S&P: Food And Beverage Group Danone 'BBB+/A-2' Ratings Removed From CreditWatch Negative And Affirmed; Outlook Negative
The affirmation reflects our view that Danone is likely to continue expanding profitably across its global franchise of health and wellness-oriented businesses and to generate free operating cash flows (FOCF) of €1.8 billion-€2.0 billion per year from 2017. It also reflects our forecast that Danone's debt-to-EBITDA ratio should move comfortably into the 3.0x-3.5x range by the end of 2018 through a mixture of profit growth and debt repayment with free cash flows. Our main operating assumptions include the FOCF contribution from WhiteWave (which generated adjusted EBITDA of $507 million in 2015); and steady earnings growth in early life nutrition and, to a lesser extent, in the smaller clinical nutrition segment. We also forecast stable sales and profit developments in the fresh dairy and waters divisions, with a broadly neutral foreign exchange impact across the global franchise.
We consider the WhiteWave acquisition (15% of the newly combined group revenues) as strengthening Danone's leading market positions in the U. S. and European fresh dairy markets. WhiteWave's products are mostly evolving in fast growing subcategories (such as plant-based milks and organic dairy) and have good brand recognition and consumer perception at the premium end of the market. In addition, the acquisition will broaden and diversify the product range for Danone in the fresh chilled food and beverage categories, as well as increase the share of profits and cash flows coming from the dynamically expanding U. S. market.
Regarding Danone's existing core business, we view positively the profitability improvement measures it has taken since 2013: we forecast an adjusted EBITDA margin of 18%-19% in 2017-2018 compared with 16.5% in 2015. This should come notably from a higher share of earnings from high margin businesses, such as early life nutrition and medical nutrition, and from a gradual turnaround of fresh dairy (especially in Europe), with a return to positive revenue growth and higher operating margins (although still below historical margins of 12%-13%). That said, there are business headwinds in large emerging markets--in fresh dairy in Russia and Brazil and in flavored waters in China (Mizone affected by structural category changes)--and some uncertainty on margins for the new business model in early life nutrition in China after the new regulatory environment.
Danone's main business strengths include the relatively low cyclicality and seasonality of its business activities and its leading global market positions--notably in fresh dairy, which we estimate will account for more than 40% of the group's operating income once WhiteWave is integrated. We view positively the growth prospects of early life and medical nutrition divisions; geographical diversification between large, stable markets of Western Europe and the U. S.; and large expanding emerging markets such as China and Indonesia. Danone's prospects for continuing profitable growth benefit from a portfolio of well-known international and local brands, such as Activia in dairy and Evian in waters; the large product range; and successful brand extensions that support premium pricing and sustainable competitive positioning. Danone's profitability also benefits from a large-scale manufacturing and distribution footprint. The rating is one notch above the anchor of 'bbb' to reflect our forecast that Danone's debt leverage should be at the stronger end of our benchmark range for the significant category. We estimate the debt-to-EBITDA ratio to reduce substantially--supported by the large free cash flow base in the next two years--to reach 3.0x-3.5x at end-2018. We believe this to be in line with the group's financial policy commitments and understand that Danone's management will be closely monitoring operational performance for unexpected developments in order to take corrective actions and repair the capital structure.
Our base case for 2017-18 assumes: Revenues of €26 billion-€27 billion (an increase of 3%-4%), driven by about 2% growth in fresh dairy and 3%-5% growth in early life nutrition, waters, and medical nutrition. We assume WhiteWave's revenue growth to be 5%-8%. Adjusted EBITDA margin of 18%-19%, driven by an improving operating margin in fresh dairy from operating cost cuts in Europe, growth in the profitable U. S. yogurt market, and a rising share of earnings from the high margin operations of WhiteWave despite slightly higher milk input costs. We assume high and stable profitability for early life nutrition (following the sale of Dumex China) and medical nutrition, as well as a gradual recovery in operating margins in waters. FOCF of €1.8 billion-€2.0 billion annually with about €1.5 billion of capital expenditure (capex) annually. Adjusted net debt of €17 billion-€18 billion, which includes the acquisition debt for WhiteWave, pension liabilities, and operating lease commitments. Additional supportive financial measures by Danone including limited debt-financed acquisitions. Based on these assumptions, we arrive at the following credit measures: Debt to EBITDA of about 3.7x in 2017 and 3.2x in 2018.FFO to debt of 20%-25%.FOCF to debt of 10%-15%. The negative outlook reflects our view that there is at least a one-in-three chance that we could lower the ratings on Danone in the next 12-18 months if it was unable to pursue strong deleveraging and maintain a large and stable free cash flow base.
Our base-case scenario is that Danone will likely generate a free cash flow base of about €1.8 billion-€2.0 billion annually in 2017-18 and that debt leverage should decrease from high levels of above 4x post-acquisition to be well positioned in the 3.0x-3.5x debt-to-EBITDA range at end of 2018.
We believe that volatility in emerging markets--especially in Russia, Brazil, and China--might still reduce near-term profitability and cash flow prospects for Danone in a way that is difficult to forecast and despite generally stabilizing market fundamentals and competitive conditions in these countries. Competitive pressures in Europe, as well as integration risks related to WhiteWave, present some further downside risks to our forecast of higher earnings, albeit on a smaller scale. These risks are partly mitigated by Danone's readiness to take corrective measures, such as increasing the equity component in the capital structure.
We could lower the ratings if we saw that debt leverage was still likely to remain above 4x debt to EBITDA at end-2017, indicating that the deleveraging trend is materially slower than expected and difficult to remedy over a medium term. We believe this could occur should there be a drop in earnings growth from early life nutrition or earnings decline in fresh dairy, due to a sharp rise in milk prices and market competitive pressures in Europe and China. We would also view negatively a decline in free cash flow generation owing to a step-up in spending on capex or in-fill acquisitions to support geographical expansion plans.
We could revise the outlook back to stable if we saw tangible signs of deleveraging progress in 2017 from earnings and free cash flow growth, in line with our current base-case scenario. This would mean that we observed a higher likelihood than currently that at end-2018 Danone's debt to EBITDA would be well positioned within 3.0x-3.5x and FOCF to debt well positioned at 10%-15%.