Danone has indicated its decision to "fight" for market share in southern Europe - and in Spain in particular - is one of the primary reasons that it has lowered its margins outlook for 2012.
In a regulatory announcement on 19 June, Danone dropped its margin forecast for the financial year from "stable" to "down 50 basis points".
Speaking during a conference call with analysts, CEO Pierre-Andre Terisse said rising unemployment was hitting consumer confidence in Spain, a market that accounts for about 7% of group sales.
"We all know that unemployment is clearly above 20% in Spain... high unemployment has been pressing on consumption. Maybe more importantly... consumer confidence has been affected by that and it has dropped from level of 70 a year ago to level of 50 in April," he revealed.
Terisse said that Danone has witnessed a "slow down in all categories", with fresh dairy turning negative in April and May. The company's product mix has been hit by consumers trading down and the group has lost share to private label.
Nevertheless, Terisse insisted: "Spain is an important market for us. It is a market where we have the intention to fight".
In order to maintain brand equity in the country, Danone is investing heavily in brand support, price, and innovation, Terisse revealed.
"This will obviously have a cost and this is the main reason for the adjustment of margins," he said.
An additional factor, Terisse added, was that inflation in "certain specific materials" such as milk proteins and "some packaging" has increased by mid- to high-single digits, instead of the "half-single digit" inflation Danone had projected for the year.
Weak consumer sentiment has meant the group is unwilling to pass these higher costs on in the form of price increases and, while the group is working to improve productivity, Terisse said that would recover "part of the gap only".
Danone retained its full-year sales outlook of 5-7% growth as it anticipates a strong performance from emerging markets will offset softening sales in southern Europe. Nevertheless, the group said this would not feed through to the bottom line as its businesses in emerging markets require higher levels of investment to grow.
"We believe that building these markets is critical for the group and it is therefore our choice not to make any compromise on that," Terisse said.
According to Bernstein analyst Andrew Wood, weaker margins are therefore likely to feed through to a 5% cut to EPS estimates. However, Wood suggested that management's credibility is likely to take a bigger hit.
"The stock is likely to react very negatively today...not only due to the EPS hit, but also due to the renewed belief from investors that Danone management cannot be trusted and that negative surprises are always just around the corner. We also anticipate that investors will fear another more company-wide "reset programme" in an effort to grow volumes in the difficult trading environment. Clearly management credibility is likely to take as much, if not more, of a hit than its EPS following today's warning," he commented.
Shares in the French dairy giant had fallen 7.29% by lunchtime today.
By: Katy Askew | 19 June 2012