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At a glance

Case study stock: Danone

Category: Food production

Revenues (2010): €17.01 billion, up 6.9% from 2009.*

Operating profit (2010): €2.58 billion, up 7.1% from 2009.*

Thematic driver: changing diets and increased expenditure on food in emerging markets.

Other beneficiaries: Nestle

*"Danone is world number 1 in fresh dairy products; world number 2 in bottled waters; world number 2 in baby nutrition; and European number 1 in medical nutrition."

*Source: Danone Annual Report 2010

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Healthy food sales in fast-growth markets

In this episode, we look at the prospects for the food production sector in the context of increasing demand for protein and dairy-rich, western style diets in emerging markets. We highlight Danone, outlining the investment rationale behind our positive rating on the stock. We also mention other beneficiaries of this emerging market consumption theme such as Nestle, which also benefits from a high-quality stable of leading food brands.

Stock Check : Danone

Danone is a leading global food producer headquartered in France. It operates in the fresh dairy, bottled water, baby food and medical nutrition markets. Globally, it has a leading presence in a wide range of geographies, with over 100,000 employees working in 184 plants.1

Danone is world number one in fresh dairy products; world number two in bottled waters; world number two in baby nutrition; and European number one in medical nutrition. In addition, to its healthy dairy products (such as Activia and Actimel), the company has a comprehensive suite of bottled water brands. These include the internationally recognised Volvic and Evian brands, as well as a range of locally recognised products which help to make it the leading vendor of bottled water in both Asia and Latin America. The company is also a major player in baby foods, having acquired Numico in 2007. Lastly, Danone is in an innovator in medical nutrition for the management of digestive and immune-related diseases.

Stock Story Synopsis: The Right Product in the Right Geographies

Our investment team believe that Danone’s combination of healthy products in fast-growing categories and its position in high-growth emerging markets will allow it to deliver market-beating earnings growth. Our analysts believe that food production stocks like Danone and Nestle enjoy sustainable competitive advantages over new entrants in terms of scale, expertise and branding via their stables of high-quality brands. Danone, in particular, benefits from a healthy product portfolio and the fact that 49% of its total business comes from emerging economies.1 In this regard, the company looks particularly well positioned to benefit from rising incomes in emerging markets and increased expenditure on dairy as emerging consumers embrace higher-protein, western-style diets. By further globalising their ‘healthy food’ platform, Danone has the scope to deliver strong growth in earnings.

Investment Rationale: In Depth

“Danone has a clear focus on healthy products and fast-growth markets that is delivering best-in-class sales growth. Combined with its ability to manage costs and its superior pricing power, this should allow it to deliver consistently strong earnings growth.”
Heidi Rauber, consumer staples analyst

“Danone is a good example of a high-quality, well-managed European company that is sensibly exploiting consumption growth opportunities in fast-growth emerging markets.”
Matt Siddle, portfolio manager, European equities

A transformed business

In 1996, dairy accounted for only 26% of Danone’s sales, water 10% and Danone did not have a baby or medical nutrition business. The business was centred on Western Europe, which accounted for 77% of sales with emerging markets making up only 17%.

Now, Danone’s sales are 60% dairy, 16% water, 19% baby food and 9% medical nutrition. Emerging markets make up over 50% of sales, while Western Europe now contributes less than 40%.

The investment case for Danone is based on proprietary analysis of stock-specific and industry drivers as well as meetings with senior management and detailed comparison with competitors in the consumer staples sectors. Our analyst team believes that Danone can deliver the best line top-line growth in its industry. In so doing, it can comfortably beat the earnings growth rates offered by other competitors in the staples sector, especially in household & personal goods. Historically, Danone has grown faster than most of its staples peers delivering 7.5% organic annual sales growth on average over the last five years.

Danone benefits from its market-leading position in some of the fastest-growing staple food categories globally, namely dairy, bottled water, baby food and medical nutrition. Specifically, our analysts believe that the water and baby food divisions can continue to surprise positively by delivering stronger than expected sales, driven principally by emerging markets.

The management team have transformed the focus of their business in recent years, selling noncore businesses in order to concentrate on healthy food categories in the fastest-growing markets. We highlight some key areas that support the investment rationale:

Clear product focus - Danone’s management have been keen to focus on their core competences; the company does not feel the need to be in every single food and beverage category; instead they want to concentrate on growing their core businesses in dairy, water, baby and medical nutrition. The management team have shown their ability to be agile and creative in terms of building Danone’s presence in these areas. They are also passionate about the idea of bringing healthy food to the maximum number of consumers globally.

Geographic rebalancing - Danone has been concentrating heavily on what they call the MICRUBs; Mexico, Indonesia, China, Russia, the US and Brazil. The company have been present in these countries for a number of years laying the foundation for double-digit sales growth that will increasingly drive the overall business forward.

Innovation in products and marketing
– Danone has a strong rate of product innovation with many of its current products having launched within the past two years. The company’s R&D resource extends to 1200 people, based in two scientific centres in France and Holland. The company has also been testing new displays in supermarkets that make the dairy section look less cold and uninviting, via the use of dark grey shelving and spotlights; this is leading to material sales uplifts in testing. The integrated “Live Young” campaign for Evian which included videos on YouTube and a Facebook page was very successful in raising sales. The “Roller Babies” video became something of an internet phenomenon, scoring more than 150 million views and winning several awards.

