Danone: Dairy and Infant Nutrition Leader at Attractive Valuation

Stuart Mitchell of S. W. Mitchell Capital presented his in-depth investment thesis on Danone (France: BN) at European Investing Summit 2020.

Thesis summary:

Danone is the world’s largest fresh dairy and plant-based drinks company and is number-two in infant nutrition and packaged water. Sales split by division in 2019: 52% Essential Dairy and Plant based (EDP), 30% Specialised Nutrition, and 18% Water. Specialised Nutrition is the most profitable business area (25% operating margin), making up 50% of group profit, followed by EDP at 35% and Water at 15%. Danone’s top three brands are Aptamil, Activia, and Danone. Sales breakdown by region: 54% Europe and North America and 46% rest of the world (including 10% in China).

According to Stuart, we have been presented with a rare opportunity to buy this company at a compelling valuation. The share price has fallen to 2014 levels as investors have lowered their organic growth expectations from 4-5% to 3% following the 2019 profit warning. Sentiment has been depressed further with the “single-serve” bottled water business suffering terribly in the first half of the year (-32%, H1 sales) as the pandemic took hold. The group has also faced €115 million extra Covid-related costs in the first half of the year (7% of group profit).

In Stuart’s view, organic growth is likely to be somewhat faster than many analysts expect, driven primarily by continued 15% organic growth in the plant-based drinks business (8% sales). Growth is especially strong in Europe where plant-based drinks have penetrated 30% of households, as compared to 45% penetration in the US.

Stuart also believes that the Nutrition area can continue to grow at 5% per annum in the mid-term. In his view, analysts have underestimated the ability of the highly developed Chinese market (25% sales) to grow at 3-5% in the future. Infant nutrition is sold like a luxury product in China and the ultra-premium Aptamil Platinum category is still growing very fast.

Stuart is also somewhat more optimistic about the outlook for the Water segment. While the division has suffered in the short term from 50% lower single-bottle sales in China, the industry should still grow at 3-5% in the future. The quality of tap water continues to deteriorate across the world as the increased use of pesticides demands more intensive water treatment. In regions like California, furthermore, there have been prolonged periods when there is no tap water at all. Danone is working hard to “green” the division by introducing recyclable PET’s.

With regard to valuation, Danone trades at 15x prospective earnings, as compared to Unilever and Nestle at 19x and 24x, respectively. Despite being somewhat less profitable, this appears harsh considering that Danone has grown sales organically at a similar rate to both groups over the past ten years. More interestingly perhaps, valuing the different business areas separately suggests a valuation nearer to €83 per share, or 45% above the recent share price.

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About the instructor:

Stuart Mitchell is the Managing Partner and CIO of S. W. Mitchell Capital and the Investment Manager of the SWMC European Fund, as well as a number of managed accounts. Prior to founding SWMC in 2005 Stuart was a Principal, Director and Head of Specialist Equities at JO Hambro Investment Management (JOHIM, now Waverton Investment Management). At JOHIM he set up and managed the Charlemagne Fund, a long/short European fund, and the JOHIM European Fund, a long only European fund. The JOHIM European Fund rose by 133% since inception in December 1998 until March 2005 compared with 8% for the benchmark index and was number 1 rated by Micropal within its sector and three star ranked by S&P. Upon leaving university in 1987 Stuart joined Morgan Grenfell Asset Management (MGAM) and soon afterwards assumed responsibility for managing the continental European equity assets for MGAM’s British pension fund clients. Stuart was appointed a director of MGAM in 1996. He was then made Head of European Equities and was responsible for $27 billion of equity assets. Whilst at MGAM he managed the Morgan Grenfell European Fund which rose by 123% from January 1990 to June 1996 compared with 85% for the benchmark index and was awarded 1st place by Micropal (5 year awards) in 1996. Stuart was born in Scotland and educated at Fettes College and St. Andrews University where he read Medieval History. He is also a graduate of the Owner/President Management programme from the Harvard Business School. Stuart speaks English and French.