October 3, 2007

 

High dairy prices squeeze Dean Foods' profits

 

 

Soaring prices of dairy is causing major problems for Dean Foods -- the largest dairy processor and distributor in the world. 

 

On Tuesday (October 2), Dean Foods hacked its full year guidance and said it would reduce its workforce to adjust to the challenging environment.

 

According to Gregg Engles, Dean Foods chief executive officer, rapidly increasing and record high dairy commodity costs have "created a very challenging operating environment and 2007 results have been well short of our expectations,". Shares of Dean Foods slipped almost 10 percent in Tuesday pre-market trading, but recovered to gain 12 cents, or 0.5 percent, to close at US$26.41.

 

The Dallas-based company makes an assortment of food products, but its dairy division is the country's largest processor and distributor of milk and dairy goods. As a major player in the dairy market, the company's profit margin depends on low dairy prices.

 

In recent quarters, dairy commodity costs have reached all-time highs because of a number of factors. High fuel prices have increased the cost of transporting materials, while the rising cost of grain, which reflects the growing demand for corn and ethanol production, has made it more expensive to feed cows. Meanwhile, the global demand for non-fat dry milk powder is surging, as developing countries like China consume more milk.

 

Roger Hoskin, an economist with the SOY Department of Agriculture said prices are not likely to return to its normal levels as demand continues to surge.

 

With dairy prices expected to stay sky high for the rest of the year, Dean Foods is far from reaching its initial sales targets. The company now expects to earn 15 cents a share in the third quarter -- far below the previous range of 24 to 28 cents. In turn, Dean Foods now predicts it will earn US$1.25 a share for the full year, which is also significantly below the previous range of between US$1.52 and US$1.58 a share.

 

Under the revised expectations, Dean Foods will miss the Street's call by a long shot. Analysts were hoping for earnings of 26 cents a share for the third quarter, and US$1.46 for 2007.

 

The company said the dairy rut will continue to negatively impact earnings until the second half of 2008, when a growing milk supply is expected to ease dairy prices. For now, the company will focus on tightening its ship. It will immediately cut 600 to 700 jobs, or roughly 2 percent of the workforce. Engles said the company's decision is "part of our multi-year productivity initiative which will help better position the company during this incredibly difficult period for Dean Foods."

 

The problem is certainly a disappointment, but for Dean Foods, it did not come as a complete surprise. Dairy costs have weighed on the company for multiple quarters. In August, the company said third quarter net income fell 1.7 percent, to US$28.4 million, or 22 cents per share, from US$28.9 million, or 21 cents per share, in the prior year's corresponding period.

 

In what has become a familiar refrain, Engles had said then that the company was struggling through a "difficult environment."

 

Of course, Dean Foods isn't alone. A plethora of other food makers like Hershey and restaurant chains like the Cheesecake Factory have also been adversely affected by rising dairy and grain prices.