This French Food Giant Has a 46% Upside Potential

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Recently, famous activist investor Nelson Peltz turned bullish on one of the largest French food companies, Groupe Danone SA (NASDAQOTH: DANOY). After Nelson Peltz’s presentation at the beginning of November 2012, Danone’s share price has risen from €49.80 ($64.91) to €53.46 ($69.68). The company’s American Depository Receipt (ADR) has risen from $12.50 to $14.50 in the same period. Nelson Peltz thought that the company must be worth €78 ($101.67) per share by the end of 2014, a 46% premium on its current share price.

Let’s find out whether or not investors should follow Nelson Peltz into Danone at its current share price.

Yogurt is the biggest business

Danone is considered to be one of the largest French producers of fresh milk products, baby foods, biscuits, cereal products, and bottled water, operating in four main business segments: Fresh Dairy Products (Yogurt), Waters, Baby Nutrition, and Medical Nutrition.

The majority of its revenue, €11.67 ($15.21) billion, or nearly 56% of total revenue, was generated from the Fresh Dairy Products segment. The second biggest revenue contributor was the Baby Nutrition segment, with nearly €4.26 ($5.55) billion in 2012 revenue, while the revenue of the Waters segment and the Medical Nutrition segment were €3.65 ($4.75) billion and €1.29 ($1.68) billion, respectively.

Danone seems to have a quite reasonable capital structure. As of December 2012, it had €12.25 ($15.97) billion in total shareholders’ equity, €6.29 ($8.2) billion in net debt, and nearly €5.38 ($7) billion in working capital. However, it had a huge intangible asset of more than €16.26 ($21.19) billion at the end of 2012. The huge intangible assets have made Danone’s tangible book value negative.

Three reasons to invest in Danone

In November 2012, Nelson Peltz’s Trian Fund Management reported that it had around 1% economic interest in the company.  He believed that the company was trading at a huge discount to its intrinsic value, and he “targeted strategies to improve performance, such as a leaner cost structure and refraining from dilutive mergers, could generate significant shareholder value.”

There are three main reasons to get excited about Danone. First, Danone possesses a great “21st century” portfolio. The majority of its earnings before interest and taxes (EBIT) are derived from the Yogurt segment. Bottled Water represented 17% of the total EBIT, and Baby/Medical Nutrition accounted for 37% of the total EBIT. Its biggest segment, Yogurt, is the leader with 23% of the global market share.

Second, Danone has the highest exposure to the emerging markets among consumer staples companies. The majority of the company’s sales, 52%, come from the emerging markets, while Nestle (NASDAQOTH: NSRGY) generated 40% of its sales from the emerging markets. Mondelez International (NASDAQ: MDLZ), another giant food corporation, has 45.4% of its sales in the developing markets.

Third, the company is cheap. At the current price of €53.46 ($69.68) per share, Danone is worth about €32.1 ($41.84) billion on the market. It is valued at 8.86 times EV/EBITDA, which is cheap when compared to those of both Mondelez and Nestle. Mondelez is trading around $28 per share, with a total market cap of nearly $51 billion. The market is valuing Mondelez at 12 times EV/EBITDA.

Nestle is the biggest company, with a total market cap of around $226 billion. At the current trading price of around $70 per share, Nestle is valued at 12.92 times EV/EBITDA. In terms of profitability, Nestle seems to be the most profitable among the three. Over the past twelve months, it generated 15.64% operating margin, while the operating margin of Danone was a bit lower, at 14.17%. Mondelez’s operating margin was the lowest at 12.2%.

Going forward, Nelson Peltz would keep pushing for a leaner cost structure to offset the economic challenges in Europe. The company could adopt a balanced approach to driving value by balancing between sales and EPS growth. In addition, Danone could invest significantly in R&D and marketing to drive its core brand portfolio, however, it should hold back from its dilutive mergers & acquisitions.

Foolish bottom line

Indeed, Danone has a much cheaper valuation compared to both Nestle and Mondelez. With the similar valuation of 12 times EV multiple, Danone should be worth €43.47 ($56.66) billion, or €72.40 ($94.37) per share.

hoangquocanh has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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