Danone SA

PAR:BN

Earnings Call Analysis

Company Reports Strong Sales Growth

The company has reported a robust quarter with a like-for-like net sales growth of 6.4%, praising contributions from all geographies and a notably resilient performance in China. Aspects like the European transformation plan are progressing as intended. The second quarter growth benefitted from solid EDP and Specialized Nutrition categories and a strong performance from the Waters category. Despite some headwinds from foreign exchange and deconsolidation impacts, the total reported growth for the quarter was 2.4%. Expectations for the full year 2023 anticipate like-for-like net sales growth to be at the upper end of the 4-6% guidance and a moderate operating margin improvement over the previous year.

Executive Summary

In a complex market environment, with a need to address margin pressures, the company under review is taking a focused approach to growth, quality improvements in sales, and productivity gains to underpin margins. Strategies such as streamlining product lines, attending to underperforming segments, and investing in high-growth areas are expected to lead to a better volume and leverage, while reinvestments in areas like Advertising & Promotions (A&P) aim to fuel long-term value creation and establish a sustainable growth model.

Financial Highlights

The first half of the year witnessed a recurring operating margin of 12.2%, reflecting a 14 basis point improvement over the previous year. This positions the company to achieve a moderate improvement in full-year margins. The operating margin from operations saw a considerable rise by 93 basis points, marking a turnaround from previous years. This change stems from continued top-line growth and record productivity gains, which helped offset substantial inflation. Furthermore, recurring earnings per share (EPS) increased by 7.6%, buoyed by operational performance, and free cash flow experienced a noteworthy growth to EUR 1.1 billion, around EUR 400 million higher than the previous year".

Productivity and Cost Management

Strong productivity measures are aiding in managing cost pressures; the company delivered productivities above industry norms, offsetting more than one-third of inflation costs. Capital expenditures were maintained at last year's levels but were strategically managed for optimal return, and working capital showed positive movement thanks to better receivables and inventory management. This disciplined approach helps to preserve free cash flow and asserts a competitive edge for the company moving forward.

Portfolio Streamlining

The organization has engaged in a significant rationalization of its product portfolio, refining its offerings to discontinue lower-margin businesses and promote profitable segments. For example, in Brazil, the water business was discontinued, and the milk business was outsourced, refocusing efforts on higher-value and profitable portfolio parts. These actions, coupled with strategic pricing and advertising, have shown positive effects in markets like Spain. Looking ahead, there will be a shift to a 'permanent reason of pruning' or continuous portfolio optimization to sustain the portfolio's health while maintaining market shelf presence.

Volume and Margin Outlook

The management is optimistic about recovering volumes, particularly in the EDP Europe division, expected to drive operational leverage and reinforce gross margin expansion. These improvements are anticipated to provide room for further reinvestment. Despite previous underperformance, corrective measures are beginning to yield positive outcomes, positioning the company for balanced growth and margin expansion.

Guidance and Future Outlook

Reaffirming confidence in the 2023 strategy, the company maintains its full-year guidance commitment to moderate margin growth. The focus on sequential volume improvement, gross margin expansion, and value creation suggest a favorable outlook. This confidence is substantiated by previous actions leading to gross margin inflections and enhanced profitability across categories. The management remains intent on building a business model that consistently generates value over time.

Earnings Call Transcript 2023-Q2

[Operator]

Good day, and thank you for standing by. Welcome to the Danone 2023 Half-Year Results Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session [Operator Instructions] Please be advised that today's conference is being recorded.

I would now like to hand the conference over to your speaker today Mathilde Rodie, Head of Investor Relations. Please go ahead.

[Mathilde Rodie, Head, Investor Relations]

Good morning, everyone. Thank you for being on this call this morning for Danone's 2023 H1 result. I'm here with our CEO, Antoine de Saint-Affrique, and our CFO Juergen Esser, who will first go through some prepared remarks before taking your questions in the second step.

But before we start, I draw your attention to the disclaimer on page 35, related to forward-looking statements and the definition of financial indicators that we'll refer to during the presentation.

And with that, let me hand over to Antoine.

[Antoine de Saint-Affrique, Chief Executive Officer]

Thank you, Mathilde. Good morning, everyone and welcome to our half-year ‘23 conference call. I hope you're all well and safe.

Before we dive into the results, let me start with a few words on the situation in Russia. Obviously, my very forsooth go to all our colleagues there after our EDP business has been placed under temporary external administration of the Russian authorities. There are of course financial implication, which we have referenced in our press release this morning and Juergen will come back to them. Given the sensitivity of the situation, I hope you will understand there is not much we can say at this stage other than the fact that we remain focused on people's safety and on continuity of operations.

Let's now go into the results starting with a brief introduction on slide number three. As you will have seen we closed a solid first-half of the year further building our track record of delivery. This semester like-for-like revenue was up 8.4%, with broad-based growth across geographies and categories. Growth was driven by pricing, up plus 9.4% and resilient volume mix, down minus 1.1%.

Importantly, we made consistent progress on our strategic agenda in an environment that remains volatile and challenging. The combination of resilient volume mix, continued pricing where needed, and high productivity allowed us to expand our margin for operation by 93 bps, compared to last year. And this increase in margin from operations gives us the ability to further drive our investment journey, which is at the heart of Renew Danone. This first-half investments were up 99 bps, compared to last year.

And we did all of that while delivering on our ambition to moderately improve our recurring operating margin, which was up plus 14 bps versus last year and securing a healthy cash flow at EUR1.1 billion, up by EUR400 million, compared to last year. So I'm happy with the first-half of the year as we keep not only delivering consistently, but as importantly as we are doing so in line with our strategy.

Let me elaborate a little on this and start with our Core now on page four. Speaking of the Core, there is no better illustration of it than our EDP in Europe. We started the transformation of the strategic activity at the back end of ‘22, making it clear that we will not have short-term tactical fixes, but rather aiming at structurally driving EDP back to value creation in Europe.

