Danone Stake Poses a Challenge for Heinz Investor Peltz

Nelson Peltz helped bring change to H.J. Heinz Co. that led to a $23 billion bid for the company last week. Now he’s turning his attention to Danone SA.

The billionaire investor, whose Trian Fund Management LP disclosed a 1 percent stake in Danone in November, is following a game plan similar to the one he put to work at Heinz after buying into the ketchup maker in 2006. At Danone -- which makes Evian water, baby food, and is the world’s biggest yogurt producer -- he says management should focus on cash returns above acquisitions.

The Danone stake “follows the playbook he’s used with a lot of acquisitions,” said Rahul Sharma, founder and managing director of Neev Capital in London. “There will be a lumpy period, but Danone will be a good investment.”

Danone, which reports full-year earnings tomorrow, is struggling to contend with a consumer slump in western Europe. Its Activia and Actimel brands have been hurt by a shift toward cheaper private labels in the region, and analysts covering the stock are more downbeat than they’ve been in six years.

Peltz prefers to focus on the company’s strength in fast-growing emerging markets and its products that appeal to health-aware consumers.

“We believe the market is offering investors a world-class business for relatively low multiples of earnings and cash flow,” Trian wrote in a presentation on its website, which lists Danone as one of its current investments.

Wendy’s, Cadbury

Peltz’s track record in consumer goods means his opinions aren’t to be taken lightly. Investments in Heinz, Wendy’s Co. and Family Dollar Stores Inc. in the last decade showed gains of at least 20 percent in their first year.

At U.K. confectionery maker Cadbury Schweppes Plc, where he pushed for a spinoff of the soda unit, the investor bought in 2 1/2 years before a 13.6 billion-pound ($21 billion) takeover by Kraft Foods Inc., netting a gain of about 35 percent.

Trian sold most of its stake in Heinz before the takeover by Berkshire Hathaway Inc. and 3G Capital. But it was Peltz and his partners who got the company to focus on shareholder returns as well as its top brands, said John Sini, a portfolio manager at Douglas C. Lane & Associates Inc. in New York.

Trian says in its Web presentation that it wants Danone to pare costs and avoid costly acquisitions. The fund has backed Chief Executive Officer Franck Riboud, who it said has transformed Danone “from an unfocused company to having one of the best-positioned portfolios in the large-cap food space.” A month later, Danone unveiled a restructuring plan to pare about 200 million euros ($267 million) in costs over two years.

French Resistance

A Trian spokeswoman declined to comment on its stake in Danone or on whether Peltz is pursuing a strategy similar to that he used for his investment in Heinz.

Peltz may not be able to exert as much influence at Paris-based Danone as he has at other companies because of French resistance to activist investors, said Julian Lakin, head of research at Mirabaud Securities in London.

“France is very sensitive to outsiders telling them what to do, and yogurt is a protected industry in France,” Lakin said. “I’m not sure an activist investor will make a big impact.”

Such sentiments could protect Danone from takeover even though the company is among the “most obvious targets” in consumer goods, said Martin Deboo, an analyst at Investec in London. French lawmakers voiced opposition to a potential buyout of Danone in 2005 after a media report that PepsiCo Inc. was preparing a $37 billion offer. No formal bid was ever made.

Infant Nutrition

Danone may say tomorrow that adjusted net income rose 8 percent to 1.81 billion euros in 2012, according to the average estimate of 30 analysts surveyed by Bloomberg. In the fourth quarter, like-for-like sales, which exclude currency shifts and divestments, probably rose 3.7 percent, the data show.

Without direct influence, Peltz will be relying on a three-pronged investment case based on a strong presence in health-related food, a large exposure to emerging markets, and what Trian says is an “attractive valuation.”

Danone’s business areas of yogurt, infant nutrition and bottled water are high-growth categories, according to Peltz’s fund. The French company is in a stronger position than most competitors in emerging markets such as China, which comprise about 52 percent of sales compared with 40 percent for competitor Nestle SA and 21 percent for Heinz, Trian said.

The firm expects Danone stock to reach 78 euros by the end of 2014, 56 percent above Friday’s closing price. The goal assumes a ratio of 17 times estimated 2015 per-share earnings, which according to the fund would still be below the average of

18.7 times for the 10 years through Nov. 2.

Waning Enthusiasm

Danone now trades at 16.5 times estimated 2012 earnings, according to data compiled by Bloomberg, versus 18.9 times last year’s reported earnings for Nestle and 18.6 times for Unilever.

The shares fell 0.4 percent to 49.95 euros at 11.30 a.m. in Paris trading. Since Peltz disclosed his stake on Nov. 7, Danone has gained 3.9 percent. That trails Nestle’s 6 percent rise and a 7 percent climb in France’s CAC 40 Index over the same period.

Peltz’s optimism about Danone comes as analysts are becoming less enthusiastic. On a scale of 1 to 5, with 5 the most positive, the consensus rating is 3.19, the lowest since February 2006, according to data compiled by Bloomberg. For Nestle, the consensus is 3.67 and at Unilever it’s 3.53. The number of analysts with a buy rating on Danone stock has fallen to 16 from a peak of 25 in 2010, the data show.

Health Claims

The main area of concern is the dairy business in western Europe, which accounts for about a fifth of revenue, according to Andrew Wood, an analyst at Sanford C. Bernstein in Singapore.

“Danone’s business is still in rapid decline, not just in Spain, but also in Italy and Germany,” Wood, who has a market perform recommendation on the stock, wrote in a Jan. 30 note. The “problems have not yet bottomed out.”

On average, Danone’s products cost about 80 percent more than private-label alternatives, according to Wood. Although that is down from 89 percent in 2012, the discrepancy is still too great, “compounding the market weakness and driving share losses,” Wood wrote.

Though regulators ordered Danone to stop making claims about the specific health benefits of its products in 2010, the company is still charging “premium prices,” said James Edwardes Jones, an analyst at RBC Europe in London.

“Margins in Danone’s dairy business are too high and they’re going to come down as the business commoditizes,” said Edwardes Jones. Peltz’s presentation “made no mention of that, so I can only assume he doesn’t think that’ll be the case.”