Danone SA ADR (DANOY, $13.34): “Do’s and Danonet’s”
By: Elise Olwig, AIM Student at Marquette University
Disclosure: The AIM Equity Fund currently holds this
position. This article was written by myself, and it expresses my own opinions.
I am not receiving compensation for it, and I have no business relationship
with any company whose stock is mentioned in this article.
- Danone
SA ADR (OTC:DANOY) is a multinational food and beverage
company that operates through the following segments: Fresh Dairy Products,
Waters, Early Life Nutrition, and Medical Nutrition. Products include yogurts,
milks, soy alternatives, infant formula, bottled waters, and more.
- Margins have remained flat in the first half of 2021, as cost cutting measures through the Local First initiative helped to offset inflationary headwinds, although larger competitors are better equipped to weather the storm.
- Increasing pressures from early life nutrition competition and regulation in China pose a risk to the company’s growth prospects.
- Antoine de Saint Affrique became the new CEO as of September. He has not announced any differing initiatives, although the market expects a margin reset.
Key Points
Danone reported steady Q2 results, with management reiterating margin guidance despite inflationary headwinds. The recent topline beat of +6.6% versus consensus growth of +5.1% was almost entirely attributable to price and mix, while volume growth of missed Street estimates. The margin beat was driven by productivity, as the negative impact from commodity inflation was offset entirely by pricing and efficiency. Margins are expected to remain relatively flat, with the potential for a margin reset in 2022 under the new CEO, Antoine de Saint Affrique, effective as of September 15th, 2021.
Inflationary pressure is truly the largest risk plaguing the food industry in 2021. The company’s cost base increased +7% in the first half of 2021, which is forecasted to accelerate by 8-9% in the second half. This mainly affects milk / milk ingredients and packaging / logistics. Key components of Danone’s strategy to keep margins under wraps include savings from their strategic Local First initiative, dissipation of abnormal COVID-19 related costs, and selective use of pricing. The Local First Plan, implemented in 2020, aims to reduce SKUs by 20% and re-allocate decision-making power to five geographical levels to improve efficiency in those areas. The restructuring plan is largely on track, as 15% of SKUs have already been eliminated, and it is expected to contribute €1 billion of cost savings by 2023.
Another key risk to consider includes headwinds in China, where lower birth rates and increased competition from internal brands like Feihe pressure the high-margin Specialty Nutrition segment that has historically been a key driver of growth for Danone. There is intensifying regulation in the infant formula space, and China is seeing consolidation in the home market Additionally, Danone has high exposure to soy products in the dairy products and substitutes segment. Not only are consumers seeking out alternative plant-based options such as almond and oat products, but also soy is the slowest-growing ingredient in the plant-based market, deeming production less efficient. For further acceleration of adjacent plant-based products in faster-growing categories such as yogurt, ice cream, cheese, and creamers, which altogether represent ~33% category revenue, Danone will need to significantly increase advertising and promotional spend, which is difficult to achieve given the already increasing margin pressure from both inflation and competition.
What
has the stock done lately?
Over the past month, Danone has returned (-5.05%), representative of market sentiment towards continued inflationary cost and pricing pressures. The stock has seen a continued, steady price decline since August. Danone trades on a 16x P/E and 11.5x EV/EBITDA versus European Foods 20x/14x due to higher operational volatility.
Past Year Performance:
Danone is up 3.89% YTD, with more bullish trends over the
past 6 months. Where one would typically expect a strong
recovery scenario as COVID-19 cost and volume pressures gradually dissipate
from the market, the stock is down (-6.77%). DANOY hit its 52-week high of
$15.38 in August before retracting to current levels. Since being added to the
portfolio, the stock has contributed a 9.71% return.
My
Takeaway
Danone has a much shallower product
portfolio compared to its larger, more diversified peers. While this has served
the company well in the past, providing them with more flexibility to focus on
core brand initiatives that align with consumer trends (e.g. the shift towards
plant-based dairy alternatives), it is altogether riskier considering larger
competitors have a greater ability to grow margins despite inflationary
pressure as opposed to simply working to keep margins flat. Namely, Diageo,
Pernod Ricard, and Nestle exhibit more premium portfolios, healthier pricing
power, and higher margins, therefore deeming them more equipped to withstand
current commodity headwinds. It is recommended that we liquidate our position
to mitigate some of this current market risk through investing in a larger
peer.
