Dairy firms Borden and Dean Foods (NYSE: DF) each recently filed for bankruptcy, as consumers’ dietary habits have been generally shifting away from cow’s milk and towards plant-based products.
The conventional dairy crisis falls amid a dynamic combination of factors, including changes in industry offerings, struggling farmers and unsustainable costs, which has spurred an upheaval in domestic raw milk consumption and production.
Dallas-based Borden, which was founded in 1857 and touts itself as the first to patent the process of condensing milk, as well as the first company to use glass milk bottles, became the latest casualty Monday in the recent whole milk-related massacre.
In the company’s Chapter 11 filing, Borden CFO Jason Monaco said that while “milk remains a household item in the United States, people are simply drinking less of it.”
Monaco pointed out that aggregate U.S. consumption of conventional dairy milk has declined by an estimated 6% since 2015, while the number of U.S. dairy farms has fallen rapidly since the turn of the century.
He added that from 1992 to 2018, over 94k family dairies have closed their doors at the rate of 10 dairy farms per day, and in the past year and a half alone, more than 2,730 dairy farms have gone out of business.
More recently, the latest Milk Production report from the U.S. Department of Agriculture (USDA) showed the headcount of milk cows on domestic farms had fallen 27k year-on-year in November 2019 to 9.33m.
Dairy Farms and Retailers Getting Creamed
Indeed, dairy farms across the U.S. appear to be facing a significant dilemma, amid lower demand for conventional milk, lower intake for producers, and rising costs for consumers.
New York State governor Andrew Cuomo in mid-September 2019, for example, allocated more than US$18.6m to support the conservation easement projects of 25 New York dairy farms, amid prolonged low milk prices, as well as the increasing threat of converting viable agricultural land to non-farm development.
The dairy industry in New York comprises the largest sector of the state’s agricultural industry, accounting for roughly 50% of its on-farm production, agricultural support services and related products. Since early 2018, the state has awarded over US$30.7m to its dairy farms, aiming to protect roughly 15k acres.
In fact, nearly 4k dairy farms with more than 620k cows, producing 14.9bn pounds of milk are domiciled within New York State, placing it fourth in the production of milk, and first in the nation in other dairy products, such as yogurt and cottage cheese.
But while New York State has committed to providing grant-based funding to support its dairy farms, iconic retailers such as Borden and Dean Foods have not been able to keep pace.
Borden CEO Tony Sarsam said that despite the company’s “numerous achievements” during the past 18 months, it continues to be impacted by “the rising cost of raw milk and market challenges facing the dairy industry.”
He added that these “challenges have contributed to making our current level of debt unsustainable.”
Borden said it plans to continue its business operations as usual, under the court’s supervision, while it pursues a financial restructuring to reduce its current debt burden.
The 163-year-old company, which employs around 3,300 people, operates 13 milk processing plants, as well as nearly 100 branches across the U.S. that produce and distribute close to 500m gallons of milk annually for its customers in the grocery, mass market, club, food service, hospitality, school and convenience store businesses.
Meanwhile, Dean Foods in mid-November said it intends to use the Chapter 11 reorganization process to “protect and support its ongoing business operations and address debt and unfunded pension obligations while it works toward an orderly and efficient sale” of the company.
The firm noted that it had secured US$850m worth of debtor-in-possession (DIP) financing to support its operations and has been engaged in advanced discussions with the Dairy Farmers of America (DFA) about a potential sale of substantially all its assets.
Eric Beringause, who joined Dean Foods as CEO in July 2019, also blamed the “challenging operating environment marked by continuing declines in consumer milk consumption” as the culprit thwarting the company’s “best efforts” to make its business “more agile and cost-efficient.”
Beringause, who holds more than 30 years of experience in the food, beverage and consumer products sectors, said that in recent months, the company installed a new senior management team who not only hail from the dairy and consumer product industries but are also well-versed in “executing major turnarounds.”
He added that he is “confident we have the right people in place to lead us through this process.”
Dean Foods, whose portfolio of brands includes Berkeley Farms, Country Fresh, Friendly’s, Garelick Farms, and Land O Lakes, boasts an estimated 15k employees across the country.
Around mid-December 2019, credit default swaps (CDS) on Dean Foods had been settled in a credit event auction at a final price of just US$0.09 – about half of what the Dallas-headquartered company’s bonds indicated at the time the auction was called, according to Creditflux.
Invasion of the Milk Snatchers
Against this backdrop, the U.S. plant-based retail market has been reaping the benefits of changing consumer behaviors – from fresh whole milk to alternative milks such as those sourced from almond, coconut, oat, hemp and soy.
According to the Plant Based Foods Association and The Good Food Institute, plant-based milks have grown 6% over the past year and are now comprising 13% of the entire milk category, while cow’s milk sales have fallen by 3%.
The organizations also observed that emerging plant-based dairy categories have been growing even more quickly, as more households are introduced to other plant-based dairy products.
In the past year, for instance, plant-based yogurt has grown 39%, while conventional yogurt has declined 3%; plant-based cheese has increased 19%, while non-plant cheese was unchanged; and plant-based ice cream and frozen novelty have risen 27%, while traditional ice cream and frozen novelty have grown by only 1%.
