Once upon a time, in a land far away (Tver Oblast, Russia), a Fool by the name of Rich got badly sunburned on a picnic featuring vodka, precious little potable water, and no shade to speak of. Upon returning home, a kind woman suggested that he slather himself in copious amounts of a local dairy beverage called "kefir," to cool down his damaged dermis. Long story short, it worked. The patient lived.
Today, as most market indices read a shade of red that looks nigh on sunburned as well, investors might consider cooling off with a few shares of local kefir maker Lifeway Foods (NASDAQ:LWAY). Lifeway reported its second-quarter and first-half results for fiscal 2007 on Tuesday, and the news was good. Taking the long view and focusing on the first-half results, we see:
- Sales grew 51% versus the first half of 2006.
- Cost of goods sold rose 60% (primarily because of the rising cost of milk).
- The firm achieved its targeted 40% gross margin for the first half (over the past 12 months, the firm has grossed only 37%).
- Selling, general, and administrative expenses rose only 30%.
Thus, even though its raw materials costs outpaced sales growth, the firm's growing scale of operations, and the efficiencies it yields, allowed Lifeway to eke out a tiny 10-basis point increase in operating margins (to 19%), and its net margin by 20 bps (to 13.5%). And by the time we reach the bottom line, we find that despite near-record-high milk prices, Lifeway's profits outgrew its sales 54% to 51%.
Curdles in the cream?
Now, it wasn't all "bottles of kefir and half-loaves" (an obscure Chaif reference for my native readers) during the quarter. Free cash flow remains an issue at the firm. While it was positive -- about $0.6 million year-to-date -- it grew only 28% year over year. But if you dig deeply into the reason for the slower-than-GAAP growth in FCF, I think you'll like what you find.
You see, by all accounts, bottles of Lifeway kefir are flying off the shelves, at both highbrow shops like Whole Foods (NASDAQ:WFMI) and Trader Joe's, and at more plebeian places like Ruddick's (NYSE:RDK) Harris Teeter, Supervalu's (NYSE:SVU) Jewel, and Safeway's (NYSE:SWY) Dominick's. To meet surging demand, Lifeway has had to ramp production, and built out its physical plant -- both of which require additional capital investment. As a result, capital expenditures grew 119% year over year. So in Lifeway's case, the only reason free cash flow is not growing as fast as profits is because the firm is gearing up for even more sales -- and more great earnings reports.
For more on this little kefir maker that could, read:
Fool contributor Rich Smith does not own shares of any company named above. Whole Foods is a Motley Fool Stock Advisor recommendation. The Motley Fool's disclosure policy is always in stock.
