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EQUITY REPORT

November 2013

Sector Analysis
REVENUE EVOLUTION

Consumer Goods Sector An Overview:


The fast moving consumer goods sector is a large and important part of almost every economy in the world, insofar as the products associated with the industry represents a big part of every consumer budget. In this report, the focus will be the market for foods and beverages. Danones competitors in its respective business lines include large multinational food and beverage corporations such as Nestle, Grupo Bimbo, Kraft Foods, large corporations in the medical nutrition and baby nutrition segments such as Abbott, Mead Johnson, Fresenius, more local and smaller companies specialized in certain product lines or markets, or retail chains offering generic or private label products. The food and beverage sector is highly competitive due to the large number of national and international competitors and also due to the high demand of products in the emerging markets such as Russia, China and Brazil.

FEP Finance Club; Annual Reports of each company

STOCK PERFORMANCE

Growth in Emerging Markets boosts sales:


One of the evolutions registered in this sector during the last few years is the growth registered in emerging markets. This trend can be clearly seen in the results presented by Nestle, in September. The company reported a sales growth of 11,7% in emerging markets, while only registering a growth of 2,4% in developed markets. These growth rates have been registered throughout the entire sector and companies have reacted by intensifying their activity in these countries.

FEP Finance Club; Yahoo-Finance

MIDDLE CLASS GROWTH EXPECTATIONS

Demand for Greek yogurt shoot up:


The demand for Greek yogurt has been increasing during the past year, all over the world, leading to a strong increase in the sales of this product. However, in this case, we are not only witnessing a growth of this market in emerging markets, but also in the United States. Even though this is not a market where we usually find growth similar to the one in emerging markets, the demand for this type of yogurt has presented itself as a surprising exception.

Studies point out harmful effects of milk:


During the last few months, some studies on the harmful effects of milk became public. This can pose a threat to the consumption of dairy products and
FEP Finance Club; OCDE Development Centre

consequently reflected in a decrease in sales.

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Company Analysis
COMPANY:
Shares Outstanding:

Danone
592.145.734

Share Price (28/06/2013):

57,66

P/E:

16,84

Ticker (Bloomberg): Volume (Bloomberg):

BN.FP 1.117.885

EPS Date of Valuation:

2,96 Jun 2013

Market Capitalization: 34.143,123 (M)

CONSOLIDATED SALES BY DIVISION

Danone Company Synopsis


Danone, whose mission is bringing health through food to as many people as possible, is a multinational company in the consumer goods food and beverage sector with four division lines: - Fresh Dairy Products which produces and markets yogurts, fermented fresh dairy products and other specialized fresh dairy products. Famous brands include Activia, Actimel, Vitalinea. Greek Yogurt, etc. - Waters sector which comprises the natural waters business along with flavored and vitamin-enriched waters business, such as Evian, Volvic, Bonafont, etc. - Baby Nutrition sector which focuses on specialized foods for babies and young children to complement breast-feeding, with brands such as Cow & Gate, Aptamil, etc. - Medical Nutrition sector which focuses mainly on people receiving medical treatment, babies afflicted with certain illnesses and frail elderly people. The main brand of this segment is Nutricia.

FEP Finance Club; Danones Annual Reports

SALES BY GEOGRAPHI C R EGION

Business Strategy
Danone is focused on strengthening its position in the markets with strong growth potential, such as Russia, United States, Brazil, Mexico, Japan and South Africa, where the per capita consumption of fresh dairy products is low. This strategy focuses on the development of the existing product lines, as well as on the continuous introduction of new products. This enables the company to reach new segments and develop new consumption moments while covering the full range of price points. To build the credibility of the baby nutrition brands as an answer to the specific needs of babies and young children is also extremely important for this company. The goal is to make these products better known and understood among opinion leaders, healthcare professionals and order-givers in the sector. The development of the business also consists in increasing the global coverage of the brands by penetrating new countries and developing various distribution channels.

FEP Finance Club; Danones Annual Reports

STOCK PRICE PERFORMANCE

FEP Finance Club; Yahoo Finance

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RESULTS ANALYSIS
(i n Mi l l i ons )

Result Analysis:
2012 20.869 3.628 2.958 1.787 2,96 2013 - Jun 11.058 1.812 1.475 1.045 1,76

Net Sales EBITDA EBIT Net Income EPS ()

2008 15.220 2.795 2.270 1.491 3,02

2009 14.982 2.843 2.294 1.521 2,69

2010 17.010 3.172 2.578 2.034 3,30

2011 19.318 3.480 2.843 1.855 3,07

FEP Finance Club; Danones Annual Reports

ROE DUPONT ANALYSIS

Danones financial performance has been improving for the last four years. Even though, during the financial crisis (2007-2008), Danones performance declined a lot, in the subsequent period, this trend has reversed and the performance of this company has been enhanced. In the period from 2009 to 2012, Danones sales have grown at an increasing rate, presenting an increase of 39% during these four years. This fact led to a growth of the gross margin by 27% and of the EBIT by almost 29%, within this period. The company registered a lower growth rate of the EBIT, when compared with the growth of sales, due to an accentuated increase in the cost of sales, which grew at a rate higher than sales, in the years from 2010 to 2012. On the other hand, the net income has been decreasing in past two years, mainly due to higher values presented for taxes expenses.

