One of the main issues with the company has been that every year, one of its businesses or regions confronts a large-scale operating issue, even though its business has strong category and market exposure, according to analyst Andrew Wood of Sanford C. Bernstein.
“In recent years it has been the removal of health claims for Fresh Dairy in Western Europe, business momentum and integration issues in Russia following the Unimilk acquisition, the growth of Greek yoghurt in the US and, most recently, the China baby formula recall impact,” wrote Wood in a research note.
Baby woes
Baby nutrition in China accounts for 4-5% of Danone’s total company sales. It has been a huge engine for growth at Danone over the last 4-5 years but, in August 2013, the company was forced to recall its milk formula from China and other Asian markets due to potential contamination issues with milk sourced from Fonterra.
While no harmful substances were found in the product, the impact of this recall was significant for Danone, and particularly so in a market like China, where food safety has become such a major controversy for consumers given previous food scares, including the 2008 baby food melamine crisis.
“Danone has estimated that it will lose €350m [US$479m] in sales, €280m [US$383m] in EBIT and €300m in cash impact all in Q3/Q4 2013 as a result of this recall,” continued Wood.
“No guidance has yet been given for the impact on 2014 as we consider that management wants to get some visibility on trends before doing so.”
Accordingly, Bernstein compiled a report to assess the China baby formula market and Danone-specific trends for the fourth-quarter of 2013 and into 2014. This is based on a detailed review of Nielsen data for China through to December 2013, the latest available data.
Falling growth
Following fast-paced growth of 18% in 2012, this slowed to 13% during the first-half of 2013 before falling dramatically to an average of just 1% in the second-half of the year.
“Danone’s growth has dropped even more than the market… and has been a big factor in the market’s weakness,” the Bernstein report said.
“Following the recall announcement in August, Danone’s growth fell ‘off a cliff’ and averaged -58% in the last 5 months of the year...with a deteriorating trend in each month from August (-39%) to December (-65%).”
With growth falling much faster than the market, Danone is losing share, delivering some “winners” from Danone’s massive losses. Nestlé, for example, has made some major gains since August, while Biostime, Yili, Beingmate and Mead Johnson have each seen share growth.
“Clearly the data is indicating that not only have trends not improved… but they have become even worse in recent months,” wrote Wood.
To stem the tide, Danone has been investing heavily in rebuilding brand image, so this makes recent trends even more troubling. This, the analyst believes, could potentially push out the expected timing of any recovery of the business, and make it even more expensive. In turn, this could prove to be a major drag on Danone once again in 2014.
“Currently, our model embeds a recovery in Baby Nutrition organic growth for Danone in H2 2014. We expect Q4 2013 like-for-like growth (-9%) to be as weak as Q3 (-9%), which our China Nielsen analysis supports,” continued Wood.
“However, given the heavy brand investment, we had expected to see a slow build in growth to -3% in Q1 and +2% in Q2… before a recovery back to 7-8% growth in H2, helped by the easy comps of H2 2013.”
Recent Nielsen trends have made Bernstein sceptical about the extent and speed of Danone’s China recovery, especially with growth still declining even when Danone has been investing heavily into the business.