Over the last quarters, we are focused on getting back to category leadership fundamentals. We have prioritized methodically the key demand spaces we want to play in, focusing on health underpinned by strong functionality, indulgence, kids and everyday nutrition. We started sharpening our portfolios again, those four spaces, with less overlaps between brands, rationalized and more focused portfolios.

Having clear streamlines and more focused portfolios enables us to now start reinvesting more assertively in A&P, while making sure all of this is also visible to consumer through superior shelf execution. This groundwork is starting yielding encouraging results, it shows for example on the Activia, YoPro and Danone brands, I'll come back to that in a minute. And while we know there is still work to do, I'm not pretty confident in our ability to sequentially improve from H2 onwards and to progressively reconnect with competitive growth in Europe.

We certainly have a good example of this with the Danone brand. And now moving to slide five. Over the last few months, we have defined a new architecture for the Danone brand tiering and segmenting the brand by occasion, by format, price points, and channels. On the one hand, we have strengthened the core of the offering, adapting formats and price points to recover volumes and obviously operating leverage, but also, and this is important to drive brand penetration at a time where some shoppers may start feeling the squeeze from inflation.

On the other hand, we started developing a range of value-added proposition in the Danone from Skyr to Greek with the objective of further building superiority and differentiation, which ultimately drives mix and profitability. This work, which we deployed since the beginning of the year in Spain, is showing very promising results. There, monthly brand penetration has for example doubled since the beginning of the year, and obviously next to Spain, we are in the process of deploying a similar approach in France.

Moving now on to page six, I'd like to illustrate how we have further boosted our winners in the first-half of the year. You have seen this winners several times already. And this is totally intentional. This is a clear testimony to our determination to be very consistent in driving this winning proposition further ahead, building on differentiating science, strong brands and execution. Yet again, our Coffee Creations, Evian and High Protein have delivered strong and competitive performance this semester with strong double-digit growth, and again our Specialized Nutrition business posted a solid and competitive growth at plus 8% in H1.

We believe these platforms have more room to grow in and around the Cafe category in Premium Waters, in High Protein Dairy. We will continue then -- we'll continue expanding them across channel and geographies. This is the case for example with our Dairy High Protein portfolio as we roll it out in the U.K. as we speak, and as we further expand into new segments such as Desserts. And I would obviously be remiss not to mention Specialized Nutrition, where we will continue to leverage the full pallet of our portfolio from Aptamil in IMF to Neocate in our pediatric specialties and Fortimel in Nutrition in adults across geographies.

Let me finish this performance for you on page seven with a brief mentioned to Mizone. Last year, we told you that we would address our underperformers with method and with courage. It is exactly what we have done with Mizone. We took the time since the Capital Markets event to do a proper root cause analysis to understand the reasons of Mizone underperformance. On that basis, the team built a turnaround plan leading us to dramatically simplify our portfolio, now down to four SKUs. We have also invested in the superiority of our formulation, making sure Mizone is back to being among the best functional hydration options in the market. And we have delayered our distribution system with the goal to improve in-store execution.

All of this range product, quality of execution, higher investments, all of this is now starting to play. Even though we are at the early stages, we see tangible signs of turnaround. Mizone as you've seen grew by 15.9% in like-for-like in H1, driven by a strong volume recovery, and the market shares, we are positively oriented for the first time in a very long time. It is obviously not yet time to celebrate, as we have to sustain this performance in the long-term. But this is certainly encouraging and something the team should be proud of.

Let me finish this introduction with page eight. Since last year's Capital Markets event, we have been consistently delivering against our strategic roadmap. This shows in the results you've seen as published over the several last quarters, but also in the progress we continue to make on our key battles. What we are doing systematically and with confidence is about restoring Danone's value creation model and we do it for the long run not going for short-term tactical wins, but striving for sustainable long-term value creation.

On A&P, we are investing more, but we're also investing better. We continue to improve the allocation of our resources across geographies, brands and channels, improving our working versus non-working media ratio. We're also progressively strengthening the quality of our advertisement. I'm sure that you have seen the Evian, Live Young advertising and the Danone ads are played in the waiting room of today's webcast. They are great examples all that we can be proud of. And there is obviously more to come.

Next to A&P, we continue to step change the way we leverage our cutting-edge science and technology assets at the service of patients and consumers. And it is not only about the science assets we have, it is about bringing more discipline in the way we develop and execute our innovations. There too, we are making substantial progress from bringing superiority imperative in our innovation to delivering fewer, bigger, better and accretive innovation.

All our categories are moving to the front foot with a clear focus on developing superior differentiated product supported by strong claims and in some cases clinical evidence. And as you also know, our value creation in fact making the most of our ecosystem and here we are starting to reinvent the way we work and collaborate with our partners. I'm happy to announce that Danone will host by the end of the year its first partner summit in a long time. This is a great opportunity for us to learn, to leverage, and to expand our reach and impact.

So all in all, our Danone is starting to move to the next level. All the pieces of our Renew Danone framework are coming together. And despite the volatile environment, we continue to make consistent progress. Expect us to keep at it with determination and with focus.

And with that, let me hand it over to Juergen for the financial review.

[Juergen Esser, Chief Financial Officer]

Thank you, Antoine, and good morning to all of you.

Let's start the financial review with page number 10 and our topline performance of the second quarter of this year. We are reporting for this quarter a solid performance of like-for-like net sales growth of plus 6.4% with again all our geographies contributing. Very consistent with our first quarter sales, we are reporting broad-based growth.

I'd like to especially mention the resilient delivery of our China zone, while highlighting also the fact that we are making good progress on our European transformation, according to our plan outlined earlier this year. But let me come back to the performance by zone in a minute in more detail.

