarter rise represents a 0.3 per cent rise in volumes, with the rest coming from price. Stripping out pharmaceutical sales at Alcon and its Galderma venture, food and beverage volumes were off 0.1 per cent.

So there is a danger sales growth will have to rely on price rises, which could be difficult to achieve, leaving Nestlé hard pressed to reach its 2009 target for underlying sales growth approaching five per cent.

By contrast Danone said last November its sales growth this year will be a few percentage points below its medium-term guidance of eight per cent, guidance which reflected Danone's previous fast growth.

In other words Nestlé's growth is catching up with Danone and may even surpass it this year.

"We expect Nestlé to be top-of-class," said Bernstein's Wood. "And we believe that this warrants a sizeable premium to its peers, whereas Nestlé currently trades at only a slight premium."