Stock price: €44.1 ($57.61 USD)
Conclusion: As expected, Danone (DANOY.PK) is revising its sales growth guidance to 6%+ this year. However, negative pricing coupled with higher input costs prevent Danone from raising margin expectations. Assuming a return to double digit growth next year, CAGR in EPS between 2008 and 2011 should not exceed 5%. We find Danone fairly valued in light of such growth rate.
H1 results: Sales up 11.2% to €8.3bn (+7% organic-+6.9% organic in Q2).EBIT +6% (+2% organic) EPS -2%. Guidance 2010: sales up 6%+, margin stable, Free Cash Flow up 10%+
Solid growth, still driven by lower pricing
- Volume grew 9.8% in H1 (+8.9% in Q2). All businesses reported high single digit growth in Q2 (+8 to +10% volume). Dairy growth is driven by new markets (US, Latam) and a return to growth in Europe except Southern Europe. Water is also boosted by developing markets and improved demand in Europe. Japan and Spain remained tough. Infant milk is up double digits while weaning food is flat. Medical keeps growing double digits.
- Pricing remained negative in Q2 (-2% vs -2.8% H1), notably in dairy (-2.7%) and in water (-3%), while baby food and medical remained flat.
- We are surprised by the magnitude of pricing decline in Europe (-3.7% Q2 almost unchanged vs -4.3% in Q1) at a time when large markets such as France or Poland, according to management, returned to positive numbers. We think of two probable reasons, first Spain where the crisis deepened, second a negative mix in water. The good news comes from the return to positive pricing in Asia and in the Rest of the World.
No leverage, volume is not enough
- We estimate the underlying decline in margin at -134bp vs -74bp reported given the 60bp decline in A&P spending in H1. The decline results from higher Input cost (94bp), negative country mix (15bp) and pricing, partly offset by savings.
- Stable margin for the full year will require +70bp gain in H2. We find the target challenging given the further increase in input costs in H2, above 10%. It will depend on pricing which has to turn positive, and also on costs savings (€500m) skewed towards H2.
- All in all we look for €16.9bn sales-stable margin at 15.3%-€1642m net profit-EPS +6% to €2.73.
- Beyond 2010, Danone needs to come back to positive pricing. Much will depend on brand equity at a time when health claims become harder to defend (cf our April 15th comment). We will also look at the integration of Unimilk in Russia which will initially weigh on Danone’s margin. Last, it remains to be seen whether margins will take off in water following years of steady decline.
Danone trades at 16.3xP/E and 10.5xEV/EBITDA based on our 2010 estimates. We think the stock looks fairly priced in light of its EPS growth track record since 2008 and the challenges for H2 and next year. Our valuation range of €48-€50 remains unchanged.