Cost reduction - Danone uses milk cracking technology which allows it to separate milk into its individual components and select the best parts for a dairy product. This helps to reduce the cost of some yoghurt products significantly while also saving on the use of milk. Unlike its competitors, the company could absorb material increases in milk prices by using milk cracking as well as nondairy proteins in yoghurts. This should allow Danone to largely offset rising milk prices, with many years of savings ahead. Our analysts also believe that Danone also benefits from a material degree of pricing power in its dairy products that should allow them to pass enough inflation to consumers in order to deliver ongoing margin expansion.

Ability to refocus – In dairy, Danone traditionally depended on its blockbusters in basic dairy products like yoghurt. These needed little impetus to grow but the company realised it was ignoring some of the more basic products. After being hit by the sharp slowdown in economic growth in 2008, the management stepped up their focus in this area innovating and segmenting new and existing products, backed up with promotional spend in markets with high growth potential.

Shareholder friendly – after issuing a significant tranche of new equity in 2009, Danone’s management have reversed course and been at pains to enhance shareholder value by growing dividends and undertaking buybacks via an annual share repurchase program.

Dominating the Global Daily Herd

Powerful Product Innovation

Activia, one of Danone leading blockbuster brands, is sold in 72 countries in a range of sizes and product variations.

Densia - Designed specifically for women, Densia yogurts are rich in the calcium and vitamin D needed for healthy bones.

Danonino – Specifically marketed at children, Danonino is enriched with nutrients such as calcium to help kids grow.

Danone is best known for its dairy heritage and yoghurt remains a favourite in the company’s traditional markets of France, Belgium, Germany and Spain, where per capita consumption tops 20kg per year. In these mature markets, Danone expects only moderate growth. However, geographically, the fast-growth action is in the dairy under-penetrated MICRUB markets.

With its core products underpinning the ‘functional’ yoghurt category, Danone has been expanding into higher-margin ‘nutritional’ and ‘indulgent’ dairy products. Nutritional dairy includes yoghurt fortified with added vitamins and minerals like Densia and Danonino, while the indulgent category includes frozen and dessert yoghurt, Greek yoghurt, pouring yoghurt (for cereal) and milkshakes.

In the US, the dairy category has been growing strongly from under-penetrated levels (yoghurt consumption per person is one-sixth that of France). Taking out the recession year of 2009, US yoghurt sales have been growing in the 8-10% per year since 2000. Supermarkets such as Walmart (with whom Danone have a white label agreement) have begun to allocate more space to dairy, which is helping Danone to establish a foothold in a key market that can deliver strong growth over the longer term.

In Russia, Danone’s acquisition of Unimilk, one of the largest dairy brands in the country, gives it an instantly recognisable brand and an extensive distribution network (throughout the CIS states) through which they can introduce higher-margin dairy products. The combined Danone-Unimilk is the market leader for dairy products in the CIS with a 40% share in Russia. Given the likelihood of a long-term appreciation in oil prices, Danone’s exposure to the Russian market appears sound.

A Developing World of Water

Environmentally aware

In its Evian water range, the weight of the water bottle has been reduced and the recycled PET content increased from 25% to 50%. Evian will be carbon neutral by 2012.

Danone launched an Actimel vegetal bottle that was made of 85% green polyethylene from sugar cane, which reduces the carbon footprint of the product by 70%.

Danone are the largest producer of bottled water in the world by volume, and second only to Coca- Cola by value. Their international brands include Volvic and Evian, Bonafont (Latin America), and Mizone (Asia). This is augmented by a strong range of local brands including Lanjaron and Font Vella in Spain, Villa del Sur and Villavicencio in Argentina. The company’s portfolio of water brands in fast-growing Asian markets includes Aqua in Indonesia and Robust in China, which help to make it the leading vendor of bottled water in Asia.

Bottled water may be a disposable purchase in advanced economies, but in many emerging countries with areas of poor drinking water, it is a necessity. In Mexico, for instance per capita consumption is highest in the world at 10 litres per year. Danone is also expanding into flavoured and vitamin-enriched waters to take advantage of rising incomes and higher consumer spending on these products in its fast-growth emerging markets.

Baby Food: An Emerging Winner

Danone’s baby food division has a presence in western markets like the UK as well as emerging markets, such as China and Indonesia, where it currently ranks first and third in terms of sales. Its brands include Bledina, Cow & Gate, and Milupa.

However, the strategic focus is on emerging markets, particularly in Asia. China became the Baby Division’s largest market in 2010, with sales rising 24% from the previous year. Danone’s Dumex brand leads the Chinese market for revenues and volumes in infant formula. Given that the margin on baby food in Asian markets is actually higher than in western markets, rising incomes and growth in middle class consumers should ensure there is considerable scope for Danone to profitably grow their baby food business in these markets.

