* Risk profile is shifting; Upgrade to Buy with 16% upside
We upgrade Danone to Buy on: (1) higher conviction in a Dairy recovery; (2) forecasts of
prodigious growth in Nutrition into 2016; and (3) improving capital allocation with a
focus on ‘white space’ in Waters. We believe these factors imply risk is moving in
investors’ favour and leverage to a recovery is underestimated. Our EPS upgrades place
us +4-7% ahead of cons. in FY15-17E and imply a 3yr EPS CAGR of 11% (> Staples avg.
at 9%). BN currently trades at 10-20% discounts to the sector on 19.4x P/E and 11.1x
EV/EBITDA. Considered on a SOTP, this implies a 3.0x 16E EV/EBITDA multiple for Fresh
Dairy (vs. peers’ average of 11x). We expect a re-rating as confidence returns and raise
our PO to €73, implying 16% upside potential (with Fresh Dairy on 6.5x EV/EBITDA).
* Fresh Dairy: Structural headwinds to continue but stabilising
We are encouraged by signs of stability in the EU yoghurt market (post 3yrs of decline)
and a reacceleration in N America (as per Nielsen data). We expect Danone’s sales to
recover to growth of +3.25% by 18E in (from +0.4% in FY15E), driven by 5% growth in
key brands and EMs. We also forecast a margin recovery to 12% by 19E (from 9.7%
FY15E) on lower A&P spend (vs. ‘15), op. leverage and mix, more than offsetting 15%
assumed milk price inflation.
* Early Life Nutrition: China opportunity outweighs the risk
ELN has bucked the recent trend of weakness in China with a 400bp OSG beat in Q3’15.
We forecast +2% for Q4’15 (vs. +28% Q4’14), implying +8.5%/10.8% OSG in FY15E
/FY16E as BN continues to leverage its positioning in ecommerce to outperform peers.
* Waters: Likely to be a focal point of capital allocation
We are optimistic that Danone’s strategy of small deals and commitment to a 4-5%
capex/sales imply capital discipline. In our view, capital could be invested in sustaining
Waters’ growth (11% 5yr CAGR). We look for confirmation at the CMD on 16th Nov.
* Valuation: PO up to €73; 16th Nov. CMD a potential catalyst
Our DCF-based PO (7.5% WACC, 2.25% terminal growth) rises to €73 from €55 on
upgrades & lower risk, implying 22.5x P/E and 12.6x 16E EV/EBITDA (vs 22x for Staples).