Danone's first-quarter sales report supports our thesis that stiff competition in the dairy industry will make it difficult to raise prices. However, the firm is positioned in health and wellness categories that should allow it to achieve solid growth in the medium term, and we are maintaining our EUR 35 fair value estimate.
On a constant currency basis, first-quarter revenue grew 7% from the same period a year ago, led by higher volume in health and wellness categories. The baby and medical nutrition segments were particularly strong, with volume growing 9% and 8%, respectively. However, for the second consecutive quarter Danone's revenue did not grow at the same pace as volume because the company cut prices in its dairy segment. As the cost of dairy commodities fell in 2009, manufacturers were forced to lower prices to consumers, an indication of the industry's intense competitive environment. Although we expect retail prices to rebound along with commodity inflation as the economy recovers, the competitive nature of the industry should prevent significant margin expansion.
Despite Danone's presence in the highly competitive dairy and bottled water industries, we like the firm's portfolio of functional foods. We expect further consumer migration to health and wellness products to benefit Danone in the long term.
Philip Gorham, CFA is a Morningstar equity analyst.
