Danone has laid out the ground work to reboot its profit margins with a new locally-focused corporate structure and a cost-savings plan. The strategy has been met with certain reservations in some quarters, particularly as it comes replete with job losses. Simon Harvey looks at the key aspects.
Danone investors may have to wait another year until a newly-launched transformation strategy starts to yield results as the French giant has earmarked 2021 as a transition period toward returning profit margins to pre-Covid levels.
Chief executive Emmanuel Faber has admitted the Alpro and Activia owner is somewhat behind the curve with respect to some of its packaged food peers in adapting to the challenges posed by the pandemic, almost a year since the virus first emerged in China last December.
Investors will also need some convincing over the efficacy of the new strategy to drive a turnaround in the share price, which has plummeted 30% this year, while FMCG stalwarts Kraft Heinz, Mondelez International and General Mills have seen their valuations rise.
Faber was spurred into action after Danone’s like-for-like sales fell 1.6% in the first nine months of its current fiscal year and margins dropped to 14%. Those figures bucked historical trends over the five years through 2019, when sales rose by an average of 3.1% (but still below a mid-term target of 3-5%), and margins expanded 260 basis points to 15.2%.
“They are not good numbers,” Faber told attendees at an investor day held virtually on Monday (23 November) when he detailed and explained the new strategy dubbed Reinventing Danone. “What led us from being a company which in mid-2018 was trading at par or at a premium versus our peer group to be today in a situation 18 months later where we trade at about a 30% discount? The share price is not where we believe it should be.”
The CEO continued: “I don’t think we want to blame Covid for all the impact that we are seeing in this year’s numbers. I think we had our fair share of opportunities that we’ve missed in the last several years. Our margin has expanded faster than ever but it is still lagging behind a series of our peers. Many of them have gone through heavy restructuring and significant reorganisation plans over the last five, two, three years and we have not. And it is high time we do.”
“I don’t think we want to blame Covid for all the impact that we are seeing in this year’s numbers”
A common theme running through food manufacturers during the pandemic has been consumers seeking out trusted and established brands. But Faber is taking that to another level by converting the three existing business divisions to six separate zone teams with a “local first” philosophy slanted toward geographical units to “reconnect us with our profitable agenda as soon as possible”.
Europe; CIS and Turkey; Asia, Africa and the Middle East; Greater China and Oceania; Latin America; and Specialised Nutrition make up the new teams, each headed up by a series of leaders.
Faber hopes the initiative will lead to a less complex decision-making process more adept at responding quickly to customer needs in product innovation in individual markets, and with it has launched a “design-to-delivery” function headed up by chief operating officer Henri Bruxelles.
Danone is taking a lead from others like Kraft Heinz and Mondelez in eliminating product lines to weed out dead wood and improve efficiencies, as retailers continue or step-up efforts to reduce their SKU counts. Next year, the company plans to cut 20%, or 2,000 SKUs, as the CEO seeks to realise EUR1bn (US$1.18bn) in cost savings by 2023 – EUR700m from SG&A expenses and EUR300m through extra efficiencies aimed at improving gross margins.
But those particular measures were met with scepticism by some analysts, despite a plan to reinvest 20-25% of the savings.
John Baumgartner at Wells Fargo said a “tempered net savings assumption of 50% (EUR500m) is more reasonable but that evolution will not become clearer until 2023”.
And Alain Oberhuber at Stifel said cost cuts and SKU reduction could lead to lower organic sales, an issue Faber was faced during Monday’s Q&A session.
Bruxelles was left to respond: “We see this as dynamic portfolio management. We think it is a powerful exercise where we will actually review the long-tail of our SKUs, and when we talk about 20% it can be just 1-2% of our net sales.”
Oberhuber is less convinced. “According to the company, Danone’s SKU reduction of 20% should only have a 1-2% negative impact on the organic growth of the company in the long term. In our view, a reduction of 20% of SKUs [to] only lose 1-2% organic sales growth rate looks ambiguous to us,” he wrote in a note to clients. “We conclude that the market will be disappointed with fiscal year 2021 being another transition year, and more announcements of potential portfolio pruning would have been welcomed.”
CFO Juergen Esser, who replaced Cécile Cabanis in October, outlined the financial targets in a two-phased recovery plan. Next year will see the “lasting consequences” of Covid-19 and a new organisational structure in the first half, followed by a return to growth and margin expansion in the back half.
Danone is then aiming for a recurring profit margin above 15% in 2022 (14% was confirmed for this year along with EUR1.8bn in free cash flow). The Actimel owner’s “mid-term ambition” is to achieve a margin in the “mid to high teens” and a reiteration for like-for-like sales growth of 3-5%.
