Text size

When Nelson Peltz talks, the wise corporate managers listen. Peltz, head of Trian Fund Management, is an activist investor with a long and successful record in numerous industries, including packaged foods. He has helped to transform and boost shareholder value at companies ranging from H.J. Heinz (ticker: HNZ) to Cadbury Schweppes to Kraft Foods (KRFT).

In November, Peltz and his associates set their sights on Danone (BN.France), the French dairy giant, whose management so far seems willing to lend an ear. Perhaps it's just coincidence, but after several years of lackluster performance, Danone is cutting costs and chasing profits, instead of market share. The change in strategy could lead to robust profit growth at the Paris-based company starting in 2014, and a powerful rally in Danone's shares.

Danone markets yogurt under many brands, including Danone, Dannon, Stonyfield, and Oikos. Barron's Graphics

Trian, which reported a 1% stake in Danone last November, believes that the company can unlock value by implementing a leaner cost structure and avoiding dilutive mergers, a problem in the past. Peltz indicated in November, at an investment conference in Chicago, that Trian will have an implied per-share value for Danone of 78 euros ($102), including dividends, by the end of 2014. That suggests a return of 47%, given the stock's current price of €53.

Danone has a market value of €34 billion ($44 billion). The shares also trade in the U.S. via American Depositary Receipts (DANOY), which fetched $13.80 on Friday. The European shares yield 2.7%.

DANONE HAS ALL THE right ingredients for success, despite disappointing sales in Southern Europe and tough competition from cheaper, private-label yogurt brands. At a time when people are worrying about long-term health problems like obesity and diabetes, the company has built one of the best and broadest portfolios to meet the needs of health-conscious consumers.

In addition to yogurt products sold under the Danone, Dannon, Stonyfield, and Actimel brands, Danone sells bottled waters such as Evian and Volvic, and infant formula. It also has a small medical-nutrition business that sells dietary supplements for children and adults. Its largest business segment, Fresh Dairy Products, accounts for about 56% of annual sales.

Danone was founded in 1919 as a small yogurt company in Barcelona and named for the owner's son Daniel. In the 1970s, its successor company merged with a French glassmaker. By 1990, Danone had sold the glass businesses to focus entirely on food.

PepsiCo (PEP) was rumored to be mulling a takeover bid for the company in 2005, but an offer never materialized after Danone Chairman and CEO Franck Riboud declared that the company wasn't for sale, and the French government decried the potential sale of a national "jewel."

DANONE EXPECTS TO EARN €3.11 a share in 2013, a largely transitional year, with estimated earnings rising to €3.41 in 2014. The company netted €1.8 billion, or €3.01 a share, in 2012, up from €2.89 a share in 2011, on revenue of €20.9 billion. Free cash flow rose more than 11% last year, to €2.09 billion, and has more than doubled in the past five years.

Investors aren't paying a lot for Danone's shares, which have yet to revisit their all-time high of €60.11, set in January 2008. Depressed by profit warnings, the stock trades for 15.6 times forecast 2014 earnings, well below its 10-year average price/earnings multiple of 18.7. Nestlé (NESN.Switzerland), in contrast, trades for 16.7 times 2014 estimates. Historically, Danone has traded at a premium to Nestlé.

Danone's business model is far from broken, but management is taking aggressive steps, possibly under Peltz's influence, to regain competitiveness, especially in Europe, which accounts for 52% of annual sales. In announcing 2012 results in mid-February, Danone said it plans to cut about 900 jobs in Europe, streamlining marketing, which will save it €200 million by year-end 2014.

That will help to reverse a decline in profit margins even as sales tick higher, but the impact won't reach the bottom line until next year. The company declined to comment, as did Trian executives.

Danone's profit margin shrank in 2012, to 14.2% from 14.7% in 2011, largely due to the financial squeeze in Europe. It is expected to contract by another 30 to 50 basis points (a basis point is 1/100 of a percentage point) in 2013, depending on how quickly the company can realize benefits from savings. Profitability at rivals has been increasing; Nestlé's profit margin swelled by 20 basis points in 2012, to 15.2%, and Unilever's (ULVR.U.K.) improved by 30 basis points, to 13.8%.

Trian has said it thinks Danone can boost its profit margin to 15.1% in 2015, if management can meet its cost-cutting goals. The savings alone could add 80 basis points to margin by then, taking Danone to within reach of Trian's target, says Chris Pavese, chief investment officer at Broyhill Asset Management in Lenoir, N.C., which owns Danone shares.

The Bottom Line Danone's Paris-traded shares have been laggards in recent years. They fetch about €53, but Trian Fund Management sees an implied year-end 2014 value of €78 a share.

"We think these hurdles are set pretty low, so it's hard to say [Danone] won't hit them," he says.

DANONE DERIVES MORE than 60% of revenue from what it calls growth markets, where sales rose 12.4% last year. The category includes major markets such as Russia, France, the U.S., and China. European sales, excluding greater Russia, fell 3%, but carry profit margins of 15.7%, above the 13.2% margin in growth markets. The company's most promising region is the U.S., currently 8% of sales. Danone has captured almost a third of the U.S. market for fresh dairy products with the help of Dannon's Oikos Greek yogurts.

Russia has overtaken France, meanwhile, as Danone's biggest country market, after the company expanded there a few years ago through a joint venture with a local partner, Unimilk.

The joint-venture strategy has worked elsewhere, as well, although Danone was involved in a messy exit in 2009 from a Chinese venture following a dispute over revenue sharing.

Investors worry that Danone might direct more of its resources to mergers and acquisitions, but for the time being its management seems focused on increasing profits. Riboud recently dismissed the notion that the company planned to raise its 20% stake in Yakult Honsha (2267.Japan), a Japanese maker of fermented lactic drinks.

Trian's plans for its Danone stake are unknown, and Danone could yet snub its Gallic nose at Peltz & Co. But Danone's determination to address weak markets and declining profitability is a step in the right direction.

"It shows that Danone has matured in some ways," says Jon Cox, an analyst at Kepler Capital Markets, who rates the stock Buy with a 12-month price target of €59.

In other words, the shares could be a tasty meal for investors.

Snacking on Dividends Packaged-foods companies in the U.S. and Europe tend to pay delectable dividends. Danone is inexpensive relative to many competitors. Earnings could grow sharply in 2014. Recent12-MoMktP/EDivCorporateCompany/TickerPriceChgVal (bil) '14E YldHeadquartersDanone/BN.France€ 53.195%$44.1 15.62.7%ParisNestlé/NESN.SwitzerlandCHF65.5018225.516.83.1Vevey, Switz.Unilever/ULVR.UK£26.2829117.716.93.0LondonMondelez Intl/MDLZ$27.641149.215.71.9Deerfield, Ill.General Mills/GIS$46.252129.914.7*2.9MinneapolisE=Estimate. *For fiscal year ending May 2015.Source: FactSet /BN.France€ 53.195%$44.1 15.62.7%Paris/NESN.SwitzerlandCHF65.5018225.516.83.1Vevey, Switz./ULVR.UK£26.2829117.716.93.0London/MDLZ$27.641149.215.71.9Deerfield, Ill./GIS$46.252129.914.7*2.9MinneapolisE=Estimate. *For fiscal year ending May 2015.Source: FactSet

E-mail: editors@barrons.com