As Milk Prices Keep Rising, Should You Stay Away From Dairy Companies?

As milk prices continue to grow, what's the impact on Dean Foods, Nestle, and Groupe Danone?

Apr 7, 2014 at 3:43PM

Despite the increase in U.S. output for the fifth consecutive year, milk prices are not dropping. Class III milk futures, which is the variety used to make cheese, are up 23% this year. What is going on?

Although it's true that domestic milk production is growing, exports have also been increasing -- and at a greater rate. In fact, according to the U.S. Dairy Export Council, they now account for 15.5% of sales, compared with 5% a decade ago. Prices are also on the rise, as U.S. January dairy exports' value rose 35% year over year, holding a quantity increase of 19%.

Drivers
Futures traders might explain the rise in milk prices as a "tough commodity inflation environment," but basically, there is one global driver pushing prices up: demand.

The growing middle classes in Asia and South America are boosting demand for dairy products in general, and these include cheese and processed foods containing milk, such as ice cream for example. The Chinese example is clear, as dairy producers in the country have been unable to keep pace with rising demand, and as a consequence, China increased its dairy imports dramatically.

The interesting thing here is that demand for dairy in the U.S. is shrinking. According to the USDA, domestic per-capita consumption of fluid milk has decreased 25% since 1975, after a non-stop drop for the past four decades.

What's the impact on dairy companies
Certainly, it is tough times for the largest dairy processor and distributor in the U.S., Dean Foods (NYSE:DF), as the higher prices are eroding its profit margins. The company's CEO, Gregg Tanner, stated in the latest earnings call that these unusually high raw-milk prices are "an undeniable headwind for their business." In fact, the company's costs may rise by as much as $600 million this year, and transferring these costs to retail prices carries the risk of adding pressure to local demand. U.S. consumers might just reduce their milk consumption.

The case for Nestle (NASDAQOTH:NSRGY) is a bit different, since the company is not 100% reliant on dairy prices. Nonetheless, things are not in an optimal state. According to the company, 2014 will be "challenging," in line with its 2013 performance, when it recorded the slowest organic growth rate in four years, at 4.6%. Unfortunately, Nestle CEO Paul Bulcke does not expect much growth in U.S. consumer confidence, and he does not foresee strong growth back in Europe, either. He is a bit more optimistic about the emerging markets, as he reckons they will continue to grow, but at a slower pace. The company continues to grow in these markets; in fact, it showed 8.8% organic growth in the first nine months of 2013, versus a 1.1% rate in the developed markets.

For France-based Groupe Danone (NASDAQOTH:DANOY) in particular, this year should be more promising. This has to do with the major impact of a recall that affected several of the company's infant formula products in Asia last year. Fortunately, this issue is over, and inventories are back to normal levels. In fact, the company expects this year's like-for-like sales to grow in the range of 4.5%-5.5%, maintaining an operating margin variability of 0.2%.

The recovery in European dairy is gathering momentum for Danone, and if things march on as planned, the company should return to profitability in mid-2014. Despite the growth in dairy prices, overall margins are recomposing from the damage caused by the recall in Asia, which affected the company's operating profit margin by 26 basis points.

Final foolish thoughts
Don't get confused: The rise in milk prices is good for farmers and milk producers, but not for dairy processors and distributors, simply because it represents a rise in costs that is not easily transferred to retail prices. This just plainly reduces company margins, and makes investors stay away from their stocks.

Dean Foods will probably continue correcting until mid-2014, when prices find more stability and the company manages to restore volume growth. Reducing costs to improve profitability will not be easy with the current price scenario.

Regarding Nestle, the company's milk products and ice cream category accounted for 19% of total nine-month sales in 2013. So, the impact on its cost structure could be significant, especially if prices continue to rise. Watch out, as almost 20% of the company's sales are related to dairy.

Danone is even more exposed, since it is the world's largest yogurt maker and dairy products account for 60% of the groups' sales. Hence, although the company's situation will improve compared to last year, mostly thanks to the resolution of its recall in Asia, it will be tough to grow if higher raw milk costs persist.

The main issue here is that for processed milk products like the ones Nestle and Danone produce, transferring the rise in raw milk costs to final retail product pricing is complicated because of intense competition in the retail sector.

3 stocks poised to be multi-baggers
The one sure way to get wealthy is to invest in a groundbreaking company that goes on to dominate a multibillion-dollar industry. Our analysts have found multi-bagger stocks time and again. And now they think they've done it again with three stock picks that they believe could generate the same type of phenomenal returns. They've revealed these picks in a new free report that you can download instantly by clicking here now.

Louie Grint has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Money to your ears - A great FREE investing resource for you

The best way to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as “binge-worthy finance.”

Feb 1, 2016 at 5:03PM

Whether we're in the midst of earnings season or riding out the market's lulls, you want to know the best strategies for your money.

And you'll want to go beyond the hype of screaming TV personalities, fear-mongering ads, and "analysis" from people who might have your email address ... but no track record of success.

In short, you want a voice of reason you can count on.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich," rated The Motley Fool as the #1 place online to get smarter about investing.

And one of the easiest, most enjoyable, most valuable ways to get your regular dose of market and money insights is our suite of free podcasts ... what we like to think of as "binge-worthy finance."

Whether you make it part of your daily commute or you save up and listen to a handful of episodes for your 50-mile bike rides or long soaks in a bubble bath (or both!), the podcasts make sense of your money.

And unlike so many who want to make the subjects of personal finance and investing complicated and scary, our podcasts are clear, insightful, and (yes, it's true) fun.

Our free suite of podcasts

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. The show is also heard weekly on dozens of radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable. Rule Breaker Investing and Answers are timeless, so it's worth going back to and listening from the very start; the other three are focused more on today's events, so listen to the most recent first.

All are available for free at www.fool.com/podcasts.

If you're looking for a friendly voice ... with great advice on how to make the most of your money ... from a business with a lengthy track record of success ... in clear, compelling language ... I encourage you to give a listen to our free podcasts.

Head to www.fool.com/podcasts, give them a spin, and you can subscribe there (at iTunes, Stitcher, or our other partners) if you want to receive them regularly.

It's money to your ears.

 


Compare Brokers