Milk Price Fluctuation: How Do Dean Foods, Groupe Danone, and Nestle Look in 2014?

When it comes to food consumer products, the U.S. and Western European markets are relatively mature. Looking more specifically into the dairy industry, weak sales volumes and declining profits from fluid milk processing are affecting the companies' numbers, especially Dean Foods (NYSE: DF  ) . The main reasons for this are the increase in promotions on private-label milk distribution, and, of course, price volatility.

However, despite the continuous pressure coming from the rise in raw milk prices, markets like China and Latin America are showing better opportunities for faster longer-term growth.

Considering this scenario, Dean Foods along with Groupe Danone (NASDAQOTH: DANOY  ) and Nestle SA (NASDAQOTH: NSRGY  ) are reviewing their strategies so they can remain profitable and gain more market share. Let's look at their plans.

Dean Foods: Fighting price fluctuations
First, we have the leading processor and distributor of milk and other dairy products in the U.S., Dean Foods (NYSE: DF  ) .

The company's profit soared in the third quarter in comparison with the period last year, driven mostly by effective cost management and the disposition of WhiteWave common stock. Net income went from from $36.44 million in the year-ago quarter to $415.12 million, but since $415.78 million came from the disposition, the rise should not impress. 

In order to offset the impact of raw milk price volatility, Dean Foods implemented several initiatives that included passing input cost inflation to customers, cost cuts, and volume efficiencies. Moreover, Dean Foods' sale of its Morningstar business and its spinoff of WhiteWave have helped the company focus on its core business. All of these are helping the company prevent its profit from declining and even rebuild its profit, but the situation is far from optimal.

Danone: Recall in China
Second, we have one of the largest food and beverage companies in the world and a big player in the dairy industry, with annual sales of EUR 21 billion: Danone.

The company reported a 4.2% rise in sales for its third quarter, which is a good performance considering unfavorable exchange rate translations and the major impact of a recall that affected several of the company's infant formula products in Asia.

The company's presence in the emerging markets is impressive, accounting for more than 50% of sales. Growth in these markets should be able to offset the more sluggish growth in mature, developed markets. That's why the significant loss of sales caused by the false alert issued by Fonterra concerning certain ingredients supplied to Danone will impact the company's operations in China. However, Danone is deploying an action plan to restore its sales levels. The plan is generating results, but very gradually.

The big issue here is that of all the segments in which Danone operates, baby nutrition seems the most promising, especially considering its profitability. This category accounted for one fifth of consolidated sales in 2012 and showed an EBIT margin of nearly 20%. Despite the issues in China, the recent acquisition of more than 90% of U.S.-based baby food company Happy Family is reaffirming Danone's intention to become a leader in this segment.

Nestle: Selling non-core businesses
Finally, we have the largest packaged-food company in the world by revenue and a strong player in dairy as well, Nestle.

The company showed a 4.4% organic growth in its nine-month sales, with contributions from all three geographies. Nonetheless, emerging markets remain very important, showing 8.8% organic growth versus 1.1% in developed markets.

Regarding dairy, the company's milk products and ice cream category accounted for 19% of total nine-month sales in 2013. It is the second most important category, right after the powder and liquid beverages category, which has been growing strongly for the past several years.

Strategy-wise, Nestle has been openly discussing its intent to dispose of non-core brands over the past several months. In fact, last month it sold its weight management business Jenny Craig in North America and Oceania to North Castle Partners. Moreover, the sale of its 10% ownership position in flavor and fragrance manufacturer Givaudan goes in line with this strategy. This sale will bring about $1 billion which will probably be used to pay down debt, repurchase shares, and pursue small bolt-on acquisitions. These moves seem appropriate considering that other peers, like Unilever, have been executing similar decisions.

Bottom line
The fluctuating prices of raw milk are very likely to have adverse impacts on margins in the future. These impacts will be stronger on companies like Dean Foods which are more specialized, and hence more exposed to milk price variations.

Danone's issue in China is affecting the profitability of one of its most auspicious businesses. Nonetheless, the problem will be temporary, especially considering that the problem was a false alarm and that Danone is on top of the situation.

The divesting decisions are helping Nestle focus on high-return opportunities. The company will remain a consolidator in the global consumer product industry, despite volatility in milk and other commodity prices.

No Pitch


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