Couple of comments on the performance by category, the growth in the second quarter was supported by the solid contribution of our EDP category at plus 6.2% net sales growth with our High Protein, Everyday Nutrition, and Coffee Creation platforms all growing double-digits. In parallel, our Specialized Nutrition category sustained its competitive growth with plus 4.9%, led by further market share gains across most geographies like in China or Southeast Asia to name a few.

Reviewing the dynamics of this category important to look at the first semester performance with a growth of more than 8% and this is providing a better view on the underlying dynamics, neutralizing the Q1, Q2 phasing effect, which we discussed at length with the first quarter results.

And finally, our Waters category that delivered another quarter of strong growth was plus 9.6%, notably driven by Evian brands growing well into the double-digits in Europe combined with the encouraging momentum behind our Mizone brand in China growing mid-teens for the second quarter in a row as Antoine just mentioned.

Moving now on to our Q2 sales bridge on page number 11, our Q2 like-for-like net sales growth of plus 6.4% was composed of a price effect of 8.7% and volume mix down minus 2.3%. On the pricing, we can clearly observe a deceleration versus previous quarters as you will remember that our Q1 sales were still benefiting from as much as 10% price effect. We're starting in many geographies to lap last year's high price increases and we, therefore, see further reduction of the price effects during the remainder of the year.

On the volumes, and as mentioned already important to keep in mind the calendar-related phasing effect between Q1 and Q2 of this year, especially in our [Indiscernible] category, which make that the underlying volume performance is better understood by looking at our first semester volumes of minus 1.1%, demonstrating improving resilience in many geographies and categories.

Outside of the like-for-like, ForEx had a negative effect of minus 4.3% as a result of a number of currencies depreciating against the euro. And finally, scope effects that had a negative contribution of minus 0.5%, due to the deconsolidation of our Waters business in Argentina in December of last year. In total, reported growth reached plus 2.4% for the quarter, bringing our quarterly net sales to EUR7.2 billion, up from EUR7.1 billion in Q2 of last year.

Let's now have a look at the performance of each zone in more detail starting with Europe on page 12. Europe delivered the second quarter of solid growth growing at plus 6.5% with price up 11.7%, while volume mix were down minus 5.1%, and we are progressing with the transformation of our EDP portfolio. From a country perspective, France, Poland, and Spain were driving the growth, all of them starting to benefit from a streamlined and repositioned EDP portfolio, as well as from increased brand and promotional support.

In Germany, we are also -- we've also started to recover by rebuilding listings and distributions after the supply disruptions we had during the past periods. The overall dynamics over the last weeks and months make us confident that you will see our volumes sequentially improving further supported by an increased level of investments. On the other categories, Specialized Nutrition and Waters remained resilient in this quarter with especially the Evian brand reporting a strong performance over the last months.

Looking at the numbers of this first semester, Europe closed the first-half with like-for-like sales growth of plus 6.4%, while recurring operating margin declined by minus 232 bps versus last year down to 6% -- 10.6%. Margins are temporary down as a result of the portfolio transformation there is still high inflation and the timing gap of materializing our price increases for prescribed and reimbursed products of our Specialized Nutrition business. With volume dynamics sequentially improving moving forward, we should have reached now an inflection point for the profit margin of Europe, despite the fact that coming quarters we'll see higher levels of reinvestments.

Let's now move on to North America on page 13 now. North America delivered plus 5% like-for-like sales growth in the second quarter. This quarter, pricing started to sequentially normalize after we left the pricing ways of last year, moving from 11% price effect in the first quarter down to 7.7% in the second.

Volume and mix dynamics in the second quarter were a bit softer. We are cycling a high base of comps in some categories. The growth in North America was notably led by our Coffee Creations business Antoine spoke about it. It posted strong double-digit growth this quarter coupled with continued market share gains under the International Delight and SToK brands.

Next to Coffee Creations, our Yogurt business also delivered a solid quarter driven in particular by Oikos that registered another quarter of steep double-digit growth and by Activia growing mid-single-digits with an accelerated performance in key strategic channels. Plant-based led a particularly high base of comparison considering the extra sales we registered last year related to supply issues experienced by one of our main competitors. We are at the same moment also clear that we have here still a job to do to reestablish consumer-led competitive growth in the plant-based portfolio.

And finally, while our Evian brand posted another quarter of steep double-digit growth our Specialized Nutrition category was lapping this last quarter, the shipments realized in the context of the Operation Fly Formula last year. The good news here is that our competitive position on our Neocate business, our allergy proposition, remains very resilient great base to build upon. Overall, these all closed a solid semester at plus 8.3% like-for-like sales growth supported by resilient volume dynamics.

Importantly in North America, our recurring operating margin is improving this semester up by more than 200 points, compared to last year, driven by gross margin expansion, something we are happy about and it bodes well for our ability to consistently invest and support our brands over time.

Moving to the next page, page number 14 of our China, North Asia and Oceania zone. The zone registered plus 9.6% like-for-like sales growth in the second mainly driven by volume mix up plus 8.8%.

Let me start with China. In Infant Milk Formula, Aptamil delivered another quarter of solid growth with continued market share gains. Our competitiveness in the category remains supported by the combination of the strong brand equity and disciplined execution. We continue to carefully and intentionally navigate the shift of the entire category from old to newly registered recipes a process which will probably last until the end of this year.

Beyond IMF, our medical portfolio also posted a strong quarter, with our key brands, Nutrison in adult and Neocate in pediatrics delivering double-digit sales growth. And finally, in Waters, Mizone registered a plus 50% growth this quarter, notably driven by volumes, and more importantly, with the market share gains. As Antoine mentioned already, we are very pleased to see that the turnaround of the Mizone brand is underway with encouraging first results from both the renovated core range and the recently launched innovations.

