In the week since fast-growing dairy concern Lifeway Foods (NASDAQ:LWAY) reported its fourth-quarter 2006 sales results, the stock has proven remarkably volatile, first rising 3% in reaction to the news, then reversing course and tumbling for a 2% decline from its pre-news price. When compared to the slow but steady 1.5% rise in the S&P over the same time span, that suggests to this Fool that investors don't like what they're seeing at Lifeway -- despite having initially liked it very much indeed. But why?
Buy the numbers
Let's take a look at a couple of trends in Lifeway's sales, on both the macro and micro levels, and see whether we can figure this out:
- Quarterly sales for the firm grew 52% year over year, to $7.9 million.
- Full-year sales were up 38%, to $27.7 million.
- Backing out the "inorganic" sales gains that came with the firm's acquisition of No. 2 kefir-maker Helios, Lifeway proper grew its quarterly sales 27% to $6.6 million.
- Accordingly, Helios's contribution to the quarterly take was $1.1 million in kefir sales, or 12% better than last year; and $0.2 million in milk sales.
Do you see it?
After staring at the numbers a while, I think I now see the problem that has investors so upset: Helios isn't growing as fast as anticipated. If you recall from August's column on the Helios acquisition, I had sketched out a scenario under which "Lifeway looks fairly priced ... if every one of the generous assumptions laid out above proves true." Those assumptions break down as follows:
- Lifeway proper needed to continue growing at its usual, blistering pace. (The 27% organic growth shown above bears that out.)
- Its Helios acquisition needed to continue growing at about 17% per annum.
- The combined firm needed to book about $30.2 million in sales for the year, and net 12.65% of that as profit.
And there you have it. Helios has proven itself (at least temporarily) the Achilles heel of this thesis. Instead of growing 17%, it seems Lifeway's acquisition grew 12% at most this quarter, and at worst, its combined product lines flatlined year over year.
Mind you, I don't think this is a fatal blow to Lifeway. Helios is by far the firm's largest acquisition to date, and some kinks in the integration of the two businesses are to be expected. But Lifeway looked "priced for perfection" back in August, and it's risen 15% since. That richly priced stock simply couldn't absorb Helios's sales stumble. And if the earnings news, when it comes out, shows that the firm netted less than 12% on its sales, I would expect to see the price weaken even further.
Long shelf life
So that's my view on the short term at Lifeway. What about the long term? There, my opinion remains unchanged. Having acquired Helios, Lifeway now has no credible competition in the U.S. kefir market. Potential competitors are either geographically distant -- such as Russia's Wimm-Bill-Dann (NYSE:WBD); contractually forbidden from competing -- France's Danone (NYSE:DA); or apparently uninterested in this growing subset of the dairy market -- America's Dean Foods (NYSE:DF). That lack of competition means that any sales in this market are Lifeway's for the taking. In addition, the firm can charge whatever price the market will bear, creating little to no pressure on the firm's net margins.
Over time, that's a recipe for continued growth in the share price. I simply think that in the short term, things will get worse before they get better.
Fool contributor Rich Smith does not own shares of any company named above.
