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October 4, 2007

Dean Foods dairy woes divide opinion

US dairy giant Dean Foods has been described as an organisation in crisis after it announced this week that jobs would go as it continued to battle rising raw material costs. But Dean Best found opinion divided on the outlook for the company.

By Dean Best

An organisation in crisis. That has been one description of Dean Foods, the US dairy giant, after the company indicated this week that jobs would go as it struggled with rising raw material costs.

Dean Foods, the largest milk processor in the US, has suffered as dairy costs continue to rise. The company, like many dairy groups around the world, has faced a steep increase in the powdered milk costs due to a combination of the drought in Australia – a key milk-producing nation – and growing demand in Asia. The US government’s promotion of biofuels has also added to feed costs, as grain is diverted into ethanol production.

Earlier this year, Dean Foods revealed the impact of these external factors on its business. First-half profits slumped as mounting costs hit earnings. This week, it became clear that the company’s problems were showing no sign of abating with the announcement that third-quarter profits were going to be lower than expected – and that up to 700 jobs were to go. Dean Foods blamed “unprecedented” costs and a glut of organic milk in the US. “This is by far the most difficult operating environment in the history of the company,” admitted CEO Greg Engles.

Some may see Dean Foods as a victim of factors outside of its control. However, some industry watchers believe that the company itself is to blame for its current woes. Mark Kastel, senior farm policy analyst at The Cornucopia Institute, a US farm policy research group, has been a critic of Dean Foods’ organic business.

Kastel, for instance, believes the company helped create the current over-supply of organic milk in the US. Kastel argues that Dean Foods’ strategy of building “factory-scale organic dairies” in order to dominate the organic milk sector encouraged others to enter the market.

Crucially, Kastel argues, while Dean Foods struck three-year contracts with organic farmers to secure supply, the company was also facing growing price competition at retail level, and the two factors have combined to erode margins from sales of organic brands like Horizon. “In terms of organic dairy, Dean Foods has helped to create a monster that has now turned around and bit them in the rear end,” Kastel told just-food.

In recent months, the Cornucopia Institute has criticised the likes of Dean Foods – and rival Aurora Organic Dairy, the largest producer of own-label organic milk in the US – for the way in which the companies have run their organic operations. Kastel says the institute has petitioned the US Department of Agriculture to argue that the companies have violated regulations covering organic farms or, at least, that they have not been “following the spirit” of the regulations. As a consequence, Kastel says, the perception of Dean Foods as a purveyor of organic products in the US has taken a bit of a hammering.

According to Kastel, natural food retailers have begun delisting Dean Foods’ organic brands, while a consumer group in the US has called for a boycott of certain products. “You had the dual impact of [Dean Foods’] reputation suffering as the [organic] milk supply was going up,” Kastel says.

As one would expect, some take a less harsh stance on Dean Foods’ current predicament. One Wall Street analyst, who wished to remain anonymous, believes the company’s profits warning was “entirely due to market conditions”.

The analyst said: “I wouldn’t say they’ve done anything wrong from an operational stand-point – it has been the growth in China and ethanol policy in the US that has created the inflationary cost environment.”

However, the analyst conceded that Dean Foods had not handled the situation completely competently. “They have shot themselves in the foot to a degree, in terms of their credibility with the investment community when they opted to maintain guidance. The best thing they could have done six months ago was say: ‘This is a tumultuous market’ and just pulled down the guidance.”

Nevertheless, the analyst argues that the outlook for Dean Foods is not as bleak as some would make out. “Commodity markets are self-correcting; that’s a truism. It’s a just a question of time.”

The management at Dean Foods no doubt hopes that the company’s shareholders will be similarly relaxed.

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