* Yoghurt seen weaker during recession, hurting valuation
* Medical nutrition to post sustainable high sales growth
* Acquisitions seen likely to boost medical nutrition
* Analysts see dairy starting to turn round later this year
By James Regan
PARIS, July 10 (Reuters) - The world's biggest yoghurt maker is not necessarily the first company a person with a milk allergy would turn to for help.
But that is one example of the sort of customer French food group Danone is targeting to grow its medical nutrition business alongside baby food as dairy sales dip through the economic crisis and bottled water loses its sparkle.
Acquisitions are likely to play a key part in that expansion, where barriers to entry in foreign markets are often high, after Danone carried out a rights issue to raise some 3 billion euros ($4.18 billion). "As people become more health conscious, I think clinical nutrition offers huge opportunities for growth," said Bernstein Research analyst Eric Scher. "It is fast-growth, high-margin. I believe that double-digit growth can be sustained."
But he said there was no obvious target that could give the business greater scale overnight: "I don't think it's going to be one transformational change. It's going to be smaller acquisitions and pushing into markets where they are not."
Danone's medical nutrition business provides liquid food for hospital patients unable to eat solids, food supplements for elderly people with failing appetites and tailor-made products for allergy sufferers or those with conditions such as epilepsy. Brands include Nutricia and Neocate.
The division contributed only a tenth as much revenue as dairy last year, but sales jumped to 854 million euros from just 133 million the previous year, boosted by the purchase of Dutch group Numico that also helped baby food sales more than triple.
Danone last month sold new shares to existing shareholders to help cut net debt, which reached 11.26 billion euros at the end of 2008 after the 12.3 billion purchase of Numico in 2007.
The company said the move would enable it to make acquisitions worth up to around 500 million euros.
Medical nutrition buys are on the group's radar, with its footprint "still very much in its infancy" and "very much focused on Europe", co-Chief Operating Officer Emmanuel Faber said when the rights issue was unveiled.
It is an "industry that will consolidate in the next several years and we intend to be a proactive contributor to this consolidation," he said.
SHARES SUFFER DAIRY DISCOUNT
Danone was founded 90 years ago in Spain to promote yoghurt containing cultures from France's Pasteur Institute to combat widespread intestinal disorders suffered by children in the years after World War I. It expanded to France a decade later.
But now the company, whose brands include Evian water and Actimel yoghurt, is seen by some analysts as too dependent on dairy, parts of which can be vulnerable in recession.
Indeed, this is reflected in the fact the shine has come off Danone's historical valuation premium. Danone now trades on a multiple of 13.9 times estimated full-year earnings, behind larger Swiss rival Nestle on 14.3 times, based on Reuters data.
Danone shares have lost 14 percent this year, while Nestle stock is almost flat. The DJ Stoxx European food and beverage index has added 4.1 percent this year.
Nestle has reduced the proportion of sales from milk products to around 17 percent and, like Unilever, benefits from diversification.
But at Danone, dairy provided 8.7 billion euros of 2008 sales, more than half the total, growing at 4.8 percent last year, with its main domestic market saturated and price competition intensified. Growth slowed to 1.7 percent in the fourth quarter.
Like-for-like dairy and water sales fell in the first three months of 2009 while medical nutrition was the best performer with almost 11 percent growth.
Bulking up medical nutrition could help Danone shares regain some of their lost premium, especially as the division is expected to continue with double-digit percentage growth in coming years as ageing populations lead to more demand for its products and the industry consolidates.
Fresenius Kabi, part of Germany's Fresenius and Europe's leading clinical nutrition group, saw 2008 sales rise 23 percent and operating profit grow 33 percent. It forecast 25-30 percent sales growth at constant exchange rates in 2009.
Nestle Nutrition, which includes the Swiss company's healthcare, weight control and infant nutrition businesses, posted 10.4 percent sales growth to 10.4 billion Swiss francs ($9.6 billion) last year, with over half in the Americas.
Nestle bought Novartis Medical Nutrition two years ago to become the world No. 2 in healthcare nutrition.
ING Financial Markets analyst Marco Gulpers said that Danone's Souvenaid multi-nutrient drink for Alzheimer's patients could grow to sales of around 100 million euros.
Another analyst said that mere organic growth in medical nutrition would not be enough to improve Danone's valuations.
"It is the speed of the acquisitions and putting this strategy of external growth in place," he said.
But Danone has certainly not abandoned growth in the dairy business that made its name and is looking to expand in new countries with growth potential. This could include the UK, U.S. and Italy, and not just emerging markets.
"As long as dairy is at least 50 percent of sales that is what is going to drive the stock," said ING's Gulpers, adding that the business was set to start recovering later this year.
"It's too early to say that the business model is broken. Whether it's becoming more difficult to grow at the same levels as in the past? For sure. To say that dairy has gone ex-growth, I don't believe that." (Editing by Sitaraman Shankar)