The financial markets seem to be responding to the changes in the dairy industry, as the sector increasingly focuses on plant-based products and more environmental, social and governance (ESG)-related attitudes among consumers and corporations alike.
For example, prices on the current CME contract of Class III milk futures, which are used to produce American cheese, have plunged around 9.75% since their latest 52-week peak of US$18.99, set in early December, according to the IBKR Trader Workstation. While it had spiked to close to US$19, the January 2020 contract has averaged only US$16.68 over the past 12 months.
Further evidence may be gleaned from the performance of certain exchange-traded funds (ETFs), including Defiance’s DIET (NYSE: DIET)— a Next Gen Food & Agriculture ETF, which was launched in mid-November 2019.
Defiance describes the fund as one that offers exposure to companies centered on “the whole range of technological, ethical, environmental and social challenges of ensuring food security.”
DIET, which includes among its top holdings former DowDuPont agrichemical company Corteva (NYSE: CTVA), Swiss flavor manufacturer Givaudan (OTCMKTS: GVDNY) and Canadian fertilizer firm Nutrien (NYSE: NTR), has seen its shares grow more than 4.15% since its inception, according to the IBKR Trader Workstation.
Other Related Stocks and Bonds
Meanwhile, some grocers, such as Cincinnati-based behemoth Kroger (NYSE: KR), have been shifting gears to accommodate the changes in consumer behaviors.
In its third-quarter of 2019 financial report, released in early December 2019, Kroger said it launched over 231 new brand items, including its ‘Simple Truth Plant Based’ collection, which features meatless burger patties and other products that “appeal to a growing number of customers exploring meat and dairy alternatives.”
Of the 156 items under the category of “Milk & Plant-Based Milk” on the supermarket giant’s website, nearly 65% is comprised of items related to almond, cashew, nut, rice, oat, pea, coconut and soy milk, while 21% is dedicated to non-dairy coffee creamers, 13% to coffee creamers and just 1% apiece allocated to milk and chocolate milk products.
Total company sales at Kroger in Q3’2019 amounted to US$28bn, up US$200m year-on-year, and a rise of 2.7% ex-fuel and dispositions.
Gimme Credit analyst Carol Levenson recently noted that the company’s “Restock Kroger” initiatives to increase operating profit via alternative revenue streams, among other drivers, is “in its early innings,” and while the firm typically posts positive same-store supermarket sales ex-fuel and gains, “some of its sales success has been at the cost of ‘investing’ in price and thus pressuring gross margin.”
In Q3’19, Kroger’s gross margin was 22.1% of sales, with its first-in, first-out (FIFO) gross margin rate, ex-fuel, down by 24 basis points. It also suffered a US$23m last-in, first-out (LIFO) charge, up from US$12m in the same year-ago period, due in large part to higher inflation in dry grocery, pharmacy and dairy.
Against this backdrop, the company’s stock has lifted to about US$28.61, an increase of more than 39.2% since its latest 52-week trough set in late July – and in spitting distance of its February 2019 highs — amid generally positive consumer staples and discretionary spending.
Kroger also noted that it reduced its net total debt by US$1.5bn over the last four quarters, boasting a leverage ratio of 2.50 (which resides at the high-end of its target range of 2.30 to 2.50) compared to 2.72 a year ago.
As a result of being within its targeted debt range, Kroger said it plans to initiate share repurchases in Q4’19 under its US$1bn board authorization.
Bond investors generally welcomed Kroger’s latest bond sale.
The company at the start of this past week sold US$750m worth of 3.95%, triple-‘B’-rated notes due January 15, 2050, amid a congested primary market, which hosted 17 other issuers.
New U.S dollar-denominated, high grade corporate debt issuance tallied nearly US$25.5bn Monday, as interest-rates remained ultra-low, and the allure of yield in the U.S. investment-grade primary market generally continued to attract overseas bond investors who continue to grapple with negative interest rates or a lack of local paper.
Kroger’s offering met with decent demand, with price spreads on the deal having compressed by around 20bps from initial talk to a final level of 170bps more than U.S. Treasuries of comparable maturities— a yield to maturity of 3.969%.
Ron Quigley, head of fixed income syndicate at Mischler Financial, observed that the company had increased the 30-year senior note offering from US$500m at the launch and at the tightest side of guidance – indications of very good interest from bond investors.
In line with its debt management strategies, Kroger said it intends to use the net proceeds from the sale to refinance debt maturing in January 2020, and for general corporate purposes.
The issuance was co-lead managed by BofA Securities, Mizuho and RBC Capital Markets.
Spreads on certain of Kroger’s outstanding bonds have recently tightened in the secondary market, with its debt due April 2038, July 2040 and April 2042 each having narrowed intraday Tuesday by about 1bp.
In the meantime, investors tuned-into the increasing popularity of how ESG is triggering changes in the dairy industry, as well as in other areas of food, beverage and consumer behavior, will likely be keeping a close eye on the survivability of other companies slow to adjust to new business models.
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