Beyond China, our EDP business in Japan posted another quarter of double-digit growth, led again by the Danone and the Oikos brands. Overall, the second quarter led the zone to register like-for-like sales growth of plus 12.4% in H1, mostly driven by volume and mix. Recurring operating margin stood at 30.9%, down 107 bps versus last year, mainly due to mix effects with the Waters and EDP category, both growing at double-digits. But also due to higher investments across the segment. Let me just remind you that all categories in this zone are having an accretive margin profile versus company average.

Moving now to Latin America on page number 15. Latin America registered plus 10.8% like-for-like sales growth in Q2 with price up plus 12.9% and volume mix down minus 2%. All countries of the region contributed to this performance with brands like Danone, Danonino, La Serenisima and Dannette driving the growth. All in all, Latin America closed the first semester with plus 11.7% like-for-like sales growth.

Recurring operating margin stood at 2.8%, increasing by plus 291 bps versus a very low base of last year. Our business in Latin America has a very seasonal profile, which makes that profit margins higher in the second semester. Having said that, overall margin profile is here not yet at the desired level, and we are taking actions to correct this.

An example of those initiatives is from Brazil, where we have discontinued our low-margin water business as well as licensed out our existing milk business under the Polystar brand which will enable us to focus our resources on the more value-added and profitable part of the portfolio.

Finally let's have a look at the Rest of the World zone on page number 16. Like-for-like sales grew by plus 3.9% in the second quarter, led by a price effect of plus 8.2%, while volume/mix was down minus 4.3%. As expected, sales and volumes normalized this quarter after a first quarter boosted by calendar-related phasing effects, especially in Specialized Nutrition.

Looking at the quarter more in detail. Specialized Nutrition business posted a good quarter like in Indonesia, where our SGM and Bifilac brands continue to gain market shares, as well as in countries like Thailand or India, where we posted strong performances coupled with market share gains. In parallel, we are making good progress on the transformation of our EDP portfolio in Africa streamlining and optimizing our operating models and product portfolios.

Looking at the first semester numbers, sales increased with a solid rate of plus 7.7%. Recurring operating margin stood at 10.4%, increasing by as much as plus 127 bps versus last year, particularly driven by the progress we make in EDP Africa, but also by the growth of our accredited SN business in the region.

Let's now move on to the margin bridge for the first semester on page number 17. Recurring operating margin stood at 12.2% in the first semester, an improvement of plus 14 bps, compared to last year, which is positioning us well to deliver on our full-year guidance of moderate margin improvements. As you can see, we are making tangible progress on establishing the value creation algorithm we are striving for.

In H1 and after many semesters and years of erosion, we were able to turn around our margin from operations. That increased by plus 93 bps. This has not only been the result of the sequentially improving quality of our top line growth, but also thanks to another record delivery of productivity gains, which supported us in offsetting a material part of the still high inflation we incurred in this first semester.

With our margin from operations expanding, we are creating the conditions for continuing our reinvestment journey in an organic self-funded manner. Our step-up in reinvestments in A&P and product superiority and capabilities had a negative effect of minus 99 bps in the first semester. Beyond the pure number, it is the quality of our investments, especially in A&P, but also in R&I that is also stepping up. This is starting to feed our long-term value creation algorithm.

Other effects remains relatively minor, as you can see, the overheads before investments continue to have a positive effect in this semester is plus 7 bps, as well as a positive contribution of changes in scope of ForEx and of the organic contribution from hyperinflation countries for a total combined effect of plus 30 bps.

Moving now on to the EPS bridge and free cash flow on page number 18. Recurring EPS reached EUR1.76 in this first semester of 2023, which represents a plus 7.6 increase, compared to last year. Main contributor of recurring EPS growth was the operational performance that we just went through. All the other effects altogether basically compensate each other and had an almost neutral impact on EPS. Among others, tax equity accounted companies and minorities had a minus 0.7% effect. Where currency and other effects had a positive plus 0.5% effect on EPS growth.

Reported EPS stood at EUR1.7, up plus 48% versus last year, driven by the sharp decrease in non-recurring costs in this first semester, as we move towards the end of the local first project. On the cash generation side, free cash flow reached EUR1.1 billion in H1 2023. This represents an increase of around EUR400 million, compared to last year on the back of a disciplined return-oriented capital allocation and working capital management.

Let's now move on to page 19 to share with you some elements about year 2023 moving forward. First, on the accounting treatment related to the recent developments in Russia. As we stated in our press release one week ago, our EDP business in Russia was placed under the temporary external administration of the Russian Federal Agency for State Property. As a result of this and as per the applicable accounting standards, we will be fully deconsolidating our EDP Russia business as of July this year triggering a cash impairment of around EUR0.2 billion, as well as the recognition of the currency translation difference of around EUR0.5 billion.

Coming back to what we already said on the last quarterly call, we are confident that year 2023 will be the year where we start establishing our desired value creation model as we demonstrated in this first semester. Concretely, we are confident that our volumes will sequentially improve. Building on the hard work our teams have done over the last quarters on our portfolio. EDP Europe will certainly be a key driver of it being on track to deliver on the plan we outlined at the beginning of the year. This sequential volume recovery will bring us more operational leverage and will solidify our gross margin expansion, which will create the conditions for further reinvestments. Our aim remains to build a business model which is consistently and sustainably creating value quarter-after-quarter, year-after-year.

A quick word then on our guidance 2023 to conclude the financial review on page number 20. Taking stock of the solid first-half of the year, we reiterate today our full-year 2023 guidance with like-for-like net sales growth between plus 4% and plus 6% and more precisely, we expect it to be at the upper range of this covenant. At the same time, we are confirming our full-year guidance for recurring operating margin, which is to deliver a moderate margin improvement versus previous year.

This outlook reflects our confidence that our Renew Danone strategy is into action, yielding first results and reflects also our commitment to reinvest into our brands and assets to build the future for the short, mid and long-term of our company.

And with that, let me hand it over back to Antoine for the conclusion.

