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Dairy and non-dairy health food products manufacturer Lifeway Foods Inc.’s (LWAY - Snapshot Report) second-quarter 2013 earnings of 9 cents per share declined 30.8% year over year. Earnings per share also missed the Zacks Consensus Estimate by a nickel. Lower gross margin primarily due to higher cost of milk resulted in the earnings shortfall.

Gross sales in the quarter rose 14.0% year over year to $25.8 million driven by increased demand for its flagship product ‘Kefir’. Gross sales however lagged the Zacks Consensus Estimate of $28.0 million.

Including discounts and allowances, net sales grew 12.0% to $23.1 million. The total allowance for promotions and discounts in the second quarter of 2013 was about 10.7% of gross sales compared with about 9.5% of gross sales in the same period last year.

During the quarter, gross profit was flat at $7.6 million. Gross margin fell 400 basis points (bps) to 33%, hurt mainly by a 20% increase in the cost of milk, which is Lifeway’s key input. The increase was in stark contrast to management’s expectation of flat prices.

Total operating expenses increased 14% to $5.1 million on account of higher general, administrative and selling expenses. This coupled with lower gross margin led to a contraction (439 bps) in operating margin to 10.8%.

Outlook

Lifeway strives hard to gain market share within its expanding health and wellness products. It continues to achieve new distribution contracts in the US with new and existing retailers. It also intends to take kefir probiotic beyond the dairy aisles to other segments of a store. The company presently dominates the kefir market in the U.S., accounting for at least 95% of the total market.

In May 2013, Lifeway acquired the Golden Guernsey dairy plant in Wisconsin. This acquisition will provide the company with additional manufacturing capacity for its booming kefir-based business and result in incremental sales from 2014 onwards.

Going forward, in order to capitalize on the existing opportunities, Lifeway is trying to spread its presence internationally. It seeks to grow in new markets like UK as Europe boasts the biggest market for organic food and beverages in the world and accounts for almost 50% of organic product sales globally. The market is expected to grow at an estimated compound annual growth rate (CAGR) of 7.5% from 2012 to 2016.

Although management sounded hopeful about lower input costs for the upcoming quarters, it refrained from guiding on the expected cost of milk. This factor slightly limits near term visibility on the stock. However, the company’s long-term prospects remain intact bolstered by increasing health consciousness among consumers.

Lifeway currently retains a Zacks Rank #3 (Hold). However, some players in the restaurant industry look attractive at current levels. These include The Wendy’s Co. (WEN - Analyst Report), The Cheesecake Factory Inc. (CAKE - Analyst Report) and Burger King Worldwide Inc. (BKW - Analyst Report) all carrying a Zacks Rank #2 (Buy).
 

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