Butter, Milk, And Money

 |  Includes: DF, SAPIF, SYUT
by: Dr. Harold Goldmeier


Investors need to focus more on fundamental analysis of dairy industry events and national agendas, and not just the numbers companies report.

Three factors affect dairy company growth and stability: a growing middle class, government intervention and controls, and globalization spiriting M&A.

Saputo, Canada's largest dairy producer, and China's Synutra, a producer of dairy based infant formulas and nutritional products, are long-term investments each presenting their own opportunities.

Walk through the brightly lit and well-stocked dairy aisles of your local supermarket. Marvel at the varieties of milk, cheese, yogurt, and creams. The dairy cases occupy among the most footage in the highly competitive fight for shelf space. Ask yourself, "How can I make money on this industry without buying my own cow?"

In the dairy industry, fundamental analysis trumps technical analysis. Three factors affect the industry. First, dairy consumption grows exponentially to the country's growing middle class. Grilled cheese and exotic pizzas are tagged gourmet foods. Yogurt is packaged in fancy containers available in a wide range of flavors with granola and other toppings. Prevention Magazine tells us, "Everyone's going gaga" for Greek yogurt elevating "the dairy dish to superfood status…."

Cereals in milk and cheese omelets are staples for breakfast. Favorite drinks are dairy. Alcohol based Gold Cadillac and Irish Cream are to die for. Coffee with cream, tea with milk, and it is recommended every toddler and young adult drink two glasses of milk a day. Remember the little wax cartons in every school and company cafeteria? Today, milk is available in chocolate, strawberry, banana, and serves as the base of health bar drink concoctions.

A new report from the Institute for Agriculture and Trade Policy by Shefali Sharma, documents the soaring growth rate over the past three decades of dairy production and consumption in China. Australia's dairy market is pushing $4b. New Zealand has an $11b dairy sector. There are economic, social and environmental downsides too.

Higher feed and grain costs ripple through economies raising the costs of other goods like meat and bread. Small farmers are sacrificed for the sake of "economy of scale" policies. Middle class expansion puts price pressures on land prices competing with grazing herds. Our family was disappointed when our cousin, the only Jewish cowboy in America, sold his 30,000 acres ranch (grazing land) south of Colorado Springs to a housing developer.

In the last decade, a spate of research reports and popular magazine articles argue dairy foods are linked to illnesses like osteoporosis, cardiovascular disease, ovarian cancer, diabetes, vitamin D toxicity, and health concerns of infants and children. We acculturate young mothers encouraging feeding their newborns "breast milk" instead of yucky sounding "formula." Milk bottle babies grow faster and bigger and graduate to a glass of milk. Consumption is one factor determining profits and losses, therefore dairy company share prices. Scientific reports scare off consumers when there is talk of hormones fed milk cows manifesting in humans. So do scandals. A Canadian company stopped buying milk from one supplier when severe cow abuse was revealed.

In 2008, milk in infant formula and other foods was knowingly laced with melamine in China. Six children died and 300,000 were sickened. In 2002, the milk was cut with water resulting in infant mortality from malnutrition. Food safety concerns are paramount to the production of dairy products.

The second factor affecting dairy companies is government intervention and control. Industry protection is done with import tariffs and quality control standards. Exports are subsidized to be price competitive. For example, the U.S. has a Federal Milk Marketing Order setting minimum prices for milk and other dairy products. All farmers receive a blended price for their products. The Milk Price Support Program kills capitalism in the industry, in order to assure product availability. The government buys dairy products at set minimum prices. The Milk Income Loss Contract program gives cash subsidies to milk producers when market prices fall, and to encourage farmers to export their products for trade balance purposes. In 2011, Israeli cottage cheese producers were boycotted after raising prices in a country that considers this a basic food item. It began with 100,000 protesters on Facebook, and grew into a social protest movement resulting in the election of new parties promising social change.

Third, globalization is spiriting mergers and acquisitions and national alliances. Bright Foods of China owns 56% of Israel's Tnuva that controls more than 70% of the dairy market in Israel. Dairy farmers protested, one complaining to the media, "This is a matter of food security. We cannot trust our food supply to the whims of the Chinese. Israelis want Israeli milk."

Fonterra Cooperative Group exports 30% of the world's dairy products. FCG owns 20% of China's largest milk processors to "create a global supply chain aimed at China's market using Fonterra's milk manufacturing partners in Australia and Europe." New Zealand supplies most of China's imports of milk powder.

Analysts' mixed reviews and recommendations for Dean Foods (NYSE:DF) reflect ambivalence and caution for the industry. BB&T Capital Markets rates DF a buy, Stifel downgrades it to hold, and Zacks issued a strong sell warning in May. High raw milk prices hurt earnings and sparked a decline in operating income. Anthony Thorpe in August predicts milk prices will tumble creating more profit for DF driving its share price from $16.05 to the $24 range. It is Thorpe's largest position, and he's continuing to buy. DF pays 1.7% dividend yield, has a market cap $1.5b on sales of $9b. Share price fell from nearly $20 in the last 52 weeks to $13.59, despite income growth of 177%.

I like Saputo Inc. (OTCPK:SAPIF), Canada's largest dairy producer. It sells for $60.80 per share, but announced a two-for-one stock split. Sales are $9.68b, share price is up 26.5% in the last 52 weeks, and income grew 10.6% in part because of acquisitions. In February, SAPIF bought 88 percent of Australia's Warrnambool Cheese and Butter, while still digesting its earlier purchase of U.S. Morningstar Foods. The CEO claims to be looking at additional purchases in the U.S. and Latin America.

SAPIF net margin is a healthy 5.6%. Saputo has diversified manufacturing dairy, cheeses, and grocery products, including snack cakes, cookies (1/2 Moon cookies), breads, and soups with production facilities in five countries. Dividend growth over the past 5 years exceeds 10%.

Synutra International (NASDAQ:SYUT) is not per se a dairy producer, but SYUT produces, distributes, and sells dairy based nutritional products in every province of China. Its extensive distribution network and sales through 27,000 outlets makes this a company for investors to follow and buy. Therein lies the potential for profit taking. If another company wants to enter the China market fast and furious, SYUT has the distribution network in place to move product.

Q2 (Jun '14)


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SYUT shares sell for $5.68 down from a year's high of $10. Sales grew nearly 40% to more than $370m with a healthy net profit of almost 12%. It has a $325m market cap.

One of its main competitors is Beingmate Group Co. BGC produces infant formula milk powder for blending baby formulas, rice cereals, and biscuits for children. It also sells everything for babies and toddlers from strollers to bedding. SYUT also sells surplus milk powder, whey protein and raw milk to industrial customers. The company is trying to recover from damage to its brand after an infant formula scandal in 2008.

In 2012, Synutra entered a commercial partnership agreement with Sodiaal, France's leading dairy cooperative, and Euroserum, the world leader in whey powders. Synutra is building a new plant in France hoping to bring gravitas to their brand name in China, "further solidifying Synutra as a quality and trusted brand," according to Synutra's Chairman and CEO.

The dairy industry is protected and essential to the economic, social, and environmental well being of nations. Investors need not be shy or timid. Perhaps poet Shel Silverstein captured the idea best when he wrote,

I'll share your toys, I'll share your money,
I'll share your toast, I'll share you honey,
I'll share your milk and your cookies too --
The hard part's sharing mine with you.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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