Increased Volume Could Hurt Danone's Medium-Term Guidance

Danone's (DANOY.PK) rebound in volume is coming at a huge cost, so we are waiting for revised medium term guidance. The valuation looks full in light of our estimated range of €40-43 per share.

9 months: sales down 2.2% reported, up 2.4% like for like (Q3 up 4.1%). 2009 guidance: 4% growth in H2, EBIT margin improvement 60-70bp in constant currencies. +10% EPS growth but meaningless as it is ex-right issue and forex impact. Including both, we expect EPS to be down by 6% this year.

We are still waiting to see the right balance between volume and pricing. Q3 was marked by a spectacular rebound in volume, up 7%, but also by negative pricing, down 3%. Although we understand that this was the price to be paid to restore growth in yogurts, we lack visibility regarding medium term guidance. Interestingly, the CFO said he was confident about the growth drivers (innovation and new markets in dairy products) but he did not confirm medium term guidance of +8+10% growth . Last, we feel that Danone will need to adapt its health claims to the new regulation, which might take some time and adjustments (cf settlement in the US and stricter regulation in the UK).

Growth in water (+9% in volume) is also held back by a structurally negative geographic mix, as emerging markets should continue to drive future expansion. In addition, margins keep going down in water and we don’t know when they should start to stabilize.

Visibility looks better in baby foods and medical nutrition. Baby foods is slowing down, but this is mainly the result of slower demand in prepared foods,more affected by the economic downturn, and a tough comparison base in infant milk in China. Danone keeps gaining share in infant formula outside of China. Medical nutrition should also benefit from long term growth visibility at a time when baby boomers are ageing.

In conclusion, we expect management to revise down its medium term guidance which look too agressive, notably for dairy and water. The stock trades at 16.2x and 15.2x P/E based on F9 and F10 estimates and 10.8x EV/EBITDA, which looks generous considering EPS expectations for this year and next year (-6% and +7% respectively).