Dean Foods booked strong second-quarter earnings this week and said that it is on track to deliver cost savings of US$300m over the next three years. However, the US dairy giant’s management sounded a note of caution on the likelihood of higher input costs and competitive pressures. Katy Humphries takes a look at some of the challenges that may be in store for the company.
Go deeper with GlobalData
Lower raw materials and energy costs, coupled with significant progress in cost-cutting efforts, allowed Dean Foods to post a 31% increase in second-quarter profit yesterday (5 August).
The company said that milk prices are “close to all time lows”, benefitting profits by reducing the dollar value of shrink and milk that is lost in the production process.
Lower commodity costs have also helped bolster sales volumes during the economic downturn. Dean Foods has passed savings on to consumers, allowing the company to reinforce its value proposition, which has become ever more important as the recession dampens consumer spending.
Speaking during a conference call, Dean Foods’ CEO Gregg Engles said that lower input costs had also allowed the company to make headway with its “transformational” US$300m cost-cutting programme.
How well do you really know your competitors?
Access the most comprehensive Company Profiles on the market, powered by GlobalData. Save hours of research. Gain competitive edge.
Thank you!
Your download email will arrive shortly
Not ready to buy yet? Download a free sample
We are confident about the unique quality of our Company Profiles. However, we want you to make the most beneficial decision for your business, so we offer a free sample that you can download by submitting the below form
By GlobalDataThe group has started to realise early benefits from operational changes to its distribution network, where it has introduced GPS distribution technology.
“Our efforts have resulted in a 4% reduction in our overall gallons of diesel fuel and flat employee-related cost in our DSD system despite increased overall product volumes,” Engles said.
The company has also announced the closure of four processing facilities – in addition to four manufacturing sites that were closed last year – as part of its effort to rationalise its network.
“This incrementally increases our overall capacity utilisation, lowers our employee-related expense and plant energy usage, and drives further efficiency across our network. Consistent with our efforts in distribution, we see much more opportunity ahead in network rationalisation,” Engles said.
Standardisation efforts are expected to generate purchasing economies, longer product runs and greater efficiency in the group’s plants, the company added.
As a result of these savings, gross margin climbed to 28.5% from 23.8%.
Despite a 14% fall in net sales, which dropped to $2.68bn, the company said that it had stolen market share from rivals by increasing volumes, even as overall industry sales volumes trended flat to down.
Moreover, in order to drive continued growth, Engles said that there are a number of “significant opportunities” in the acquisition pipeline.
In line with its strategy to strengthen the business through “select, strategic acquisitions”, last month Dean Foods bought the Alpro division of Belgium’s Vandemoortele for EUR325m (US$468m) to boost its position in the global soy-foods market.
“I have long believed that Alpro will be one of the most strategic businesses that Dean could acquire and I am very pleased we were able to complete this transaction,” Engles said.
Dean Foods’ management will work “closely” with Alpro’s management team to drive soy consumption in their established Western European markets as well as to expand into new markets across Europe, Engles revealed.
“We also see synergies with our Silk brand to share best practices in product formulation and innovation, processing technologies and consumer insights to drive the business of both companies forward,” he added.
However, despite the upbeat tone of Dean Foods’ second-quarter earnings, the company’s revised earnings per share forecast failed to meet analysts’ expectations. Dean Foods raised its full-year earnings guidance by five cents to “at least” $1.60 per share.
In a note, titled “That’s All?”, Credit Suisse analyst Robert Moskow said that he was disappointed by the forecast.
“Management sounds a little conservative given the huge upside that the company is enjoying from record low dairy costs,” he wrote.
Engles said that Dean Foods has taken a “conservative” approach in its outlook because, according to the company, there are some clouds on the horizon. He said the group’s earnings per share guidance reflected “a balance of our strong momentum [and] cautiousness related to competitive behaviour.”
Currently, management said that competitive pressure has “stepped up” around “volume”, as lower demand has prompted Dean Foods’ competitors to cut their prices to try and fill production capacity.
However, Dean Foods said that expected milk price rises are likely to reverse this trend.
Engles suggested that the cyclical nature of the dairy commodity market means that, while the record high milk prices of last year resulted in an expansion of the US dairy herd, the current lows will lead to reduced milk production and, eventually, higher prices.
“The cyclical nature of the industry and poor dairy producer economics dictate that prices will eventually rise,” he predicted.
While the “cycle is inevitably going to get a little bit more difficult”, management emphasised that this did not represent a “disaster” for the company as milk prices are expected to remain “manageable”.
Additionally, CFO Jack Cullen said that rising milk prices would alleviate competitive pressures as Dean Foods’ rivals moved to protect margins by passing higher milk prices along to the consumer.
“A raising commodity environment really crystallises your mind on price realisation in an industry with a margin structure like ours. So yes, it does to some degree mitigate some of the competitive pressure in that kind of marketplace,” Callahan observed.
Dean Foods has also seen continued competition from growing private-label sales, management acknowledged. However, Callahan noted that the expansion of private-label sales had slowed.
“We still see a shift to private label, although clearly the rates of that shift are abating as the milk price has come down and that gap between private label and brands have narrowed somewhat in this lower commodity price environment,” he said.
According to Stifel Nicolaus analysts Chris Growe and Daniel Stephen, these factors could well have a negative impact on profits at the company’s fresh dairy businesses.
“We forecast higher milk prices starting in September although this is generally well known. When we couple this with a more aggressive competitive state, [Dean Foods’] Fresh Dairy [division] could see some reduced profit momentum,” the analysts predicted.
While Dean Foods, along with other US dairy groups, will likely pass higher dairy prices through to consumers, there remains a question mark over the impact such moves will have on consumption.
Currently, low dairy prices are allowing the company to brush off the threat of private label and appeal to value-conscious consumers. If dairy prices recover before the overall economy picks up, price hikes could result in declining consumption and therefore falling volumes.
Although Dean Foods has seen its profits improve in its most recent quarter, thanks to its cost-cutting programme and the favourable impact of low dairy prices, a number of obstacles lay ahead.
Most significant of these could well prove to be a return to higher raw milk prices. How the company navigates the generally higher dairy price environment will play a vital role in the group’s future performance.