Bruno Monteyne at AllianceBernstein is concerned a higher margin-led goal will strangle innovation rather than foster it, and Danone should instead focus on lower margins to boost revenue growth.
“The focus of this release is almost entirely on cost-cutting rather than what they will do to accelerate growth,” Monteyne wrote in a research note. “We worry about such margin targets and cost-savings focus. Margin targets lead to the lack of innovation and market share losses to both challenger brands and private label that we have seen at Danone. Danone is doubling down on a strategy that hasn’t worked for the last five years.”
Meanwhile, Faber sought to allay those concerns about too much concentration on margins.
“We want to reconnect as soon as possible with our top-line profitable growth but also we have come to realise that the volatility in the world that we live, economically in the countries, does not leave much room for manoeuvre for us in our profitability to live with the current, or actually the previous, set of ambitions, we had for margin. We believe that there is an opportunity and a need to be much more ambitious in our margin expansion to mid-to-high in the mid-term. This is not without fuelling growth.
“We expect to reinvest 20-25% of our savings from the plan to make sure we push our brands because over the last several years, gradually we’ve lost about 100 pips of margin in A&P spending which we believe we need to catch up. I want an agenda which is under our control.”
And the CEO is not just making plans to overcome the business challenges caused by the pandemic but also any future unforeseen circumstances.
“We need to create a significant safety cushion in our level of operating margin to just make sure that we have a business model that is more resilient the day something will come. And it may come. Our peer group went through significant restructuring, and we are now doing this.”
While Danone is streamlining its management structure and operational set-up, it also plans to expand its presence in the plant-based category, particularly in Mexico, Eastern Europe, Asia and the CIS. Danone has an aim of growing its plant-based sales globally from around EUR2bn in 2019 to EUR5bn in 2025
New areas of focus have also been identified, e-commerce, which according to Veronique Penchienati, the CEO for Danone’s international division, is the “fastest-growing” element of Danone’s business, along with healthy ageing, for which the company has set up an accelerator unit in Asia and will seek out partners.
To get a measure of the challenges ahead to improve efficiencies, Danone operates 190 factories around the world, with 300 co-packers, 13,000 SKUs, seven R&D centres and 53,000 suppliers. But the company has now nailed down its country-related business units to 22 from 61.
CFO Esser noted the tough comparables Danone will face in the first quarter of 2021 after this year’s pantry-loading spurred by the pandemic, while continuing cross-border restrictions into China are expected to negatively impact sales for specialised nutrition products in the same quarter.
The majority of the planned EUR1bn in savings will kick in in 2022 and the “savings will not come with a burden on the countries or on the margin of those countries”, Faber said.
However, the burden will fall on employees, with Danone planning to cut 1,500 to 2,000 jobs. The company has faced criticism from unions in France.
Monteyne at Bernstein wrote: “The new plan is going to cause major organisational disruption. We previously worried about structurally low growth in its markets [but] we now also have to worry about a long period of organisational turmoil. These are major shifts that will absorb lots of corporate energy for at least 12 to 18 months.
“We know that more strategy updates will come, probably soon, but we don’t think it is good to decouple margin growth from sales growth. Margin growth should be an outcome of higher sales growth or brands that inspire consumers more strongly than they did before. We think the corporation’s energy and focus should be on innovation and branding rather than redundancies and new organisational structures.”
Faber defended his corner on innovation, noting how Danone had perhaps that always come up with the right products in its strategy of “accelerating the food revolution”. However, at the same time, he acknowledged there were underlying issues before Covid-19 that required fixing under a new and more agile structure.
“We have too many small, not sticking, innovations on the market. When we brought our abilities from 15% of products with less than two years in our range to 30% of them last year, I already shared with my team that we were over innovating,” he said.
“We were putting on the market product solutions that we were either not able to support or ultimately wouldn’t make it to lasting innovation. There was a misuse of resources, management time, energy and money that we intend to now channel in a much more disciplined and in a locally granular manner in terms of innovation.
“Yes there is Covid, but there was more than Covid. We had structural weaknesses in the way we work and organise and the way we built our competencies, and we made them work within the company. Yes there were self-inflicted ways of working at Danone that prevented us from benefiting from the full scale of our great categories and brands that we have.”
For the time being, Covid-19 is likely to dictate Danone’s trajectory until solid evidence emerges that Faber’s transformation plan will deliver the desired results. For now, markets have yet to be inspired with the stock down on the week so far.