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With Raw Milk Prices Going Up, How Will Dairy Companies Perform in 2014?

According to dairy analysts, store milk prices could reach their highest levels ever in March with a $0.60 increase. What's going on? Basically, a short supply of cheese drove prices to a new peak in January, as they rose from $1.80 to $2.36 per block. This price jump is very likely to transfer to March fluid milk prices. Plus, when farmers had to face higher feed costs in early 2013, they responded by reducing their herd growth, which would eventually drive prices up. Since demand remains pretty much the same, with the addition of a growing international appetite, especially that of China, the tighter supplies are pushing prices up. Let's check out how three big players expect to perform in 2014.

Difficult quarter coming up
First up is Dean Foods (NYSE: DF  ) , the largest dairy processor and distributor in the U.S. This company is fairly well-known, and you probably bought its products from one the more than 50 local and regional dairy brands it owns.

Dean Foods is concerned about the rise in raw milk prices, and in fact projects a first-quarter loss per share of around $0.03. This announcement drove its share price down 10%, as investors felt the uncertainty in the market. Let's not forget that Dean Foods also posted a 7% drop in its fourth-quarter revenue, the steepest fall in six quarters, which was mainly driven by a decline in milk volumes. Net loss reached $37.7 million in the fourth quarter, which compares to a profit of $30.6 million in the same quarter a year ago.

The problems for Dean Foods became noticeable when it lost a contract with Wal-Mart in mid-2013, and unfortunately the company does not think it will recover from this loss until the second half of this year. In addition, it missed with its price projections, as it previously expected raw milk prices to fall in the early part of 2014.

Challenging 2014
Next is well-known hot cocoa mix producer Nestle (NASDAQOTH: NSRGY  ) . This company is not only a strong player in dairy, but also the largest packaged-food company in the world by revenue. Unfortunately, things are far from optimal for Nestle as well. The company announced that it will have a "challenging" 2014, in-line with its 2013 performance when it recorded the slowest organic growth rate in four years at 4.6%. Nestle CEO Paul Bulcke does not expect a rebound in U.S. consumer confidence, and he does not foresee strong growth back in Europe either. In regard to the emerging markets, he reckons that they will continue to grow, but at a slower pace.

However, some facts are encouraging about Nestle. The company is growing in a continent that is not growing, Europe, and in the emerging markets, which are slowing down. Behind this growth there's the company's innovation and its continuous pursuit of efficiencies. Let's not forget that emerging markets showed 8.8% organic growth in the first nine months of 2013, versus a 1.1% rate in the developed markets.

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

More optimistic
Finally, there's Groupe Danone (NASDAQOTH: DANOY  ) . Although it's the world's largest yogurt maker, you might have never heard of this French company as it generates only about 8% of its sales in the U.S.

Danone in particular is a bit more confident about the future. The company expects 2014 like-for-like sales growth of 4.5%-5.5%, maintaining an operating margin variability of 0.2%. Plus, the major impact of a recall that affected several of the company's infant formula products in Asia is over, and inventories are back to normal levels.

The company expects group sales growth to accelerate in 2014 thanks to a recovery in European dairy that is gathering momentum. In fact, Danone aims to return to strong profitable growth in the second half of the year.

Rebuilding confidence in Chinese markets will be essential for Danone as China accounts for 20% of its baby food sales, which makes this division the second largest contributor after dairy. The country as a whole accounts for 6% of the group's sales. The company claims that the recall in Asia cost the group EUR 370 million in lost sales in 2013, and it affected the company's operating profit margin by 26 basis points. Now, things are going back to normal. Market share in China is now at 14%, after a drop to 12% from 19% in October last year.

Dairy-wise, the company will have to make an effort to prevent raw milk prices from affecting its profitability. Let's not forget that dairy products account for 60% of the group's sales.

Final thoughts
Raw milk prices will continue to go up until supplies recompose. This process will take at least 60 days, the time required for new-born batches of calves and cows to reach peak milk production. However, the current drought in California is affecting the production of alfalfa, a key feed for cows, and this could drive milk prices to even higher levels late this year.

Dean Foods will probably continue correcting until mid-2014, when prices find more stability and the company manages to restore volume growth. Keep monitoring this.

Nestle's outlook can give you an impression of where the retail food market is going. However, regarding dairy, it will be hard for the company to transfer the rise in raw milk costs to final retail product pricing due to the strong competition in the market. Considering that almost one fifth of the company's sales are related to dairy, the price rise could impact profitability.

Considering that the China recall issue is over, Danone seems that it will outperform its 2013 results. Watch its sales growth.

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Louie Grint

I am a curious economist who likes to investigate what is behind asset price movements across the globe. My articles range from industry analysis of various sectors to understanding global macro events that could trigger volatility in the markets.

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