Danone: Restructuring In Progress (OTCMKTS:DANOY)

Introduction and Overview of Q1 Key Insights

Danone (OTCQX:DANOY) is a French food multinational that produces and markets consumer staples with a focus on dairy products, infant formulae (combined ~80%), and bottled water (~20%). Some of its most renown brands are Actimel, Alpro, and Evian.

The company is well-established worldwide, with Europe and North America accounting for ~60% of total sales. The China plus APAC region is the key growth driver and expanded volumes in Like-for-Like sales by +8.9% in Q1-2024.

Danone’s share price has not been able to recover to its all-time high of $18 in 2019. Shares are still down 33% at $12.6 on April 14^th. After the announcement of the “Renew Danone” plan in early 2022, the share price climbed back up to $13.3 in Q2-2023, from an all-time low of $9.23 in Q4-2022, and it has been moving sideways since.

In Danone’s Q1-2024 review, management confirmed the guidance of 3% – 5% sales growth for the year 2024. The company reported Like-for-Like sales growth of +4.1%, with 2.9% attributed to pricing and 1.2% to volume/mix. A positive surprise, given Danone had continuously lost volumes in 2022 and 2023, culminating at -2.5% Like-for-Like sales volume in H2 2022.

Management also suggested slight improvements in operating margins in 2024. Since 80% of the company’s COGS are attributed to the purchase of raw materials such as milk, oils, and sugar, gross margins are highly exposed to global commodity markets. The three key ingredients’ prices have dropped 17%, 15%, and 20% YoY, respectively, on April 19th, underpinning the positive outlook.

Peer Comparison

Danone’s EV of $51.14Bn is comparable to its peers in the industry, such as General Mills (GIS) and Kraft Heinz (KHC). Nestle’s (OTCPK:NSRGY) and Mondelez’s (MDLZ) are considerably larger at $323Bn and $107Bn, with larger product portfolios and more assets.

By revenues, Danone ranks 3rd among its peers with $30Bn in FY 2023, Nestle leading ($111Bn), and Mondelez 20% ahead at $36Bn.

In terms of EV/EBITDA, Danone ranks in the middle of the field compared to its peers, with a current value of 12.11 according to YCharts. Nestle is leading the field with an EV/EBITDA of 16.39 and Associated Foods is trailing with an EV/EBITDA of 7.16.

It is also noteworthy that Danone significantly underperforms its peers in terms of return on equity with 5.24% compared to 25.03% at General Mills, 28.89% at Nestle, or 17.61% at Mondelez.

Among its peers, Danone reported the median D/E ratio at 1x. Nestle has the highest leverage, at 1.5x D/E, and Associated Foods is trailing at 0.33x D/E. Also, with $935m spent in 2023, Danone’s capital expenditures are comparable to its peers.

Danone’s current strategy, “Renew Danone”

On March 8th, 2022, Danone announced a comprehensive restructuring plan called “Renew Danone”. It is scheduled to complete at the end of 2024 and its scope focuses on 4 pillars:

1. Strengthening competitiveness in categories
2. Selective expansion
3. Seeding growth
4. Portfolio rotation

In addition, the strategic plan stipulates the ambition to maintain net debt to EBITDA below 3x while investing a maximum 4.5% of net sales annually. At the end of 2023, net debt to EBITDA stood at 2.34x, and the company invested ~3.1% of sales, i.e., both metrics were well below the self-imposed maximum and with room for expansion.

As of today, Danone appears to have focused on the first and fourth pillar. As part of “strengthening its competitiveness,” major rounds of redundancies were conducted. The associated extraordinary charges resulted in the collapse of the company’s net income by ~60% from $2,189m in 2021 to $972.6m in 2023. Meanwhile, sales grew ~10% from $27Bn to $30Bn, attributed primarily to pricing measures amidst an inflationary environment marked by spikes in raw material prices.

In Q1-2024, Danone disposed of three brands under its “portfolio rotation” initiative within the scope of the plan. This led to a slight uptick of 0.48% of its share price, from $12.2 to $12.6, on April 18th. However, ongoing initiatives under the growth and expansion pillars have only moderately impacted the volume performance of the business so far, with 1.2% Like-for-Like volume growth in Q1-2024.

Danone’s dividend policy and its contribution to ROIC

Surprisingly and despite Danone underperforming, the company opted to pay out dividends in excess of 100% of its net income from 2021 onwards. In fact, the company paid out 129% of net income in 2022, and 145% of net income in 2023. This led to a -9% reduction of the company’s equity from $19.8Bn to $17.9Bn.

Danone’s ROIC, which the company aims to improve in accordance with the “Renew Danone” plan, went up from 8.9% to 9.5% at the end of 2023. The company uses the recurring net operating income to the average invested capital for the year to calculate ROIC.

In the annual report, it is noticeable that while net operating income increased by 4.1% from €3,377 m ($3,119m) in 2022 to €3,481m ($3,216m) in 2023, the average invested capital decreased -2.6% from €27,997m ($25,865m) to €27,271m ($25,194m). The 2023 average FX rate of EUR/USD = 1.08 was used for the conversion.

Consequently, it can be inferred that the improvement in ROIC from 8.9% to 9.5% is not only due to an increase in net operating income. The company’s dividend payout policy and the resulting reduction in invested capital could also have contributed to the increase in the performance metric. While this boost certainly benefits the company in the short run, its long-term effects will require more careful evaluation.

Financials

Danone’s financials are stable, not outstanding. In the FY 2023, it operated a gross profit margin of 47.37%, well above the sector median. EBIT margins outperform the sector median as well, and the company managed to generate $3.8Bn in operating cash flows for the period. Nevertheless, Danone’s could be seen as inefficient. Net income per employee is 40% of the sector median, and the asset turnover of 0.62x also points into that direction.

Risks to the business

Potential risks for Danone include but are not limited to raw material prices, competition, and changing consumer preferences. Commodities have been volatile since 2020 and some sources claim potential structural shortages in Danone’s key raw materials such as dairy and sugar.

Consequently, Danone’s ability to continue passing costs on to consumers without losing customer segments to private label producers or competitors will be critical to the company’s future success.

Also, Danone is in the middle of executing a turnaround plan, and while some measures seem to have impacted the business positively, the company could not yet deliver on potential volume growth – even on a Like-for-Like basis. As a result, the “Renew Danone” plan requires more indicators to form a qualified opinion of its effectiveness and future impact on the business.

Conclusion

Should Danone prove able to continue delivering on its “Renew Danone” turnaround plan, the company could become a buy at some point in the future. Uncertainties in the commodity markets, consumer pressures, and the slow return of volume growth pose too many risks for this stock to be a viable investment at the moment, in my view.

Also, management’s decision to keep leverage well below targets suggests conservatism and risk-aversion regarding top-line growth. Danone could increase net debt, but doing so in a high-interest rate environment could also backfire in the short term and impose even more austerity on the company.

It remains mysterious to me how reducing group equity by increasing dividend payouts in the middle of a restructuring could benefit the company in the short and medium term. Mechanically, a direct consequence is an increase in the debt-to-equity ratio and a shrinking balance sheet, everything else remaining equal. Also, it harms the company’s ability to potentially commit to investments and growth levers that may arise in the future. For a company that is committed to selective expansion, strengthened competitiveness, and seeding growth, such a policy sends mixed signals in my opinion.

Last, the company’s policy to increase dividend payout consecutively amidst a multiyear restructuring and thus decreasing group equity raises questions about the impact of potential investments and expansion plans. As a result, Danone currently remains a hold for me.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.