[Antoine de Saint-Affrique, Chief Executive Officer]

Thank you, Juergen. So moving straight to page 22. Let me conclude with the chart that you will recognize from last year's Capital Market event. As you remember the Renew Danone framework is made of four strategic pillars and four enablers. Our efforts over the last 18-months are starting to pay off. We have worked hard on restoring the fundamentals, but also making significant progress on the enablers of Renew Danone from culture to capabilities, our sustainability as you've seen from the Danone impact journey and cost competitiveness.

This shows clearly with our gross margin turning green in the first-half. This, as you can see it, is a key to us as it gives Danone the room and flexibility to reinvest. This shows our commitment to keep investing, while delivering healthy cash levels and while a lot still remains to be done on winning where we are, expanding where we should be, seeding the future, and managing our portfolio. This further strengthened our confidence in our ability to drive consistent value creation for our shareholders.

With that, let me hand over to Mathilde for the Q&A. Mathilde, over to you.

[Mathilde Rodie, Head, Investor Relations]

Thank you, Antoine. So now we're opening the Q&A I don't know, if you guys need further reminder of the method. I think the first question we have will be from Warren Akerman from Barclays.

[Warren Akerman, Barclays]

It’s Warren here at Barclays. Hope you guys are doing well. Two from me, the first one is on EDP. So we've seen a bit of a slowdown in the U.S. EDP Nielsen. I'm just wondering what's happening in the U.S. And then on EDP Europe, what's your expectation as we exit this year in terms of SKUs and underlying volumes. I know you gave us that Spanish data point, which is great, but do you have any other data points in other countries that give us the conviction this is real and will come through in the back half.

And then secondly on Specialized Nutrition, can you tell us what the growth was in China Infant Nutrition in the quarter and maybe by channel and obviously, at the R&D event in Paris you mentioned seven new SKUs in Aptamil in China as you push into ultra-premium. Can you remind us why that's important? And then maybe also why SN like-for-like margins were down 350 bps in H1? Is it related to those launches or something else? Thank you.

[Antoine de Saint-Affrique, Chief Executive Officer]

Hi Warren. We'll do as per usual, a duet with Juergen on that. I'll take the first one and Juergen will probably take the both of the second one. In the U.S., we are actually quite happy with the performance of EDP. We have Oikos that is going from our strength-to-strength. So high protein range is doing super, super well. We have a good, good performance of Activia. We saw a slowdown, and this is what is also reflected in the market shares of the Danimals, which is our more affordable kids range, where we saw some elasticities after the last price increase. I mean this product is targeted toward a modest part of the population. So that is something that we are in the process of correcting, but by and large, the dynamic of our EDP or U.S. is a good one.

In Europe, I mean, we showed the Spanish example for, I mean, for a number of reasons. I mean, the first one is, as you would recall, we had a large number of years of underperformance in Spain and the team there for the last numbers of malls I've done the work that is exemplary and which we leverage in other places by doing in some ways which we had done in the U.S. stretching very clear our streamlines, making sure that there is a proper segmentation and segmentation that is not only by brand and by benefits, but by price points, so that we can tackle the various levels of the market or being quite aggressive actually at an entry point, but aggressive not only on price, but aggressive also on the benefits we offer, so that we have a value proposition that is differentiated by the way, supporting it with advertising.

If you haven't had the opportunity to look at it, it was shot with our Danone employees super cool. And this model that is now our proven and has a real impact on penetration in Spain also a real impact in the way we start discussing with some of the key distributors or retailers in Spain. This model we are deploying into other countries. We have a good or a solid performance in France, where things are moving in the right direction as well, but still more to be done.

You will have seen, if you are in the waiting room, the advertising we put on here in France, which is a recreation of something that worked in the past done to the taste of today. We are there to externally auditing [Indiscernible] on the streamlines. And on reclaiming the fact that Danone Yogurt is not a yogurt, it's a Danone.

So testing and proving in Spain are moving next to our friends, doing the same architecture work in places like Germany reclaiming our product superiority around Activia also reframing our product portfolio in places like the U.K. So we are just deploying I mean, country after country. the method that we have put in place.

On China, I hand over to Juergen.

[Juergen Esser, Chief Financial Officer]

Yes. Good morning, Warren. On China and on the overall Specialized Nutrition margin. On China maybe first, so you saw China second quarter of very good delivery in Specialized Nutrition almost plus 7%, contributions from all the segments, including IMF.

So we see good contribution from IMF to this -- to this number. Clearly, outpacing the market as the market continues to be pretty soft in the moment and when it comes to the channel contribution clearly our controlled channels contributing to that growth -- uncontrolled channel further declining so now clearly below 10%. So we are, I would say, continuing what the dynamic we have been starting many, many years ago, so very solid performance in a moment, whereas we know the whole category is shifting from old recipes to new recipes.

We have, as you know, quite a few exciting innovations in the pipeline first one with the market towards the end of year. So they are not yet in the market, which means that the market share gains we are to-date delivering are still with the portfolio you know now, which we have in the market since many years.

On your second question, Warren, on the overall margins of Specialized Nutrition, so you are right that the margins of Specialized Nutrition are down in this first semester. It's not so much linked to the performance of China. It has only with the element of the recipes, because there are two drivers, basically there is a first drivers of investments into innovation and recipes China being part of it, but also Europe and the other part of the world. The other element, which has put temporary pressure on the margins of this first semester, is the fact that in Europe, we have a part of our portfolio, which is going from prescription and reimbursements. And here price increases take a little bit of time between six and 18 months to materialize into our P&L.

So this will materialize over the coming quarters in our European P&L and so what you can expect is that the margins of Specialized Nutrition in H2 will be superior to the one-off H1 and we are also confident that we can maintain and sustain the margins of SN globally speaking at very attractive level where they are today.

[Warren Akerman, Barclays]

Okay. Thanks, guys.

