DANONE Case - Financial analysis of Danone group PENG Bo (e113110) GE Chuxiao(e113051) JIANG Yihong(e113066) Fiancial Statement Analysis – Danone Case Agenda • Introduction • Capital structure • Profitability • Return • Liquidity • Solvency • Conclusions & Recommendations Fiancial Statement Analysis – Danone Case Introduction of DANONE Group History Initiate in 1966, DANONE evolved from the original glass manufacturer to the international leader in fresh diary products. Mission “bringing health through food to as many people as possible” Divisions he Fresh Dairy Products Division the Waters Division the Baby Nutrition Division the Medical Nutrition Division Global Approach The group now represent in all regions in world. Fiancial Statement Analysis – Danone Case Introduction Improvement in the group’s capital structure Through last half decade, the DANONE Group enjoyed an improvement in its capital structure. The group’s D/E ratio decreased by almost 50% from 1. 35 to 0. 74. In 2007, a draw-down amount on bank credit facilities of 5173 million dramatically increased the group’s debt level which led to a D/E ratio of 1. 5. This ratio continued to increase in 2008 because of shareholders’ equity loss from unfavorable exchange rate fluctuation. We only include interest-bearing financial debt when calculate D/E ratio After 2008, the group’s indebtedness greatly improved. In 2009, the D/E ratio sharply decreased to 0. 58 because that the firm decidedly revised its financial structure by raising around 3 billion new equity capital and repaying its liabilities. From 2009, the D/E ratio slightly grew back majorly due to the issuance of new bonds.
To conclude, the improvement of indebtedness is good for the group, because with a lower D/E ratio, the group can have a better strategic and financial flexibility. Fiancial Statement Analysis – Danone Case Capital Structure Analysis Improvement of capital structure from the view of cost of debt Effective interest rate 2007 2. 50% 2008 4. 11% 2009 4. 44% 2010 2. 43% 2011 2. 67% From the chart on the right we can see that the effective interest rate can be regarded as a delayed indicator of the group’s debt level.
After a continuous increase of D/E ratio in 2007 and 2008, the effective interest rate increased accordingly by nearly 50% in the following 2008 and 2009. We can reasonably assume that the heavy indebtedness of the group increased the potential risk and caused a damage of its credit rating which led to a higher cost of debt. Effective interest rate is calculated as: interest expense/financial debt The good news is that with the repayment of debt, the group has recovered from its unfavorable financial situation. And the cost of debt dropped back to an ideal level in 2010 and 2011 which was around 2. %. This situation was good. With a lower effective interest rate, the group would have more space to raise debt at a lower cost when it is necessary. Fiancial Statement Analysis – Danone Case Capital Structure Analysis Increase trend in net sales From the graph: ? Except for year 2009, Danone keeps a steady growth rate of net sales from 2008 to 2012 . What happened: ? On a like-for-like basis, 2009 sales were actually up 3. 2%, allowing the Group to reach the growth targets it had set. Hypothesis: ? Increase in net of trade discounts and customer allowances ?
Increase in costs relating to agreements on contributions to advertising ? Increase in occasional promotional actions invoiced by distributors. ? Impairment provisions increase because of the raising credit risk on accounts Conclusion: ? From 2008 to 2011, Danone kept reaching its set growth target in sales which is a good trend. ? In 2009 the decrease of net sales may largely resulted from the adjustment of group strategy. Fiancial Statement Analysis – Danone Case Profitability Analysis Not optimistic increase of cost of goods sold From the graph: ? Growth rate of COGS was greater than of sales from 2009 to 2011.
Hypothesis: ? Refocusing on dairy industry in 2010 increase the cost of raw materials ? Increase in packaging, industrial labor and the amortization of production equipment Conclusion: ? As Danone has focused on dairy market, the increase of milk price results in the higher growth rate of cogs than of net sales which is not good. Danone should consider taking some internal cost control process to offset the effect. Fiancial Statement Analysis – Danone Case Profitability Analysis Relatively stable profitability From the graph: ? EBIT margin grew from 2007 to 2008 then kept it on a stable level.
