No light at the end of the tunnel for Dean Foods as milk price wars escalate, says Bernstein

Milk price wars spell bad news for Dean Foods, says Bernstein

Milk price wars are “compressing the margin of private label retail prices over the Class I milk input cost to abnormally low levels,” say analysts at Bernstein.

In a note to investors issued after Dean Foods' net earnings plunged 47% to $17.6m on sales up 4% to $1.93bn in the second quarter, Bernstein said:

“Overall, we see this as a corroboration of our thesis that retailers are using milk as a loss leader... With Walmart running scared of hard discounters Aldi and Lidl, as well as e-commerce retailers like Amazon, we expect this pricing pressure to continue, even as milk input costs begin to rise over the coming months.”

The price premium of Dean Foods' Dairy Pure brand over private label widened to over 40% in July, which has further dented volumes of its more profitable branded products as consumers switched to private label, added Bernstein.

Meanwhile, overall volumes of fluid milk continue to decline, with USDA data showing that US fluid milk volume decreased 2.9% year-over-year in the second quarter of 2017.

What next for Dean Foods?

So what’s next for Dean Foods if retail giants such as Kroger, Walmart and Lidl continue to use milk as a loss leader? Will a CPG firm or retailer buy the company, and what's the rationale?

According to Bernstein: “Hypothetically, if it were possible to put higher margin perishable/fresh prepared foods on Dean Foods' national refrigerated distribution infrastructure, that would give a retailer or branded player a meaningful competitive advantage in their fresh prepared foods offering, then maybe eventually a buyer might come forward..."

'It’s possible that Walmart might eventually want to buy Dean Foods once the price is sufficiently low'

However, “it is by no means clear that the logistics set up would be geographically appropriate for distributing fresh prepared foods nationally – anyone getting into such a business would probably be better served designing the lowest cost supply chain infrastructure from the ground up,” notes Bernstein.

“It’s possible that Walmart might eventually want to buy Dean Foods once the price is sufficiently low. But because Dean Foods' older and smaller plants are likely at a cost disadvantage to Walmart's brand new state of the art [milk production] facility [in Indiana – due to open late 2017/early 2018], Walmart may be better served building new, especially since the investment is de minimis relative to the market cap of Walmart, and Walmart is in a high stakes game to defend itself against Lidl and Amazon.”

Meanwhile, it adds: “If Walmart wants a longer-lasting, less perishable milk option that uses UHT processing, then they won’t want Dean Food’s manufacturing or distribution infrastructure anyway.”

Dean Foods CEO: Aggressive pricing 'isn't sustainable long-term'

Speaking on the firm’s earnings call on Tuesday, Dean Foods CEO Ralph Scozzafava said the Q2 results "came in well below our expectations.”

He added: “As private label performed ahead of the category, our branded white milk volume in all channels was down nearly 6% year-over-year...

"As milk production continues to grow across many areas of the country, we're seeing surplus volume and supply that's changing some recent pricing dynamics in the category, driving aggressive pricing that we believe just isn't sustainable long-term."

Asked how Walmart's new milk production facility in Indiana would impact the company, he said: "We expect to lose approximately 90-95 million gallons of private label fluid milk volume in 2018 and 2019..."

The nation's largest processor and direct-to-store distributor of fluid milk, Dean Foods has more than 50 local and regional dairy brands including Dairy Pure, TruMoo and Meadow Gold. It also distributes ice cream, cultured products, juices, teas, bottled water and other products.

“At the Lidl store that we saw first thing in the morning, milk was being sold at $2.27 a gallon, that's a very low price point considering where raw milk prices are right now. In fact, I saw even sharper price points at a number of the other stores that we shopped in the area. So, clearly, there's loss leadership happening in certain categories.”

Alexia Howard, senior analyst, US food, Bernstein, July 2017

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