Sunday, February 21

Week 242 - Dairy Products

Situation: Now that almost 20 million people a year move out of poverty worldwide, the demand for protein is much greater than it was 10 yrs ago when that trend got rolling. Why? Because it is expensive to have 60 grams of protein in the daily adult male diet, as recommended by nutritionists. For example, a standard source for meeting daily protein needs is an 8 oz cup of whole milk. It contains 8 grams of protein. You’d have to drink 1.875 quarts a day if that were your only source, which would cost you $2.10/day if you lived in Mumbai, India. (The standard definition of “extreme poverty” is to be living on an income of less than $1.25/day.) Even in the affluent United States, people are demanding more protein in their diets because of new attention being given to the quality of foodstuffs. (It turns out that most of us haven’t been consuming our 60 grams of protein a day.) The most convenient source of protein is milk but demand for milk has been falling for decades. For example, here in the US we drank 19.9 million pounds of conventional whole milk in 2000 but only 11.4 million pounds in 2015. This falloff in demand has led to more creative ways of processing milk (to interest consumers in buying it), Greek yogurt being the most recent “crowd pleaser.” But there is still more milk being produced from our dairy herds than is being processed, which results in a trend toward smaller herds and lower prices. Since 1995, the price of conventional whole milk has risen 1.4% (vs. 2.1%/yr for the Consumer Price Index), but in recent years has tracked inflation.

Mission: Find out how publicly-traded companies and farmers cooperatives make money by processing less milk each year and selling it at prices that barely keep up with inflation.

Execution: The short answer is that they don’t. Less processing = less income. Dean Foods (DF) is the only nationwide company that relies on revenue from selling conventional milk, having recently spun off its division for producing organic milk and soy milk (to Whitewave Foods Company) and its division for producing yogurt (to Schreiber Foods). Line 11 in the Table makes clear that Dean Foods has been struggling, even though its stock price has managed to ride along with the stock market bubble. The other 7 companies in the Table also process milk but their milk-related sales generally represent less than 10% of their income.

Administration: Let’s look at how these 8 companies make money from milk.

   General Mills (GIS) sells Yoplait yogurt.
   Unilever plc (UL) sells Ben and Jerry’s ice cream and frozen yogurt.
   Nestle S.A. (NSRGY) sells Carnation milk, Nestle chocolate milk, Nesquik chocolate milk, Coffee-Mate, Dreyers ice cream, Haagen-Dazs ice cream, and a variety of yogurt brands.
    Coca-Cola (KO) has partnered since 2012 with Select Milk Producers (a nationwide farmers cooperative) to create a company called Fairlife LLC that filters milk into its separate components (water, butterfat, protein, vitamins & minerals, lactose). Those are recombined into a product (Fairlife) that has less than half the sugar (zero lactose) and twice the protein of conventional milk.
    Kroger (KR) has opened a new plant in Denver (Mountain View Foods) to process conventional and organic fresh milk for its King Soopers label, giving it a total of 17 plants in the US for processing “non-GMO milk.”
   Danone (DANOY) sells Dannon yogurt and Dannon Oikos Greek-style yogurt.
   Hain Celestial (HAIN) sells Greek Gods yogurt (my favorite).
   Dean Foods (DF) has co-marketing arrangements with 30 dairy cooperatives, including the largest (Land O’Lakes Dairy), for distributing milk products nationwide including butter and cheese. 
Bottom Line: Milk is a commodity, meaning there are high fixed costs for ramping up production in response to a shortage--to have an efficient and robust supply chain. Then a global recession occurs and people rethink their need for that now-expensive commodity; substitution occurs and the supply chain has to be truncated. “Rinse and repeat.” The 4 companies at the top of our Table take the smart route, depending little on milk products to support a sustainable earnings trend. The 4 companies at the bottom have made a greater commitment (total in the case of Dean Foods), so their earnings are at the mercy of the milk production cycle.

Risk Rating: 7

Full Disclosure: I own shares of KO and GIS.

Note: Metrics are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. VBINX, our key benchmark at Line 14 in the Table. Total Returns in Column C of the Table date to 9/1/2000 because that turning point marks the peak of the S&P 500 Index before the “” recession. There have been two peaks since then, in 2007 and 2015, so we are now entering the third market cycle since 2000.

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