Wholesale Haves And Have-Nots

Investor's Business Daily

Food wholesaling is a tricky business.

On the raw materials side are commodities prices — grains, meats, dairy — perpetually driven by factors like weather and speculative investors. On the end-market side are retail prices, forever changing to meet consumer's tastes and spending trends. The combination of drought and recession over the past few years has made the challenge particularly complex.

During those years, wholesalers have worked to retake a measure of control by pursuing new levels of "value-add," the process of improving or altering foods to make them more tasty or convenient. No one seems to have figured that out quite like Green Mountain Coffee Roasters (GMCR). And no one seems to have wrestled with the process quite like dairy industry heavyweight Dean Foods (DF).

Capitalizing On The Buzz

Since it bought Keurig seven years ago, Green Mountain has become an industry leader by selling the single-cup brewing devices along with its specialty coffees, under its own brand name as well as under acquired names like Tully's, Diedrich and Coffee People.

On top of that, Green Mountain's is in a pricing sweet spot. Prices for Arabica beans, those most commonly used by top roasters, recently hit a 3-1/2-year low. The reason: Brazil, which supplies about a third of the world's beans, has been producing record crops.

Meanwhile, demand has continued to grow. A survey released in March by the National Coffee Association reported that 83% of the adult population of the U.S. drinks coffee, up five percentage points from a year ago. Daily coffee drinkers held steady at 63% of the populace.

Significantly for Green Mountain, 82% are aware of single-cup brewing devices like the Keurig, up from 71% last year. Thirteen percent drank a single-cup product the day before, up from just 4% three years earlier.

"You'll see a package of Folgers coffee falling in price as a result of lower input costs, but we haven't seen any material change in the pricing of K-cups," Scott Van Winkle, analyst with Canaccord Genuity, told IBD. "Demand is strong.

This has helped drive up Green Mountain's margins, which hit 14% after taxes in the most recent quarter.

Fly In The Organic Ointment

Green Mountain shares are up almost 90% so far this year, and have played a leading role in lifting the Food-Wholesale group into the top 30 of IBD's Industry Group rankings.

Other stocks in the group, from commercial food products distributor Sysco (SYY) to cigarette and snack wholesaler Core Mark (CORE), have faced a more difficult pricing environment.

One of the big food stories of the last decade has been the mainstreaming of organic and natural foods, which for a time turned distributor United Natural Foods (UNFI) into a leading stock.

Van Winkle says investors have been disappointed at how thin United Natural's margins have remained even as it's turned out consistent topline growth in the teens.

The company has a much more diverse product mix than a specialist like Green Mountain, but it has been stymied by, among other things, the Federal Reserve's strategic effort to tamp down the inflation rate. Van Winkle says distributors normally pass inflation increase through to their customers, increasing their margins in the process.

Van Winkle expects the natural-food industry to continue to grow 10% a year, a modest rate, but still ahead of the industry as a whole.

A rising number of grocery chains, including Whole Foods Markets (WFM), The Fresh Market (TFM) and privately owned Trader Joe's, are in hot pursuit of the trend. Traditional grocery chains are also rapidly expanding natural and organic offerings. All of this means more business for the industry's wholesale segment.

The cultural shift also drove Dean Foods' recent decision to spin off its organic/vegan division WhiteWave (WWAV).

Facing Udder Failure

Dean Foods is the heavyweight in the very small Food-Dairy Products industry group. The group's six stocks have a combined market capitalization of $14 billion, less than half that of the Wholesale Foods group and in the smallest 15% of the 197 industries tracked by IBD.

But Dean Foods also occupies a niche between producers and retailers, buying milk and dairy items and turning them into products sold as Alta Dena, Berkeley Farms, Garelick and many other brands.

Dean Foods was a leading stock in the middle of the last decade. But the recession hit it hard.

Morningstar analyst Erin Lash says that even when commodity milk costs are low, retailers under competitive pressure often cut their milk prices to help drive volume through their stores.

During lean times, customers also often trade down to store-label milk.

To make matters worse, major drought's last year hit the U.S. as well as New Zealand, the world's largest dairy exporter.

Drought pinches grain supplies and boosts the cost of cattle feed. More expensive cattle feed leads to pricier milk.

Drought also forced mass reductions in dairy herds in the U.S. and New Zealand. Fewer cows mean less milk. Less milk means higher prices.

These and other problems helped drive Dean Foods deep into debt.

Fortunately, the company had built up several leading brands in growing niche markets, including Horizon Organic milks, the Silk brand of soymilks and the popular Morningstar brand of meatless burgers and sausages.

Dean agreed to sell Morningstar to Montreal-based Saputo late last year. It then bundled together Horizon, Silk and a couple of other brands into WhiteWave.

The company spun off part of WhiteWave in an IPO last October, and distributed another large chunk of shares in May, bringing Dean's ownership down to 20%. It plans to halve the rest of the company sometime in the next 18 months.

Lash says such changes are aiding the recovery in Dean's stock price, but over the last year the company also has said it sees a longer-term stabilization in the pricing environment. As a result, despite the fact that it has practically no sales growth at this point, Dean's shares are up 32% so far this year. That, and a 96% advance by the thinly traded Lifeway Foods (LWAY), lifted the dairy group to a No. 21 ranking on Friday among the industries tracked by IBD.

Weaning Of WhiteWave

WhiteWave, in spite of the optimistic name, hasn't done as well since its initial offering. Sales growth has held in the double digits. But earnings have declined for three straight quarters, and the stock ended Friday just even with its October IPO price. Lash, however, believes investors in WhiteWave may yet benefit from a future buyout, perhaps by Danone (DANOY), the French giant of the industry.

The remainder of Dean, meanwhile, is mostly dependent on the highly commodified fluid-milk space. As always, the market depends on factors outside the company's control.

"We're in the midst of the planting season with regard to grains, which could have an impact," Lash said. "Dean has talked about the fact that they don't expect retailers to use milk to drive traffic like they did a few years ago, but that's always a possibility."

View Comments (0)