Medical Nutrition: Significant Scope for Growth

The medical nutrition business, Nutricia, is perhaps the most interesting of Danone’s businesses. While it makes up the smallest part of sales at present, it has low capital investment costs, high profit margins and excellent growth potential - given the structural trends of ageing populations, rising emerging incomes and the growing incidence of immune-related diseases.

Paediatric products account for nearly 40% of sales, and include products for children suffering from allergies, such as Neocate, which is made up of amino-acids that make it an effective substitute for food. Our analysts believe that there is also optionality embedded in this division of the business which is not priced in, particularly in terms of an Alzhiemers product in development, which could accrue considerable earnings. Souvenaid is a nutrient-rich drink for mild sufferers of Alzheimers which has demonstrated some promise in clinical trials. Based on research by MIT, it claims to slow memory loss and protect cognitive function. Further clinical studies are under way and if successful the product could be on the market soon.

While the evidence is building that medical nutrition may be able to make a difference across a broad spectrum of immune-related conditions, regulators demand a high hurdle rate in terms of clinical proof. In fact, the European Food Safety Authority has made Danone withdraw certain advertising claims in some markets. That risk notwithstanding, companies like Danone (and Nestle) are intent on being at the forefront of what could be a fast-growing new category that combines food with pharmaceutical knowledge to alleviate disease symptoms.

Longer-Term Driver: Emerging Market Consumption

“Danone and Nestle are well positioned to take advantage of growing consumption in emerging markets and higher levels of spending on food.”
Nicola Stafford, portfolio manager, global consumer equities

Economic growth and rising affluence in developing countries, such as China, India and Brazil, is allowing huge numbers of people to improve their diets by adding more protein, namely meat and dairy products. In China, in particular, traditional diets were low in dairy but as consumers grow wealthier and develop western tastes, sales of dairy products have been growing rapidly. Sales of confectionery are also rising strongly as emerging market consumers develop a sweet tooth.

As incomes rise and the emerging middle class expands, one of the largest impacts in terms of consumer purchasing is on food:
  • The proportion of income spent on food declines, but
  • The overall value of spending on food increases as consumers buy more and trade-up to better-tasting, more expensive branded foods.
  • There is also a shift in the types of food consumed with an increase in higher-protein foods such as meat and dairy. There is also a move towards products that offer convenience and an increase in indulgent foods, such as confectionery.

  • Due to the fact that many regions lack safe drinking water, Mexico and Brazil are in the top four bottled waters markets by volume. In fact, per capita consumption of bottled water in Mexico is double that of the US. The scope for increasing volumes in Asia is particularly significant given that per person consumption remains very low by comparison with other countries. As the chart (below right) shows China and Indonesia are already high volume markets but remain significantly underpenetrated in terms of per person consumption of bottled water.

    Other Beneficiaries of the Theme

    “Nestle has significant pricing power thanks to a stable of strong brands such as KitKat, Shredded Wheat, and Nescafe. As the world’s largest food manufacturer, Nestle also benefits from significant scale advantages which allow it produce at low costs. This combination of low costs and strong branding give it considerable pricing power and the capability to continue growing earnings, even in tough times.”
    Sam Morse, portfolio manager, European equities

    "China Mengniu is one of my highest-conviction holdings. The company is a leading player in the Chinese dairy market and benefits from relatively high barriers to entry. I believe they can deliver strong earnings growth in the next few years."
    Raymond Ma, Portfolio Manager, China Consumer equities

    Nestle is another beneficiary of the longer-term themes of rising consumption and changing diets in emerging markets as well as the tendency towards higher-value indulgent purchases. The Swiss founded company has an international stable of consumer brands that provides it with superior pricing power and relative scale advantages. Nestle’s recent announcement that it had agreed to pay $1.7 billion to acquire a controlling interest in Chinese candy company Hsu Fu Chi underlines its strategic commitment to emerging markets. The proposed deal, if completed, would be the biggest-ever acquisition in China by a foreign company. For a price that is less than 1% of Nestle’s market capitalisation, the deal gives it an extensive distribution network in the Chinese market.

    There are, of course, also domestic players that will give international brands like Danone and Nestle a run for their money. China Mengniu is the largest domestic dairy company in China. Like Danone, it recognises that the dairy market is under-penetrated and offers strong growth potential. Domestic companies can benefit from a deep understanding of their home market and the fact they are alert to the distinctive needs of local consumers. This is why Chinese brands, like China Mengniu, can also grow strongly as incomes expand and consumption grows accordingly.


    Selected food producers, such as Danone and Nestle are well positioned to benefit from fast growth in incomes and changes in diets in emerging markets. In particular, Danone’s strong focus on its four healthy food categories combined with its geographic rebalancing to fast-growth markets should allow it to achieve strong and sustainable growth in earnings. Its best-in-class high-single digit sales growth, coupled with strong free cash flow and a good incremental return on investment makes Danone the standout stock in the consumer staples sector. Moreover, in today’s uncertain world, well-established consumer staple companies, like Danone, offer something of a haven for equity investors as they tend to be relatively resilient in low economic growth conditions.


    1. Danone Annual Report, 2010