EUR 850.00 For Business Accounts Only

Morningstar | A Strong Nutrition Franchise and Entrenched Supply Chain Position Support Danone's Narrow Moat

After revisiting our estimates and accounting for Danone’s recent investor day, we are trimming our fair value estimate to EUR 70 per share ($16.30 per ADR) from EUR 71 ($17.50 per ADR), which implies 2019 multiples of 18.6 times earnings, around 12 times enterprise value/EBITDA, a free cash flow yield of 5%, and a dividend yield of 2.6%. These multiples are roughly in line with Danone's trading range over the past decade and slightly below our valuation of most large-cap competitors, due to Danone’s more leveraged balance sheet as well as our expectation that its growth will be slower and less diversified. We preserve our narrow moat rating on the back of an entrenched supply chain position and brand equity in nutrition as well as a cost edge. However, we are increasing our uncertainty rating to medium from low because of the firm’s escalated reliance on one segment’s (specialised nutrition) and region’s (China) growth potential, as well as its elevated leverage after the WhiteWave deal.

Against secular (e-commerce, private label, smaller companies) and cyclical (inflation) headwinds, most multinational consumer product companies are struggling to reinvigorate ailing brands and categories while cutting costs to finance investments in growth. Consequently, growth has been driven more by volume and less by pricing/mix lately, although mix is playing a vital role for those companies that can take advantage of premiumisation trends.

Nonetheless, Danone's advantaged exposure in categories (yogurt, plant-based products, nutrition, water) that are in sync with the latest consumer trends (health and wellness) gives it a head start on some of its peers, which are still striving to optimise their brand portfolios. This is evident in Danone’s value contribution to organic growth, which has been the primary driver of expansion since 2014, reflecting strength in the waters and nutrition businesses (pricing/mix) that has offset weakness in fresh dairy (volume).

A critical aspect of consumer product companies’ moat is the ability to deploy their deeply grounded supply and distribution networks to market products adapted to local markets and tastes. Danone is not an exception. After the WhiteWave acquisition, the firm planned to enliven its infirm dairy business and complement its offering with new innovative plant-based alternatives, which are still growing in the high single digits.

We share Danone’s social mission and initiatives to promote social awareness across all facets of its operations and we believe that the company’s actions in that direction will yield long-term results for shareholders (manifesto brands, or brands with a specific social-driven purpose, are growing 3 times faster than the rest of the brands). Shorter term, though, we view the firm’s latest EUR 1 billion cost-saving plan as a double-edge sword: while higher profitability (management targets at least a 16% operating margin by fiscal 2020, which we find achievable, up from 14.3% in 2017) should drive free cash flow generation and possibly higher payouts to shareholders, there is always the risk of value destruction if management uses excess capital to fund pricey acquisitions to support growth, a practice that is still fresh in the memories of Danone investors.

We maintain our stable moat trend rating for Danone, as we do not see any material changes in the company's intangible asset strength or cost advantages in the foreseeable future.