[Mathilde Rodie, Head, Investor Relations]

Thank you, Warren. So next question is from Guillaume Delmas from UBS.

[Guillaume Delmas, UBS]

Thank you, Mathilde, and good morning, Antoine and Juergen. A couple of questions for me, please. The first one is on pricing. I mean at this stage, do you expect that you will have to make some downward adjustments to your prices during the back half of the year? And here, I'm just thinking in particular of EDP, because in the scanner data, we see private label gaining shares, we see promo activities still below the levels of 2019. And then looking at your gross margin development at the group level, but also your recurring operating margin in EDP. It seems that you've clearly reached an inflection point? So does it make price adjustments inevitable in the second half of the year, particularly in the developed world?

And then my second question is Antoine going back to the strategy road map. I mean you are still in the fixed and seed phase as per the slide you were showing at the CMD in March last year. But based on the progress you've made so far in establishing the desired value creation model, do you think you could enter the second phase, which is the accelerate phase as early as next year?

And if so, I mean, how should we think about this acceleration? Is it being able to do consistently 4% to 6% like-for-like sales growth or is it being able to do a little bit better than moderate margin expansion going forward? Thank you.

[Antoine de Saint-Affrique, Chief Executive Officer]

Thank you. I'll start with the second question. I will probably do a duet with Juergen on the first one. I think you you've seen from the results, you heard also from us, we are happy that we are making good progress on the fix and our seed part of our agenda. It has been now a number of quarters where we are delivered consistently and consistently not only in terms of our numbers, but also in terms of the make of the numbers. So reinvesting behind our brands, doing the right thing in terms of productivity striking the right balance and keeping a rather resilient volume or mix dimension. So yes, indeed, we are making good progress which gives us the confidence that we are heading into the right direction.

Before moving to something that is more ambitious, we need to keep delivering consistently on the transformation of our business. I mean, all of you have told us over the past year that -- or past years that we were too fast in moving to the next phase. We are delivering consistently on a model that is a value creation model. So are we preparing the next phase? Yes. Do I want today to discuss the next phase? No, because we need to continue to deliver and to consistently improve the model. So are we active in the background? Yes, we are.

But the focus and especially the focus inside the company has to be consistently delivering and strengthening the model all the time because this will deliver a very significant value creation. So yes, we are working on it. No, we are not ready to disclose it because there is still more work to do on the basics and more opportunities, by the way of growth and value creation.

On pricing, we'll do a duet with Juergen. I mean, well, the first, I mean, the first thing is when we are doing what I was explaining a minute ago in terms of streamlines and segmentation. It enables you to move from a discussion that is a broad-based pricing discussion to a discussion where some SKUs have a role to play to be fighters some SKUs are driving premiumization. So you start being much more sophisticated in the way you play. By the way, using our promotion rather than pricing. Because inflation is still there. It's lower, not on everything, by the way, but it's still there. So it is getting also much more sophisticated in the model through segmentation, through promotion and through very clear streamlines on the various elements of our mix. Juergen?

[Juergen Esser, Chief Financial Officer]

Yes. Just to build on what Antoine was just saying, when we talk price, we need to talk inflation. Inflation was still high in the first semester. A little bit decreasing as we go through the next quarter, but there will be still inflation, which will be fed by cost of labor by some agricultural ingredients like sugar, but also by milk and especially in Europe. And so what we will see is indeed that the price effect is sequentially coming down. You have seen that 10% Q1, 9% Q2, and we will have price effect, to a lesser extent in the next two quarters in front of us, but pricing will stay positive, while pricing will normalize. That is the first very important element.

When it comes to the impact it will have on our top line and our bottom line. Very important that we have created the conditions over the last quarters and you can say almost over the last two years for reinvestment. And those investments will help us to restore volume growth to go back to the balanced growth model we are aiming for. This balanced growth model will continue to deliver gross margin expansion, because the gross margin expansion you saw in H1 is not only the consequence of the improved quality of growth, and this will further improve, but also of the productivity gains we have beyond industry norms, as well as by the fact that we are starting to fix the underperformers.

And that is true for Europe, that is true for the other parts of the world. So there are several drivers, which we made that we will continue to expand our gross margin to sell fuel reinvestments and to deliver the margin expansion we have committed to.

[Guillaume Delmas, UBS]

Thank you, very much.

[Mathilde Rodie, Head, Investor Relations]

Thank you, Guillaume. The next question from Pascal Boll, Stifel.

[Pascal Boll, Stifel]

Yes, good morning, everyone. First question would be on your SKU rationalization plans you have discussed at length over the last couple of quarters. You always said that this will take an end by the end of Q2. Can you confirm that or will make it -- will that have a negative impact also for the following quarters?

Then maybe on free cash flow, can you bit elaborate a little bit more on what you mean by capital allocation? How did, for example, CapEx change year-over-year and maybe also on the net working capital impact, for example, what happened to inventories? Did you need to build more in that semester?

And then finally, on costs, could you give us some more details on what was the cost impact in H1, year-over-year and what you expect in an absolute amount for H2? Thank you.

[Antoine de Saint-Affrique, Chief Executive Officer]

Good morning, Pascal. I'll take the first -- I'll take the first one. And I mean Juergen will take the second and the third. On SKU rationalization, as you remember, we started the SKU rationalization in quarter three. Last year it was in full force by the end of quarter four. So what you will see is indeed progressively over the course of H2. We will lap the SKU rationalization and towards the end of the year, we should be on the based that is a normalized base for the big or significant SKU rationalization, once you said that we have entered also, but at less or a one-off issuer into a discipline where we will keep our SKUs under control.

So we will go into a permanent reason of pruning, but which is going to be more than a normal course of the business. So to your initial question, yes progressively over the course of H2, we will lap the significant SKU rationalization and we are entering into a more normalized where we are -- I mean, as part of keeping our portfolio healthy, we prune the -- our less performing SKUs, we challenge the return on our capital invested and we drive the clarity of our portfolio. By the way without giving up on our share of shelf, which is all the secrets of managing this, and on that, Juergen?

