Financial Security Analysis For Danone Essay Samples

As of December 31, 2014, Danone had non-current financial debt of €6,598 million and current financial debt of €4,544 million. Looking at the cash-flow statement, we learn that €150 million of this debt was issued during the year 2014, and that detailed informations about debt financing are available in note 10.3. This debt does not entirely consist of bonds, as can be seen p. 127 of the Registration Document 2014. It also includes derivatives and commercial paper, I will thus only look at the bonds financing.
As of December 31, 2014, Danone had €603 million short-term bonds outstanding and €6,087 long-term bonds outstanding, bringing the total to €6,691 million. The repayment schedule is relatively stretched, with only €603 million to be repaid in 2015, €696 million in 2016, €921 million in 2017 and €802 million in 2018. The bulk of the bonds totaling €3,669 million (i.e. 55% of the bonds outstanding) will be repaid in 2019 or later. We do not have complete information about the bonds length and the date at which they were issued, however we know that only €150 million of long-term bonds were issued in 2014, suggesting that the majority of these bonds were issued years ago. The bonds issued by the company are of two types: either EMTN financing (which are Euro Medium Term notes, with maturities shorter than 5 years) either bonds issued in the US market. The rating of the company’s debt by Standard & Poor’s is A-2 for the short-term debt and A- for the long-term debt, unchanged from 2013, which means that the company’s bonds are rated investment grade and are judged to have a low risk of default. Moody’s downgraded the long-term debt from A-3 to Baa1, which is equivalent to the A-2 of Standard and Poor’s and thus also considers the debt investment grade, i.e. with a low risk of default. Valuing these bonds at current very low interest-rates drives the market value of the bonds up, since bonds value is inversely correlated to interest rates. This is why some market participants fear that quantitative easing and low interest rates may create a debt market bubble.
The shares of Danone listed on the Paris stock exchange (ticker BN.PA) had a quotation of €62.92 at the time of this report, giving the firm a market capitalization of €40.51 billion. The average daily traded volume over the last 30 days was 1.92 million, which given the current share price implies a daily liquidity of 1.92 * 62.92 = €120.8 million. Looking at the chart, we can see that the stock is trading at its most expensive price, surpassing its €62.46 high reached on February 23, 2007. A comparison of the stock performance with the S&P500 would arguably not be relevant because the firm is French and doing more than 40% of its sales in Europe. I therefore decide to compare it with the CAC40, the French large-cap index. Starting from January 3rd, 2003, an investor in Danone would have earned a cumulative return of +99.10%, while an investor investing in a low-cost CAC40 index fund would have earned a cumulative return of 56.21%. This clear outperformance of 42.89% shows that Danone has better-than-average intrinsic characteristics as a business.
Looking at Danone’s valuation, we can clearly see that the company is trading at a premium to other global peers. The company trades at a P/E ratio of 33.9 versus a S&P500 average of 19.5, a P/Book ratio of 3.2 versus a S&P500 average of 2.8, a P/Cash flow of 17.1 versus a S&P500 average of 11.8. The only two metrics by which the stock trades conservatively is P/Sales which is 1.8, similar to the S&P500 average and the dividend yield, which is 2.3% versus 2.2% for the S&P500. It is to be emphasized that the dividend yield merely measures the cash return to shareholders and is not a valuation ratio per se. The true measure of the intrinsic value of a company is the present value of the future free cash flow to be extracted from the business, discounted at an appropriate rate of return. Performing a DCF (discounted cash flow) analysis on Danone, I find an intrinsic value of €37. Compared to the stock price of €62.92, and if my valuation is correct, this means that the stock is trading at a 70% premium over intrinsic value, and is thus overvalued. A rational reason for this is that investors are willing to pay a premium for a high-quality business like Danone, which is a global packaged foods and dairy leader.
Danone uses derivatives to hedge risk for the organization. Particularly, the company uses currency swap agreements to hedge its currency risk exposure when it borrows in foreign currencies. If the currency in which one borrows is different from the currency in which one earns money, exchange rate changes can increase the burden of debt payments – it is what is happening currently with Russian households holding dollar-denominated debt. Currency swap agreements are thus a risk-management tool. While a company having 100% of its costs and revenues in Euros would not be concerned, it is important for Danone because it is a global firm, generating c.a. 60% of its sales from outside the European Union. Moreover, Danone also uses interest rate swaps to hedge its exposure to changes in interest rates. This is particularly important for risk management as a rise in interest rates will increase interest payments on debt with floating interest rates. For the year 2014, Danone has hedged 128% of its net debt against potential increases in short-term interest rates, thereby considerably reducing financial risk. Financial markets are thus an efficient mean for Danone to dynamically reduce risk at a low-cost. They provide high liquidity for exchange-traded derivatives and allow to find counterparties willing to engage in a particular transaction.
An interesting use of financial markets worth mentioning is the fact that Danone uses flexibility in its approach to risk-management. It does not use only financial derivatives to mitigate risks but also borrows in US dollars, which removes the need for hedging. The reason is that the company makes sure to borrow in the currency that matches operating cash flows, thus creating a “natural hedge”. This is an interesting way to retain maximum flexibility and take the option that is the most cost-effective. Moreover, not entering into derivatives trading eliminates counterparty risk.