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August 5, 2009

INSIGHT: US: Dean Foods predicts milk price recovery

Dean Foods has warned that its margins are likely to come under increasing pressure as US milk prices begin their “inevitable” recovery.

Dean Foods has warned that its margins are likely to come under increasing pressure as US milk prices begin their “inevitable” recovery.

According to Dean Foods CEO Gregg Engles, the cyclical nature of the dairy commodity market means that, while the record high milk prices of last year resulted in an expansion of the US dairy herd, the current lows will lead to reduced milk production and, eventually, higher prices.

“The cycle is inevitably going to get a little bit more difficult. Milk prices are going to rise… But there is no disaster coming from our perspective – we think milk price rises are going to be manageable and we are encouraged by our continued [efforts] to differentiate ourselves from our competition,” Engles told analysts during a conference call.

Currently, management said that competitive pressure has “stepped up” around “volume”, as lower demand has prompted Dean Foods’ competitors to cut their prices to try and fill production capacity.

However, Dean Foods said that expected milk price rises are likely to reverse this trend.

“In periods of decreasing prices you are going to have expanding margins. At some point in time, those margins are going to become too tempting to the competition, who will start to focus on volume.

“A raising commodity environment really crystallizes your mind on price realization in an industry with a margin structure like ours. So yes, it does to some degree mitigate some of the competitive pressure in that kind of marketplace,” CFO Jack Callahan added.

While Dean Foods’ management said that it expects to continue to drive cost savings and margin improvement, future shifts in milk prices mean that margin gains are unlikely to be “linear”.

Dean Foods has also seen continued competition from growing private-label sales, management acknowledged. However, Callahan noted that the expansion of private-label sales had slowed.

“We still see a shift to private label, although clearly the rates of that shift are abating as the milk price has come down and that gap between private label and brands have narrowed somewhat in this lower commodity price environment,” he said.

Despite the highly competitive nature of the US dairy market, Dean Foods today (5 August) posted its fifth straight quarter of market share growth.

“We gained share vis-à-vis the rest of the industry during the quarter both organically and certainly by virtue of the acquisitive activity that we have had. So, we are performing very well in the marketplace,” Callahan insisted.

Nevertheless, shares in the group were down 10.68% to $19.04 at 3.49pm (BST) as concerns over commodity and competitive pressures dampened investor enthusiasm.

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