Activists Will Help Realise The Potentially High Danone Multiple
Summary
- Major developments have set a promising tone for Danone's medium-term future.
- Sustainability-focused CEO Faber got the axe after years of service, with activists making way for more aggressive CEOs who can realise the business' value.
- Selling of the Chinese unit represents a start to the activist's attempt to achieve multiple expansions.
- Given the weight that Danone felt under COVID relative to other consumer products companies, the move spells performance much more in line with the value in the business segments.
Danone (OTCQX:DANOY) has the profile of a stalwart. Not only are its brands well known, but it's diversified into new, excellent segments that through organic growth have developed into leadership in niche categories against even the largest consumer products giants. Yet Danone has languished, and its less flexible structure and financial profile in COVID-19, largely due to decisions by its CEO, has stunted any kind of recovery as investors took the March 2020 fire sale as an opportunity to allocate funds elsewhere. The firing of the CEO should bring on a new regime, although the fact that Danone is a French company will surely get in the way. On balance, however, we continue to see the upside in Danone.
Several Growth Engines
The reason why activist involvement is so helpful for a company like Danone is that it has several underlying growth engines that could easily convince a high multiple. We have written previously at length about the specialty nutrition business, which is highly profitable with economics akin to pharmaceutical companies. While multiple expansion from this segment is also going to be a factor in Danone's revaluation, since it is indeed so significant a part of their business, there are also other engines that contribute to Danone's superior profile. WhiteWave and Alpro, companies taken under the Danone wing along the sustainability approach that Danone was long focused on, are great growth engines, and are tapping into the very trendy markets of organic and vegan food. These businesses which form an important part of what used to be classified as Danone North America, are a big driver of performance in the EDP category. What is more is that these companies were acquired long before it became duty for consumer products companies to cater to these markets.
(Source: Danone Q4 2020 Earnings Pres)
While there are some concerns that perhaps these products will cannibalize some of their traditional dairy exposure, we believe that the underlying health benefits of dairy and plant based products will keep the pie growing, even if the constitution changes, thanks to people's greater focus on maintaining healthy eating habits.
Carve-out Value
Part of realizing a higher multiple will also be eliminating confounders from the business. The clear culprit in this case is the water segment. With Private Equity being so flush with cash due to constant money printing, even a segment with a brand like Evian, exposed to a pretty aggressive reopening thesis, would be an attractive carve-out opportunity for a lot of PE firms. The segment is also not performing that badly. While of course there is a meaningful topline hit, and an even more meaningful bottom line shift due to the changes in mix, there is an obvious margin for recovery once reopening takes effect.
(Source: Danone Q4 2020 Earnings Pres)
Evaluation and Conclusion
While carving out parts of the business and focusing on increasing investor visibility of the more exciting segments will help to generate interest in the stock, there are some forces you cannot fight. When companies were reporting after the intense pantry-loading quarters of Q1 and Q2 2020, Danone fell noticeably short of competitors despite their very favorable exposures. While it can be convenient to blame the former CEO for giving handouts to workers and making concessions to partners, these things are certainly the ethical thing to do, but also entirely necessary. France is a difficult country to have employees in, and companies are always under heavy scrutiny from the government and public. There are limits to the sort of corporate raiding that activist investors might be interested in doing on Danone, even if other aspects of their profile could lend itself to such a thesis. This is the greatest risk to the thesis, which is that Danone, existing as a French entity, might not be a good money vehicle for reasons related to unions, and a coerced sense of responsibility for wider stakeholders.
However, not all of Danone's businesses are located in France, so there is upside. Moreover, financial performance and the durability of brands is an undeniable source of value, regardless of where those brands might originate from. Indeed, Danone has businesses in China, some of which are being sold, as well as meaningful business in North America. Ultimately, France cannot harry the upside for Danone too much, and the promise of high multiples remains.
(Source: Mare E-Lab Research Database)
We think that Danone, thanks also to its dividend, is an intelligent investment, and worth holding both due to its resilience but also its potential multiple expansion potential for a longer-term horizon. We continue to remain long Danone.
This article was written by
Analyst’s Disclosure: I am/we are long DANOY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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Comments (4)
am not sure the CEO needed to depart, nor it is obvious what 'special' capital allocation changes an activist can make (not that they cant manufacture some shuffling and financial engineering, but they cannot present odds-weighted likelihood of sustained success beyond their own exit).
yes, danone has underperformed. but as you noted, most of the past strategy has been good, and they just need to hold their own and ride 2 tailwinds :
- they are in almost every global ESG grouping/index
- global demand for better-than-generic products (just like nestle, etc...)i also dislike the water business, but do not see non-home consumers going back to water fountains, despite all the evidence. maybe this is a window for them to offload it.
in the end, i see danone as a sensible alternative to holding less cash.
