Mrs PlanMaestro knows her consumer goods so she was the first person I talked with after the recent appearance of Dean Foods in the 52 week lows lists. While I have not made a decision on this opportunity, I thought that the intricacies of the milk industry were fascinating and managed to convince her to write about them. We have the pleasure to publish her first contribution to this blog … and if you like it please say so we'll get more:
The recent share drop has put Dean Foods (NYSE:DF) on the spot so I would like to comment on the US dairy industry and provide some perspective on the attractiveness of DF’s business.
In short, the US milk industry is going nowhere. USA per capita milk consumption is among the highest in the world reaching around 70 liters per person. In recent years per capita consumption has remained stagnant in the face of more innovative categories (e.g. functional drinks) which have been gaining share of throat.
While there has been some growth coming from yogurt or soy drinks, none of the dairy industry innovations have been successful at increasing the range of consumption occasions or cannibalizing other categories. Unless a radical innovation widens the range of consumption occasions and consumer profile (most probably coming from the large beverage companies, rather than the traditional dairy companies), we can only expect milk industry volume to grow at the same pace as population growth.
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What is really striking in this industry is that private label (PL) penetration has reached 70%. This is a very high number compared to any other beverage category. For obvious reasons, penetration is higher in categories with a larger share of volume sold through supermarkets (which is the case for milk). However, the gap in milk is quite astonishing. PL penetration in water is around 30%, in juices around 20%, and in carbonated drinks under 10% (click to enlarge).
Even compared to other groceries, milk remains the category with the largest PL penetration (Cereal ~30%, Mayonnaise ~20), even though volume sold in supermarkets is quite similar for all them (above 80% of volume).
While private label penetration is usually driven by heavy discounts, until very recently milk PL prices were almost in parity with branded products. Most of the PL products are now associated with high quality and as supermarkets extend their reach nationally, they are making such brands available cross-nation. On the other side, branded milk has remained mostly regional and unable to differentiate significantly from the PL offer (no single brand holds more that 2% of the industry market share). DF, after a series of acquisitions, has managed to consolidate around 18% of the industry’s market share (47% branded and 53% private label production).
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It is uncertain to me how the milk industry in the US commoditized much faster than other categories. My guess is it was the compounding result of several factors:
- Available raw material and simple process: The US produces around 15% of global milk. It produces more milk than it consumes and has a competitive raw milk market with one of the lowest worldwide producer prices. Access to milk and the relatively low investment requirements to pasteurize milk fostered the development of dairy companies.
- Fragmented and weak regional brands: The US milk market is a 100% fresh (pasteurized) market, making it difficult for the development of national brands as investments in refrigerated distribution assets for a national brand would be quite high.
- Walmart effect: The increased relevance of the supermarkets and their cross dock platforms providing a tempting and efficient refrigerated distribution network for local producers to sell milk nationally.
- Isolated in the low value category: cheese, yogurt and other high margin branded dairy products got captured by few national brands with accumulated marketing expenditures and national coverage (Kraft (KFT), Danone (OTCQX:DANOY), General Mills (NYSE:GIS)) reducing the milk producers' negotiating power vs. supermarkets.
To sum up, this is a mature industry with an unclear growth perspective with a very high level of commoditization (estimated category operating margin of 5%). For Dean Foods to compete successfully in it, requires being able to differentiate its product offerings versus Private Label while being able to widen its operating margin. A deeper look into Dean’s strategy will be developed in a following post.