A financial analyst’s view of dairy – dairy industry

A financial analyst’s view of dairy – dairy industry – Editorial

Dave Fusaro

There was a strange duality to the International airy Foods Assn.’s annual convention last month. Despite the official title, “Broadening Borders: Building the New Dairy Business,” and the locale (Toronto), there was a lot of introspection at this annual affair.

“In the past two years, $5 billion worth of revenue – 25% of the (fluid milk) business – has changed hands,” John O’Neil, financial analyst for BT Alex. Brown Inc., said in his financial overview presentation. Despite all the good intentions about “broadening borders,” it’s obvious that most time and energy in the domestic industry is being applied domestically – toward the consolidation that is consuming this business. At least right now.

O’Neil is no stranger to the dairy industry. He’s a regular watcher of Dean, Suiza and other public companies in this segment of the overall food industry, in which he specializes. He had a number of keen observations about the business – although, he warned, most of his points were about the fluid milk business, because that’s where are found both the current action and most of the public companies.

Among nine important investment characteristics for food stocks in general, dairy has four, according to O’Neil: size/scale, stable volumes, free cash flow and positive catalysts. It’s lacking internal growth, stable margins, dominant share, brand equity and high margins.

But its stability and size are attractive. Fluid milk is a $25 billion business and, despite some small reversals, it’s been on a 2% compound annual growth rate for the past eight years.

A drawing of a pyramid graphically showed the effects of consolidation – and the remaining potential for more. At the top are three companies with revenues of more than $1 billion each. In the midsection are 25 companies with sales of $200 million to $1 billion. At the base are 250 companies with revenues under $200 million.

The primary driver of consolidation, says O’Neil, is the concentration going on above and below the processors: the consolidation of milk suppliers, primarily cooperatives, and the consolidation of retailers (which has picked up in the weeks since the convention). He also believes that retailer consolidation will result in fewer captive dairies, a big plus for at least the bigger milk processors. Also pushing consolidation are competitive pressures and the obvious benefits of synergies.

Competitive pressures are excess capacity, low utilization, capital requirements and the potential for at least short-term chaos from federal regulatory reform.

If most of that sounds like gloom, O’Neil sees some positive trends beginning to take shape. He notes the development of brands, some national (he specified Lactaid and Horizon Organic) and some regional. He also acknowledges milk beginning to compete as a beverage (Frappuccino and Dean Milk Chugs), other efforts at differentiation, the two strong generic advertising campaigns and a growing realization of the power behind dairy distribution systems.

Despite the mixed reviews, dairy is an industry he enjoys following, O’Neil said privately. It’s an industry group whose potential is just being tapped.

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