[Juergen Esser, Chief Financial Officer]

Yes. And just to say that when you look back at page 17 of our full-year presentation we totally confirmed what we showed you at the time, which is the evolution of our EDP European volume sequence with volumes recovering from now onwards. On free cash flow, EUR1.1 billion, good number, EUR400 million more than last year. Two drivers. First driver definitely being what I said -- what I called disciplined CapEx and working capital management. CapEx EUR300 million I would say very return-oriented approach, the same level as last year, well below the cap we have set ourselves.

Working capital moving into the right direction on several elements on receivables, particularly, but also on inventories. We are starting to make a good job and Pascal, on your last question on the cost and COGS, I think the element, which is worth noticing, is that you see that we are able to offset no more than one-third of the cost inflation by productivities because we are delivering more than industry norms in terms of productivities. This is really becoming a competitive edge and so already as of today, more than offsetting a one-third of inflation and that will be an even larger part moving forward.

[Pascal Boll, Stifel]

Thank you.

[Mathilde Rodie, Head, Investor Relations]

Thank you, Pascal. Next question from Celine Pannuti, JPMorgan.

[Celine Pannuti, JPMorgan]

Sorry, Celine Pannuti from JPMorgan. I think you called my name. Good morning, Mathilde, Antonie and Juergen. Two questions from me. First on EDP, is it possible to understand how gross margin progress, because clearly EBIT margin had a nice increase? And when you think about duality of what you presented I think it was on slide five where Everyday Nutrition and value-added proposition, I presume the second one having higher gross margin, would it be possible to understand what percentage of your total portfolio is now in this higher value-added proposition? And whether in an environment where things could be difficult from an economic standpoint you could still maintain a good balance between the two sides of the portfolio and whether that changes that value proposition, I presume higher gross margin changes your view on the mid-term profitability of the portfolio.

And my second question is on Latin America and apologies if you mentioned that in the presentation. I just wanted to understand what drove the volume mix being negative in the quarter and we've seen that you've gone from a loss to a positive profit in the region. What should we expect in terms of the turnaround for this region? Thank you.

[Antoine de Saint-Affrique, Chief Executive Officer]

Bonjour, Celine, I'll take question two and part of three and Juergen will take question one. I mean, if we get back to the slide five of the presentation, actually, it goes back to how do you architecture your portfolio. And how do you make sure that you do allocate holes to the various parts of your portfolio having something that she is lower gross margin, but is protecting our the bottom of the segmentation and by the way, driving penetration and volume has an impact on the leverage of your factory and is helping the rest of your mix.

So we are -- we have restarted looking at the various awards both from a consumer standpoint, but also from an economic standpoint on the various components of the portfolio. And those are working together. There is plenty of room and we see lots of healthy growth in value-added proposition because they have a distinctive positioning, because they are adding perceived value for the consumer at the same time Danone and not yogurt at EUR1 billion is seen as great value formula increases the penetration of the brands in the category, but has also a positive impact in terms of factoring occupation and therefore as an overall impact on the P&L.

And so management of portfolio is the name of the game with obviously an overall impact, which is our, I mean, driving profitable model when it comes to our -- to EDP. Maybe you want to complete, Juergen, on EDP before we get to Latin America or not?

[Juergen Esser, Chief Financial Officer]

No, maybe on EDP, maybe just on the profitability, and coming back to what you said Celine on the cost margins and profit margins, you can see that for the total company across categories, we have now reached an inflection point of gross margin, as well as on profit margin. It's the same for our global dairy category and this is driven, as I said, by the fact that we are fixing the underperformers and driving more quality into our top-line growth. This will also mean that when we took a look at our overall European profitability we are now at an inflection point, maybe we will see the gross margins and profit margins increasing as we're going into the second part of the year.

For Latin America, more precisely, yes. I think the team is doing a great job increasing the profit margins, yes, from a low base organically and to some extent inorganically. You heard me talking about Brazil where we gave up a bit more than 10% of our portfolio by discontinuing Waters business, as well as licensing out our existing liquid milk business.

And on top of that we can expect the H2 margin to look even better, because we have a bit of seasonality in that business, which make the profitability a bit more acute towards the second semester. So we are well on track I would say totally in line with what Antoine is saying on managing our underperformers across the different regions.

[Mathilde Rodie, Head, Investor Relations]

Thank you, Celine. Next question from Jeff Stent from Exane.

[Jeff Stent, Exane]

Good morning. Thank you for taking my question. Very quickly just on Russia, I see you're going to be deconsolidating EDP, but I thought that the, sort of, Russian had moved a little bit beyond EDP i.e., it's actually taken the entirety of the business. So if you could just clarify exactly what's happening, exactly what would be deconsolidated that'd be great. Thank you.

[Antoine de Saint-Affrique, Chief Executive Officer]

So, Jeff, the -- what the Russian authorities have done is they have put our EDP business under temporary administration of the agency of Russian State participation. So it's the EDP business.

[Jeff Stent, Exane]

Okay. That's clear. Thank you.

[Mathilde Rodie, Head, Investor Relations]

Okay. Next question from Rashad Kawan from Morgan Stanley.

[Rashad Kawan, Morgan Stanley]

Hi, thanks Mathilde and good morning, guys. Just two questions from me. First, can you talk about any shifts in consumer behavior you've seen over the last quarter. By region, I know, volume mix was weakest in Europe, but some of that I'm sure noise from the transformation program. So if you can break down in terms of what you see by region and category that would be great.

And then the second question, just overall, on your margin progression in H2 versus H1, just trying to think what can drive upside to your margins from here and what your reinvestment plans are in the second-half. Thank you.

