No Surprise (Party) at Lifeway

Yeah, I called it. But I get no joy from the fact.

Shares of Lifeway Foods (Nasdaq: LWAY  ) are plunging today, down nearly 15% as the magnitude of the damage wrought by soaring milk prices, a weak economy, and slowing sales hits home.

As I mentioned on Monday, sales growth slowed to 19% in the second quarter. And, as I predicted, profits dropped further than Wall Street anticipated, to $0.05 per share. Sad, but not surprising. Now let's take a look at the bigger picture.

Half down, half to go
Halfway through the year, Lifeway continues to post sales growth upward of 21% in comparison to last year's first half. At $22.6 million year to date, sales approached Lifeway's objective of $1 million a week. Profits in the first six months of $0.11 per share, however, are down 27% year over year. With operating margins falling to 12.8%, Lifeway is now less profitable than larger rivals like General Mills (NYSE: GIS  ) and Kraft (NYSE: KFT  ) , but it's still beating out more mundane milk manufacturer Dean Foods (NYSE: DF  )

The primary reason, as we've said so many times before, is that milk costs are floating way above the historical norm. Across the country, from Starbucks (Nasdaq: SBUX  ) in Seattle to Hershey (NYSE: HSY  ) in Pennsylvania, the dairy drought is squeezing milk users' margins. And while Lifeway CFO Edward Smolyansky is hopeful that a recent "downward trend [in milk prices] will persist throughout the remainder of 2008," yours Fool-y, for one, isn't seeing any evidence of that at the grocery checkout counter.

Meanwhile, Smolyansky laments rising prices for "most of our other production and packaging supplies," picking up where high milk prices left off. And what meager milk savings Lifeway hasn't lost to these corollary costs, Smolyansky promises to give away in the form of "marketing and promotional activities" -- a line item already rising faster than sales.

A blessing in drag?
It all sounds pretty miserable, I'll admit. But while Lifeway has been cursed with rising prices and slowing sales, I do see one bright spot: Free cash flow in the first half grew more than 80% to $1.2 million.

I have to admit, in spite of all the bad news, it's nice to at lease to see Lifeway coughing up some cash.

Related Foolishness:

• Lifeway Throws Us for a Loop
• Lifeway Hits a Speed Bump
• The Mark of Winning Stocks