DuPont Analysis:
The companys Return on Equity (ROE) has decreased for the past two years, mainly due to the profit margin, which has been also decreasing. Still, this trend has been counterbalance by the increase in asset turnover, even if at a lower growth rate than the profit margin. While the evolution of the profit margin can be explained by an increase in sales, the trend registered by the asset turn over can be attributed to the growth of the companys total assets, which is clearly smaller than the growth in sales. Therefore, we see that Danone has become more efficient in its production.

FEP Finance Club; Danones Annual Reports

EPS AND DIVIDENDS

Market Performance
Danones share price has increased by almost 35% from 2009 until June of 2013, being set at 57,66 at the date of the valuation. The evolution of this price has been in line with the evolution has been quite similar to the one registered by CAC 40, Frances main stock index. From 2008 onwards, the companys dividend per share has been increasing. Even though both the share price and the dividend per share have grown consistently in the last few years, the dividend yield decreased in 2012 This is a result of the companys preference for a policy based on share repurchase, instead of increasing even more dividends. The Earnings per Share (EPS) has been declining since 2010 as the result of a decreasing Net Income. On the other hand, the Price Earnings Ratio (PER) presents an opposite trend, as a result of a higher share price and a smaller EPS. The Price-Book-Value (PBV) has been stable evolution in the period analyzed.

FEP Finance Club; Danones Annual Reports; Yahoo Finance

OTHER MARKET RATIOS

FEP Finance Club; Danones Annual Reports

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FREE CASH FLOW T O FIRM


(in millions) EBIT (1-T) Dep. & Amort. CAPEX Working Capital FCFF 2013 2183,00 666,81 983,13 -31,02 1897,70 2014 2385,34 688,63 1051,95 117,91 1904,11 2015 2481,42 711,16 1125,59 10,00 2056,99 33678,95 Residual Value

Growth Expectations:
The underlying assumptions of our valuation is that the emerging markets, like Russia, China, Brazil and Mexico, will continue to grow and lead to an increase in demand products such as food and beverages. The huge increase in demand of Greek yogurt recently will also play a role in increasing the sales of Danone. For these reasons, we believe that the companys sales will grow at a rate of 7% for the next two years. In terms of long-term growth, we believe that the growth rate will be in line with expected Frances economic growth that is 1,40%.

FEP Finance Club; Danones Annual Reports

WACC
Interest Coverage Ratio Rating Default Spread Risk Free Cost of Debt WACC 17,15 AAA 0,40% 2,48% 2,88% Beta Debt to Equity Ratio Tax Rate Risk Premium Cost of Equity 0,75 36,03% 33,33% 6,20% 7,13%

Valuation Discounted Cash Flow Model:


According to our valuation through the Discounted Cash Flow model (DCF), we arrived to a share price for Danone of 46,48. In order to determine the Weighted Average Cost of Capital (WACC) for the company, we needed to determine to obtain its Cost of Equity, as well as its Cost of Debt. Regarding the Cost of Debt, we applied the Capital Asset Pricing Model (CAPM). Using the data presented in the table on the left, we were able to arrive to a Cost of Equity equal to 7,13% As for the Cost of Debt, we determined that the rating for the company is AAA, based on its interest coverage ratio. For the risk-free rate we used Germany bunds 30-years (2013/06/30), since these bonds are denominated in the same currency as Danones, allowing us to avoid currency risk, and its stable in terms of its economy and investment. With this, we obtained a Cost of Debt of 2,88%. From the above discussion it can be concluded that the WACC for Danone is 5,75%. An additional consideration needed in the valuation process is linked with the companys stock options plans. At the date of the valuation, Danone had in place a total of 11 stock options plans. In order to value them, we applied the Black and Scholes model, using information collected from the companys financial reports. The total value of the options that the Danone has in place is approximately 103 million. After all necessary computations, we arrived at an enterprise value of 37 525,20 million. Taking in consideration Danones net debt, minority interests and stock options, we arrived to an Equity Value of 27.525.47 million, which corresponds to a share price of 46,48. Our conclusion is that Danone is overvalued in the market, as its share price at the date of the valuation was of 57,66.

