Monday turned into a bittersweet day for kefir maker Lifeway Foods (NASDAQ:LWAY). On the one hand, the little dairy enterprise turned in some healthy-looking numbers. On the other hand, the story behind those numbers looks a bit curdled. Let's break this one down into "good news, bad news."
Good news
The good news is pretty obvious here, and consists of some pretty remarkable sales growth numbers:
- Thanks in large part to its August 2006 absorption of archrival Helios, Lifeway boasted 52% sales growth in fourth-quarter 2006 (against a Q4 2005 in which it did not own Helios).
- For the full year, which consisted of about four months benefiting from Helios-boosted sales numbers, and eight months without, sales grew a less explosive but still impressive 38%.
Bad news
The bad news, in my view, concerned pretty much everything other than sales growth. For example:
- Q4 profits per diluted share slid 25% to $0.03.
- Full-year profits grew, but at nowhere near the rate of sales growth. On a firmwide basis, net profits were up 14%. Per share, the growth number was closer to 13% for the year.
- Margins slid precipitously. After clocking in at a 12.7% net in 2005, its second-highest level in the past decade, Lifeway's profit margin fell to 10.4% in 2006 -- its third lowest. For comparison, Lifeway's now looking only slightly more profitable than megarivals such as Danone (NYSE:DA) and General Mills (NYSE:GIS), although it still has Dean Foods (NYSE:DF) soundly beat.
Reviewing the results, Lifeway CFO Edward Smolyansky put the blame squarely on the shoulders of Helios. Smolyansky pointed out that although Lifeway's new prize brought with it an additional $2.17 million in inorganic revenue growth toward the end of 2006, Lifeway "also absorbed about $2.17 million in costs as the Helios business model was not nearly as profitable as Lifeway's." I have to agree with Smolyansky there. A central part of my thesis that Lifeway was fairly valued back in August depended on Lifeway quickly imparting its own margins to Helios' revenues. As it turns out, the opposite is happening.
Where I disagree with Smolyansky is on his optimistic interpretation of the numbers. His assertion that: "On an operating cash flow basis... we have never been stronger. In 2006 cash flow from operations was $2,157,503 compared to $1,592,491 in 2005" simply doesn't hold water. In fact, Lifeway reported operating cash flow in excess of last year's numbers twice before: $2.2 million in 2004, and $2.84 million in 2002.
Long story short, I continue to admire Lifeway's growth story, and believe its consolidation of Helios' operations with its own production is the right move for improving profitability. That said, management has a lot of work to do if it's to convince investors that its largest acquisition ever was also its best ever.
For more on this little kefir maker that could, read:
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Fool contributor Rich Smith does not own shares of any company named above. The Fool has a disclosure policy.
