NASDAQ:LWAY Lifeway Foods, Inc

Sector financial performance:

This company has been grouped in Drinkable Kefir sector of food industry. There are many reasons for us to believe that there are rooms for drinkable kefir sector of food industry to grow such as increasing awareness for its benefits to human’s health and its diversified applications as ingredients in food. However, it seems the branded products of companies in this industry encounter bottle neck in the past several years since they have had to lower down the sale prices for their products by the ways such as constant discount and promotions. Since 2017, due to continuingly unfavourable dairy and retail environment and competition from private label, we have seen branded products’ sales of those companies have been down significantly.

Considering that Kefir is an industry in which there are only a few of major competitors, we think that the pressure of downturning sale price came from the slowing down demands and competition of non-brand products. And we also think that, if the slowing down demands continues and the companies have to rely more on discount and promotion to boost the sales, they will have to find a way to improve the efficiency of production such as lowering the raw materials costs. If they fail to do it their margins and cash inflows will suffer due to the decreasing price resulted from shrinking demands.

At the same time, products innovation, especially premium products, may be an alternative to reducing price to deal with low price competition for the companies that try to keep the growth in the current situation since consumers’ preference for premium products, which are able to provide high quality and better taste, has been the major trend in today’s food consumption industry thanks to the new changes in demography, economy, and life styles of young generation.

According our data, the sector’s average enterprise price/sales ratio is currently 0.52( 2018). It is also a signal that gross margin (25% 2018) is at level at which it is more sensitive to the decline in sales and thus requires companies to using its spending on advertising and SG&A more efficiently.

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Company performance:

It seems the demand for this company’s branded product decreased sharply in 2018 and 2017 as indicated by the large decrease in volume, which had been supported by promotion before 2017. This is probably a result of the general decline in demand for dairy products in US market in the past several years and also a result of decreasing traffic in stores.

For the second quarter of fiscal 2018 compared with same period of 2017(ended 20180630)

Net sales decreased 15% due to decrease of 16% in volume offset by lower spend in promotion and increased in price.  The decrease in volume is primarily from branded products.

For the first two quarters of fiscal 2018 compared with same period of 2017(ended 20180630)

Net sales decreased 12.5% due to decrease of 15% in volume offset by lower spend in promotion and increased in price.  The decrease in volume is primarily from branded products.

For fiscal 2017 compared with 2016(ended 20171231)

Net sales decreased 4% due to decrease of 2.7% in volume, of 0.5% in price, and 0.8% in promotion.  The decrease in volume is primarily from branded products.

Generally, it seems the demand for the drinkable Kefir of this company is shrinking since its booming in 2014. The net sales have no changes in the first half year in 2017 and in 2015 mainly because increased sales volume (1% and 5% in 2017 and 2015 respectively) were offset by intensive discount and promotion. Its net sales increased by 4.4% (volume increased by 3%) in 2016 without significant discount and promotion. However, this increase in volume was not from its own brand but the private label products.

Gross margins have been kept higher in 2015 (26%) and 2016 (28%) thanks to the decreasing dairy cost. However, it went down to about 25% in 2018 mainly because of the lower sales price (discount and promotion) and deleverage of expenses as a result of decreasing sales.

Under the pressure of shrinking demand and competing with private label products, it seems this company aggressively increased its spending on advertising to try to slow down or even make a turn of the declining market share. And this apparently is hurting its profit margins, which come down below -1% from 5.4% of 2016. The shrinking margin was also attributable to the raised cost of personnel’s compensation as reflected in increased SG&A.

Therefore, with the combined impact of slightly increased sales and improved margins due to the reduced diary cost in 2016 and 2015, this company has been able to keep its cash inflow growth positive. However, its cash flow significantly decreased in 2017 and 2018 due to continuingly decreasing margin and large plunge in sales.

Stock price

Our valuation methods and analysis indicate that it is still difficult for this company to justify its current enterprise price/sales of 0.53. We think that this stock is currently relatively overvalued by the market due to weak demand for its products and the resulted decrease in margin.

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