[Antoine de Saint-Affrique, Chief Executive Officer]

So listen, I'll take the first one and Juergen will take the second one. I mean, if you look at the behaviors of consumers, first, as you said, I mean, they are very different region-by-region. I mean the China market is still very active. The China market reopened when it comes to mobility. So, you have Chinese consumer, which is reasonably confident or still absolutely passionate about science, still absolutely passionate about added value or -- and reacting to very strong mixes.

So very much continuation of what we've seen for long-term in China with the plus at the very beginning of the year of the opening of the market. If you look in Europe, actually, there is no such thing as a consumer in Europe. The degrees of inflation are very different from country by country. I mean you see what's happened in the U.K. or in Poland is very different from what happened in France to take an example. Degrees of inflation and therefore the degrees of consumer actions are very different.

What we have seen this being said, a couple of things. Whenever you have a very strong one with very strong benefits our consumers tend to be very loyal and follow those brands. When the brands are less differentiated or places where the ones or less differentiated you saw, I mean, great competitiveness of private labels. I think what we have seen recently in Europe and we've seen some of it also in the U.S. is a tailing off of the growth of our private label. What we saw as well is private label was taking a lot out of smaller brands, so there was also a bit of cleaning of the market so to speak.

In the U.S. for a very, very long time, there was no price sensitivity. So no real consumer action. We saw a bit more consumer action in the last quarter. Once again, differentiated category by category, which translated in greater weight in some channels, discount and clubs did very well, while some other channels did less well, which by the way is not fully captured by Nielsen, because they don't property follow clubs, so that you don't see.

In the rest of the world it very much depends. I mean, Turkey and Argentina are in hyperinflation. Other places, I mean, it’s literally place by place by place by place. So I mean that's the beauty of having, by the way, I mean, a strong team in every country, which is you adapt your pricing and your position to each of the country to make sure that you remain relevant.

[Juergen Esser, Chief Financial Officer]

On the margin question, Rashad, yes we do also expect in the second semester the gross margin to expand on the back of, as we said the further improving quality of our top-line growth with volumes sequentially recovering in the back of continued productivity on the back of further progress in managing up our underperformers. All of these will contribute. We may face a bit less favorable geo mix and category mix however, but overall, it will be a positive driving our gross margin.

So that will be again in a position to significantly reinvest into our business confirming our intention to deliver moderate margin improvements. And if the inflation should come down a bit faster than what we expect we will reinvest any good news into the business to build the future.

[Rashad Kawan, Morgan Stanley]

Thank you.

[Mathilde Rodie, Head, Investor Relations]

Thank you, Rashad. And the last question from Jon Cox, Kepler Cheuvreux.

[Jon Cox, Kepler Cheuvreux]

Yes, thanks. Thanks very much, guys. Jon Cox, Kepler Cheuvreux. A couple of questions, maybe first of all for Antoine just on the kind of the outlook for the year, I think there were some people assuming you may just change the wording a little bit on the 4% to 6% for this year. Consensus is already above 6%. You're reiterating 4% to 6%. Just wondering if you see something coming up that maybe we don't expect, because you're talking about volumes probably accelerating in H2 even if pricing just comes down slightly sequentially.

Incidentally, I know, we don't want to talk about your -- the next step, in the financial report today you actually mentioned that the 4% to 6% is in line with medium-term targets. I think originally you were talking about 3% to 5% currently and obviously we've had inflation and the rest of it. So there's a question on the top line?

And then maybe one for Juergen, just on the free cash flow side of the equation. Looks like a very decent result there. Just wondering what you think about the full year, can we think about maybe towards EUR3.5 billion free cash flow for the year. And I'm wondering, is this really like a new baseline for you guys, because you're talking about how all your margins have hit bottom and everything is going to get better. If you look at your free cash flow margin, it was 10% plus a few years ago and there were around 7% or 8%?

Just wondering, should we expect that to sequentially improve typically Danone actually has a negative working capital. Should we see a return to that. And just an add-on Russia, you talk about the impairments, et cetera, this EUR0.7 billion. Would that be it or would there be any more, just wondering if you see that EUR0.7 billion being everything in terms of exiting Russia dairy? Thank you.

[Antoine de Saint-Affrique, Chief Executive Officer]

Hey, Jon. On your first question. No, I don't see on the horizon, things that you don't see. I mean the -- we said we will be in the upper part of our guidance, so we slightly changed the wording, as I'm sure you have noticed and this is a reflection of the fact that our, I mean, pricing has reached a peak and so change over time will progressively normalize, while we'll see some of the volume and our mix kicking in. So indeed, actually we changed a little bit. We would be in the upper part of the guidance, and no, we don't see anything on the horizon that you don't see.

[Juergen Esser, Chief Financial Officer]

Jon, on the free cash flow. Yes, I think a good start of the year, as you say, I think we're making progress, really managing a return-oriented capital expenditure management, but also, as you say, managing better and better our working capital, which is negative and which is more negative today than it was 12-months ago, which bodes well for the future when growing our company. We don't give a guidance on free cash flow as you know, but we want to expand and accelerate our cash conversion cycle moving forward.

On Russia the EUR500 million plus EUR200 million, EUR700 million, I think it's fair to say that we do not expect a material change on that yet. We are booking that into the second semester. So there could be some currency-related minor variations. But that should be basically it.

[Jon Cox, Kepler Cheuvreux]

Great. Thank you.

[Mathilde Rodie, Head, Investor Relations]

Okay. So now the Q&A ends. Thank you very much everyone for attending the call. And we remain available the IR team to answer any follow-up questions you might have in the coming days.

[Antoine de Saint-Affrique, Chief Executive Officer]

Thanks, everyone and see you soon in one place or the other. Take care. Bye-bye.

[Juergen Esser, Chief Financial Officer]

Take care. Bye-bye.

[Operator]

That does conclude our conference for today. Thank you for participating. You may now disconnect.