My, what a difference a couple quarters makes. As recently as April, low milk prices and a strong increase in quarterly profit had Lifeway Foods (Nasdaq: LWAY ) Chief Financial Officer Edward Smolyansky boasting of his company's ability to grow "organically ... at 25 to 30 percent." Unfortunately, that's not the way things worked out.
Discussing the company's recent results earlier this week, Smolyansky said that in large part because of a tough economy, Lifeway's growth came close to flatlining in Q3. Sales grew a bare 3% versus last year's Q3. Earnings declined 34%, to just a nickel a share. And free cash flow -- the real measure of a company's profitability -- has slowed to just $2.3 million for the first nine months of 2010. So far, Lifeway has generated barely half the $4.5 million in FCF it had produced by this time last year.
Bad news? What bad news?
And yet, none of that was the reason for Lifeway holding a conference call at the end of a quarter instead of the end of a year, unprecedented for the company. Rather than rehash bad news from Q3, Smolyansky wanted to tell us about good news coming down the pike. Turns out, Lifeway has managed to convince the U.S. Department of Agriculture that the process it uses to produce its marquee "kefir" concoction should not require the purchase of "Class I" milk anymore. Rather, Lifeway will be permitted to purchase "Class II" milk instead -- saving as much as 20%.
What's it mean for shareholders? Based on September milk purchases, it suggests Lifeway could save as much as $1 million annually by buying the cheaper grade of milk, potentially adding as much as 160 basis points to the company's operating margin. If that's the way things play out, Lifeway could soon be within spitting distance of the kind of upper-teens operating margins that larger foodstuffs companies like General Mills (NYSE: GIS ) and PepsiCo (NYSE: PEP ) produce (Coca-Cola's (NYSE: KO ) still a ways off, at nearly 30%).
Two great tastes that profit together
Of course, what's a profit margin without revenue to earn it on? Lifeway's addressing that issue as well, announcing:
- Added shelf space in Safeway (NYSE: SWY ) stores -- which could triple revenue from that customer in 2011 from 2009 levels.
- A greater presence in Wal-Mart (NYSE: WMT ) superstores.
- A longer-term effort to get its products placed in more of the nation's Kroger (NYSE: KR ) locations (only about 50% to 60% of Krogers sell Lifeway kefir today).
Will it all add up to 30% annual "organic growth"? I doubt it -- but better sales and better earnings are a start, and absolutely essential if the stock's to have any chance of holding onto its consistently premium P/E ratio.
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