Hypothesis: ? In 2007, Danone’s high level of OWC result in the low EBIT margin. ? The low elasticity of food & beverage industry enable Danone keep its steady level of operating margin. Conclusion: ? It is good for the group to keep a steady EBIT margin. To achieve further increase in EBIT margin. Danone can take the product development into consideration which can lead to a higher profit margin. *According to the company annual report we consider trading operating income as EBIT Fiancial Statement Analysis – Danone Case Profitability Analysis Relatively stable return on equity
From the chart on the right, we can obviously see a dramatic decrease on the ROE from 2007 to 2008. After a careful check of the notes in the annual report, we found during 2007, the group dropped its “Biscuits and cereal product” business activities. The sale of the business was counted in the discontinued operation income which greatly increased the group’s net profit. If we exclude the effect generated from this operation, we could even observe a slight increase on ROE from 2007 to 2008 We use average equity of two years as the denominator of the calculation
Except the nonrecurring performance of 2007, the group maintained a relatively stable level of ROE(15%-17%) with a slight decrease in 2009 which can be attributed to the issuance of new equity of around 3 billions which somehow diluted the ratio. This is a good sign which indicates a constant and stable ability of the group to efficiently convert the investors' stake to profit. Fiancial Statement Analysis – Danone Case Return analysis Positive leverage effect Once a firm has debt, the final return for the shareholders consists in two parts: the return on operation and the leverage effect.
In DANONE's case, we observe a positive leverage effect which is good to the firm. In order to further investigate, we break down the leverage effect as a product of two parts: D/E ratio and the differential between ROCE and cost of debt. With a decreasing and moderate D/E level and from the chart above, we can see that the positive leverage effect mainly came from the high differential between operation return and the cost of debt. Such situation was largely attributed to the low effective interest rate realized by the group. This trend is good, it is a right way to develop a healthy leverage effect.
The group should keep its D/E level to maintain its low cost of debt to achieve a good leverage effect from the differential aspect. Fiancial Statement Analysis – Danone Case Return analysis Difference between real ROE and estimated ROE is worth more attention The estimated ROE is calculated as below: ROE=(ROCE+((ROCE-i)*D/E))*(1-T) In the chart, we exclude the data of 2007 since it was badly influenced by a discontinued operation income. We can observe from the chart that the real ROE was always higher than the estimated one. This is because that the estimated ROE only take into account the operation return and the leverage effect.
However, we can find in the income statement and the notes in the annual report that the group had a relatively unfluctuating EBIT, and almost every year the group had an nonoperating profit or loss (other operating and financial income) related to large M&A transactions and gain or loss from the stakes the group holds on other enterprises. This is not strictly a bad sign, but the investors should be aware when evaluating the firm that the declared return of the group does not entirely come from the firm’s day-to-day operation. The profitability from its operating level is worth further investigation. Fiancial Statement Analysis – Danone Case
Return analysis Stable Negative Operating Working Capital Fluctuant negative OWC, highest in 2008, then slowly gets deeper into negative. • In 2007, Danone had a hard time with both high accounts receivable and payable, as well as high other current debt, which resulted in a very negative OWC. - Possibly change in OWC policy in 2008 The high ratio in 2008 was mainly from the increase in assets held for sales and decrease in current debt. (explained in following slides) Except 2007, the inventories, accounts receivable and payable are relatively stable. Operating Working Capital (days of sales) 60. 00 40. 00 20. 0 2007 (20. 00) (40. 00) (60. 00) (80. 00) 2008 2009 2010 2011 + accounts receivable (days of sales) + other receivable(days of sales) - accounts payable (days of sales) - other current debt(days of sales) OWC (days of sales) inventories (days of sales) • • Judgment of ratios: Hypothesis and Judgment: • Stably longer period of payable than receivable – strong negotiation power as an industry leader. Negative OWC can bring a cash surplus and increase short-term liquidity. As a B2B company, a negative OWC may degrade the company’s credit rating and therefore increase financial pressure and harm future growth of the company. ther receivable = other receivable + short-term loans + assets held for sale Other current debt = other current debt + liabilities directly associated assets classified as held for sale • In our opinion: short-term loans and assets held for sale are assets owned by the company expected to transfer into cash in the future, the same as accounts receivable. • • Fiancial Statement Analysis – Danone Case Liquidity Analysis A Stable Cash Management Policy The cash level is quite flat in the past 5 years, which indicates the group has a stable cash management policy. • In 2007, the cash-flow and operating ash flow was significantly high, nevertheless the free cash flow was really low. Refocus on Waters business line, income from discontinued operation (the sale of the business activities: Biscuits and Cereal Products business) purchases of subsidiaries and high ? nancial investments Increase in both current and non-current debt (the bridge loan to finance the acquisition of Numico) 6000 5000 4000 3000 2000 1000 0 -10002006 -2000 -3000 -4000 Changes in Cash flow cash-flow operating cash flow free cash flow 2008 2010 2012 Increase (decrease) in cash and cash equivalents
