We believe shares in Danone are attractively priced and investors should have an allocation to the stock in a well-diversified portfolio. We are confident that management will continue to deliver higher profits, which should be supported by an increasingly credible savings plan and hence a continued increase in margins.
We reviewed our stance on Danone post Q3 2018 sales results and maintain our price target of €77. Recently, margins and sales have been hurt by increased pressure on European fresh dairy products. However, the acquisition of WhiteWave Foods reduced its dependency on the recovery in this category, and increased its exposure to the profitable US market.
The purchase last year of US group WhiteWave, which makes almond milk and organic products, is intended to boost Danone’s profit margins, given WhiteWave’s generally affluent clientele, while Danone has also been cutting costs. Both measures should lead towards improved margins going forward.
During 2018, the group was faced with temporary issues in Morocco where consumers boycotted milk, water and petrol suppliers after consumers took prices increases negatively. However, we expect to see a recovery in 2019.
Also the group saw weaker growth in demand in China for its infant formula business (although Danone had experienced 12 months of exceptional growth in this segment). However, the strong momentum in Essential Dairy & Plant-Based and Waters offsets Early Life Nutrition contraction in China.
Our price target of €77 is factoring in forecasts which are in line with managements’ target of an EBIT margin above 15% in 2019 (we are assuming 15.25%) and an EBIT margin of above 16% in 2020 (we are assuming 6.1%).
The situation in Morocco is a temporary one so sales should pick up in the following quarters. Management confirmed it will remain focused on accelerating growth and maximising efficiencies, including the first year of delivery of its Protein program's savings.
We remain optimistic about Danone for the following reasons:
• Sales – We are expecting sales to grow by 2% and 4% in 2019 and 2020 respectively. We believe this growth rate is achievable given the improvement in demand we are seeing for the Group’s products from most regions (except for Brazil, which remains weak). We like Danone’s portfolio of products because it is 100% made up of healthy products and 80% of its brands can be used in daily consumption.
• Strong portfolio - Through its concentrated category exposure to fresh dairy, plant-based dairy, waters, infant and medical nutrition, Danone possesses one of the most on-trend consumer portfolios, in our view, with minimal need for strategic realignment.
• China – The Group saw strong demand from China in 2018 and we expect this trend to continue with particular reference to the demand for water which is increasing strongly. Danone’s differentiated brand positioning in China (Aptamil/Nutrilon) will enable it to build a sustainable leadership position in this attractive demographically driven structural growth area
• Dividend - The shares are now trading on an indicative gross dividend yield of 3.00%. We believe this dividend is sustainable and could also be increased in the future as the Group is expected to continue to increase its cash flow
• Growth in earnings - The Group has delivered double digit growth in earnings over the last three years, (except for 2018 though this is only because in 2017 the Group paid lower taxes). We are forecasting strong growth rates in earnings for 2019 and 2020
• EBIT margin - Management is targeting an EBIT margin of 16% by 2020. We believe this is achievable as the Group will benefit from synergies and cost savings in the years ahead. We are forecasting an EBIT margin of 16.10% by 2020. We believe Danone is well positioned to see margin growth in years ahead. We see a margin recovery emerging, spread over many years, supported by margin-enhancing growth in waters and baby food over the medium term, and European dairy margins
• Earnings – EPS growth should be supported by savings delivery and margin expansion. We are forecasting EPS figures of €4.07 and €4.46 in 2019 and 2020 respectively
• Cost cutting – Danone has a cost cutting program underway. Called Program PROTEIN, the aim is to eliminate €1bn of indirect costs, i.e. from €8bn to €7bn by 2020
Key risks:
• Uncertainty in the UK due to BREXIT
• Global growth concerns
• Increased competition
• Weakening emerging market currencies given around half of sales are generated in emerging markets
Disclaimer:
This article was issued by Kristian Camenzuli, Investment Manager at Calamatta Cuschieri. For more information visit www.cc.com.mt.The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri & Co. Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website.