5,75%

FEP Finance Club; Danones Annual Reports; Yahoo Finance; Damodarans Data Sets

SHARE VALUE
Enterprise Value ( M) Debt ( M) Minority Interests ( M) Stock Options ( M) Equity ( M) Shares outstanding ( M) Share Price Market Share Price 37.525,20 9.917,00 14,00 68,74 27.525,47 592,15 46,48 57,66

FEP Finance Club; Danones Annual Reports; Yahoo Finance

STOCK OPTIONS
Option Plan 1 Option Plan 2 57,66 57,66 38,95 42,53 2% 2% 13% 13% 0,08 0,33 16,48 12,63 1.500 11.872 24.724 149.999 103.099.151

Strike Price Exercise Price Risk Free Volatility Time to Maturity Call Option Number of Options Total Value of the Option Plan Total Value of the Options*

* The company has in place a total of 11 option plans in place FEP Finance Club; Danones Annual Reports; Yahoo Finance

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PRICE/EARNINGS
Price/Earnings 2012 Nestl, S.A. Associated British Foods, PLC Kerry Group, PLC Grupo Bimbo SAB de CV Kraft Foods Inc. Tate & Lyle, PLC Danone, S.A. Peer's Median Discount to Peer's Median 17,95x 22,25x 26,20x 77,84x 16,52x 11,85x 18,01x 20,10x 10,37% 2013E 17,79x 20,91x 21,41x 36,38x 13,29x 13,03x 19,72x 19,35x -1,93% 2014E 16,69x 16,16x 14,75x 21,32x 14,33x 13,56x 16,31x 15,45x -5,53%

Multiples:
In 2012, Danone has a low P/E ratio, when compared withPrice/Sales its peers median, meaning EV/EBITDA that the company was undervalued, EV/EBITDA confirms. 2012 2013E as the 2014E 2012 multiple 2013Ealso2014E In contrast, for 2013 and 2014 and the P/S for 2,30x 2,26xthe P/E 2,17x 13,34x 13,00x 12,30x the three years are higher than the median, having 1,46x 1,34x 1,28x 9,11x 11,27x 11,30x a negative discount when12,26x compared to the peers 1,20x 1,20x 1,16x 13,00x 11,50x median. This indicates Danone 13,00x is overvalued. 1,11x 1,08x 1,04x that 13,63x 11,00x The P/E ratio represents how much 1,71x 1,71x 1,67x 11,51x 11,40xinvestors 10,40x are willing to pay for 1 of earnings. Danone, was trading 1,23x 1,16x 1,12x 8,63x 9,11x 8,83x in 2012 at a multiple of 18, which means that an 1,54x 1,49x 1,42x 11,53x 12,00x 10,80x investor was willing to pay 18 for 1 of current 1,34x 1,27x 1,22x 11,89x 12,20x 11,15x earnings. For 2013 its expected that an investor will -14,45% -16,94% -16,74% 2,99% 1,64% want to pay more for each euro of earnings3,14% (19,72x), but the scenario in 2014 its a bit more pessimistic and this multiple value may decrease to 16,31x. As for the Price/Sales multiple, we can see that investors want to pay a lower price per each euro of sales. But, when compared to the peer group Finally, looking at the EV/EBITDA multiple, we see that the company has a lower ratio when compared to its peers, meaning that Danone is slightly undervalued.

FEP Finance Club; Danones Annual Reports; Yahoo Finance

PRICE/SALES
Price/Sales 2012 Nestl, S.A. Associated British Foods, PLC Kerry Group, PLC Grupo Bimbo SAB de CV Kraft Foods Inc. Tate & Lyle, PLC Danone, S.A. Peer's Median Discount to Peer's Median 2,30x 1,46x 1,20x 1,11x 1,71x 1,23x 1,54x 1,34x 2013E 2,26x 1,34x 1,20x 1,08x 1,71x 1,16x 1,49x 1,27x 2014E 2,17x 1,28x 1,16x 1,04x 1,67x 1,12x 1,42x 1,22x

Risk Analysis:
Regarding currency risk, Danone is exposed to foreign exchange rate fluctuations in its operational activities, such as import of raw materials. Additionally, it is also exposed to translation and transaction risk. The company manages this risk by monitoring and hedging the net position of certain subsidiaries, with regular assessments of risks and opportunities to use hedging instruments. Danones financing risk corresponds to indebtedness linked with operational activities. The firms liquidity risk comes mainly from the maturities of its interest and non-interest-bearing debt, as well as payments on derivative instruments. The these risks are mitigated by (i) diversifying its financing sources, (ii) maintaining these sources available at any time, (iii) financing itself through medium term financing, and (iv) ensuring that it is not subject to any covenant that obliges to keep financial ratios in line with financing contracts. Danone is exposed to interest rate risk on its financial liabilities and cash equivalents, since interest rate fluctuations impact financial expenses. Hedging instruments are used to monitor and manage this risk.

-14,45% -16,94% -16,74%

FEP Finance Club; Danones Annual Reports; Yahoo Finance

EV/EBITDA
EV/EBITDA 2012 Nestl, S.A. Associated British Foods, PLC Kerry Group, PLC Grupo Bimbo SAB de CV Kraft Foods Inc. Tate & Lyle, PLC Danone, S.A. Peer's Median Discount to Peer's Median 13,34x 9,11x 12,26x 13,63x 11,51x 8,63x 11,53x 11,89x 2,99% 2013E 13,00x 11,27x 13,00x 13,00x 11,40x 9,11x 12,00x 12,20x 1,64% 2014E 12,30x 11,30x 11,50x 11,00x 10,40x 8,83x 10,80x 11,15x 3,14%

FEP Finance Club; Danones Annual Reports; Yahoo Finance

Cristiana Gonalves

Jos Filipe Sampaio

Mrcia Azevedo

Pritesh Nand

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