But it finally resulted into a similar level of cash comparing to other years. • • • In 2008, the cash flow indicators returned to normal level, and increase along with the raise in net income and in operating working capital in the following years. In 2009, the increase in free cash flow is mainly due to the sales of subsidiaries and the issue of additional shares . The increase of cash and cash equivalents in 2010 was mainly from the increase in net income, and keep stable in 2011, which demonstrates a stable increase in net income. Fiancial Statement Analysis – Danone Case
Liquidity Analysis Relatively High Liquidity The liquidity ratios are mostly less than 1, but still quite high. It increased during 2008, then it is fluctuant but relatively stable. • In 2008 all the ratios are really high comparing to other years. ? ? ? Refocus on Waters business line and sold the assets not align with its strategy. (Increase in assets held for sales: Huiyuan, Frucor, etc. ) Demand of long-term financial debt for acquisition (receive of bridge loan, issuance of new loans) Repaid some current financial debt with cash in hand (from 2447 in 2007 to 625) 1. 0 1. 60 1. 40 1. 58 1. 15 1. 00 0. 83 0. 64 0. 52 0. 43 0. 75 0. 65 0. 62 0. 86 0. 82 0. 68 0. 88 0. 73 Liquidity Ratios 1. 20 1. 00 0. 80 0. 60 0. 40 0. 20 2007 2008 current ratio 2009 quick ratio 2010 cash ratio Bringing liquidity to group, but the assets held for sale took time to convert into cash. • In 2010 and 2011, the ratios started to augment again. ? Cash, cash equivalent and short-term debt doubled in 2010 and remained stable in 2011 - the gain from sales of non-strategic interests - The increase in operating cash flow and OWC ?
Decrease in the current financial liabilities in 2011 - put options granted in acquisition in 2010, but repaid in 2011. 2011 Judgment of ratios: cash = cash and cash equivalent + short-term investment Short-term loans and assets held for sale are not included: • This formulas is used in Danone’s report to calculate net debt. • Assets held for sale are not so liquid: - Huiyuan and Wimm-Bill-Dann stayed in this account for two years after they finanlly got sold. Relatively high liquidity for the group, but in 2011, possibly too much cash on hand.
Fiancial Statement Analysis – Danone Case Liquidity Analysis Debt/Cash-flow, moderate but not good enough Cash flow is calculated by adding back the depreciation to the net earnings Except the extreme data of 2007, for the last three years, both the group’s cash generating capacity and the D/cash-flow ratio stayed stable. The ratio fluctuated around 3. 6 which was moderate, but not good enough, especially in present situation. A ratio near to 4 may be an indicator of insufficient financial strength to go through tough economic environment.
In difficult economic times, for instance today, the cash-flow can possibly suffer while the debt level stays still. The Debt/cash-flow ratio should be further improved, possibly by reducing the debt that the group carries Fiancial Statement Analysis – Danone Case Solvency analysis A seemingly ideal interest coverage ratio From the apparent figures, the interest coverage situation of the group is nothing but good. The ratio was high and the trend was increasing. It seems that the group was generating an operating income which could easily meet its short-term solvency requirement.
But if we look into the data, we will find that the decisive factor for such a high ratio was not a strong EBIT, but the extremely low interest expense. In another word, the group’s short-term solvency did not, to a large degree, derive from its operating level. Instead, it highly depended on its cost of debt which could be unstable and be easily influenced by this group’s capital structure(with higher level of debt, comes the higher cost of debt). To conclude, the group’s short-term solvency is not as promising as it seems to be. To focus on the EBIT increase would be a more reliable method to improve the group’s solvency.
Fiancial Statement Analysis – Danone Case Solvency analysis Conclusions & Recommendations • The increasing cost of good sold led to a more serious pressure on the group’s EBIT margin. A stricter internal cost control is suggested to offset the loss of operating income derived from the rising raw material price. • The deeply negative operating working capital may be a constraint limiting the group’s future cash generating ability and cause a damage on its credit rating. We suggest the group to improve its OWC management to drive its operating working capital to a reasonable level. Since the group had a certain amount of cash surplus on hand at the end of 2011, we recommend the manager to reinvest it, Ex: investment in R&D, repayment of debt, etc. Doubt unsolved The effective interest rate of this group fluctuated between 2% and 5%, which seemed a little bit too low for a group of this size and debt level. We checked all the notes and failed to find out a reasonable explanation for this situation. We raise the question here in hope that it can be somehow answered. Fiancial Statement Analysis – Danone Case Conclusions & Recommendations