DANOY - Danone: Sales Growth Through Price Increases May Not Be Sustainable

2023-10-17 10:43:26 ET

Summary

• Danone's stock trajectory has been mostly downward over the past five years despite some gains in the last year.
• Like-for-like sales growth has been driven by price increases rather than volume growth, posing a risk to future sales growth.
• Pricing considerations are the biggest risk to Danone, and a revival in volume-based growth is needed for potential upside in the stock.

Investment Thesis: Until such time that we see a significant revival in volume-based growth, then I do not see a case for upside in Danone at this time.

Danone ( OTCQX:DANOY ) is a leading French food products corporation, which is particularly well known for its sale of dairy products.

We can see that while the stock saw some gains in the last year, the overall trajectory for the stock has been to the downside over the past five years.

The purpose of this article is to assess whether Danone can reasonably be expected to see upside from here - taking recent performance and industry conditions into consideration. In particular, I also wish to detail what I will specifically be looking for in upcoming Q3 2023 earnings on October 26 to assess whether further upside for the stock is possible.

Performance

When looking at 2023 half-year results , we can see that like-for-like sales were up by 8.4% on that of the same period in the previous year, while recurring earnings per share was up by 7.6%.

Additionally, we can see that EDP (Essential Dairy & Plant-based) accounts for the majority of sales but has seen the biggest decrease in volume/mix growth as compared to the same quarter last year:

Given concerns over higher inflation and a reduction in sales - there has been a trend across supermarket chains where revenue has continued to rise - but this has been ultimately driven by price growth rather than volume growth. This is a risk in the sense that once we see inflation start to level off - then sales will start to dip if volume growth does not rise in response.

For Danone specifically, of the 8.4% like-for-like growth that the company saw in sales from H1 2022 to H1 2023, price was up by 9.4% and volume/mix was down by -1.1%. In this regard, it was price growth that led to overall growth in LFL sales, while decline in volume/mix brought this down slightly.

In contrast, growth of 7.4% in like-for-like sales from H1 2021 to H1 2022 was driven by price growth of 6.8% and growth in volume/mix of 0.9%. In this regard, the past two years has seen like-for-like sales overwhelmingly driven by price growth - but this trend has become more pronounced in the last year.

When analysing growth vs. volume from a longer-term standpoint, we can see that volume growth has actually been negative over the past seven years. While growth hit a 10-year high in 2022, volume growth continued to remain negative.

In this regard, it is this lack of volume growth that has contributed to the longer-term downside that we have been seeing in the stock over the past five years.

From a balance sheet standpoint, we can see that the company's net debt to total assets ratio has risen slightly over a six-month period.

Source: Figures (in € millions) sourced from Danone H1 2023: Results Presentation. Net debt to total assets ratio calculated by author.

With that being said, we did also see free cash flow of €1.1 billion in H1 2023, which marks an increase of €400 million from that of last year.

From a valuation standpoint, we can see that when comparing Danone's P/E ratio to that of Nestle and Carrefour, we can see that Danone trades slightly below that of Nestle ( OTCPK:NSRGY ), while both companies show a substantially higher ratio than that of Carrefour ( OTCPK:CRRFY ).

P/E Ratio vs. Peers

Moreover, we can also see that the company's P/E ratio remains substantially higher than that of the general trend seen over the previous five years - while earnings per share remains near a five-year low.

P/E Ratio vs. EPS

Taking this into consideration, I estimate that the range of $10-13 that we have seen over the past year represents fair value for the stock - and the decline we have seen in price over the past five years reflects the decline in earnings per share that we have seen over this period.

Risks and Looking Forward

Going forward, I take the view that Danone may well see further sales growth come under pressure, as sustaining sales growth through price increases alone is unlikely to be a sustainable strategy.

This is particularly the case when one considers that the French government is increasingly seeking to achieve price reductions across supermarket retailers and Danone can be expected significantly more price competition in this regard.

Both Danone and competitor Nestle rely on the French market for revenue - more so than any other market in Western Europe. As a result, with domestic players such as Carrefour having taken more proactive steps to show compliance with price reduction initiatives - such as placing "shrinkflation" labels on products that are getting smaller without any corresponding price reduction - it is unlikely that Danone will be able to 1) sustain price increases or 2) be able to significantly shrink product size while keeping prices constant.

I see pricing considerations as the biggest risk to Danone at this time - as the ability of the company to continue sustaining sales growth through price increases alone is likely to diminish going forward.

In this regard, I will be paying particular attention to how price and volume/mix affect sales growth in upcoming Q3 2023 earnings. Specifically, I take the view that Danone would need to see a revival in volume-based growth to justify further upside from here.

Particularly, I will be paying attention to volume mix/growth across the European market. We saw that Q2 2023 saw a -5.1% drop in volume mix/growth as compared to the same quarter in the previous year, which was the largest drop across all geographies - and which accounts for the majority of sales for Danone. Unless we start to see a significant revival in the same for the upcoming quarter, then I take the view that downside in the stock could continue. With that being said, the fact that full-year volume growth has been negative over the past seven years is an indication that the negative trajectory could stand to continue.

In addition, I would also like to see evidence of a revival in earnings growth as well as a reduction in net debt relative to total assets. While Danone has seen like-for-like sales growth continue due to rising prices - this has not necessarily affected earnings growth or allowed Danone to significantly reduce its net debt. In this regard, I take the view that investors will pay attention to these metrics to determine whether Danone can start to see a rebound in upside.

Conclusion

To conclude, Danone has continued to see sales growth but this has primarily been price-based rather than volume-based. Until such time that we see a significant revival in volume-based growth, then I do not see a case for upside in Danone at this time.

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