US dairy giant Dean Foods has moved to cool concerns about the potential impact a jump in milk prices could have on its profits.
The drought in the US has put pressure on corn stocks and pushed up the price of the commodity, sparking fears that meat and dairy costs could rise.
Dean Foods chairman and CEO Gregg Engles acknowledged dairy costs were likely to increase but insisted the impact could be "less extreme" than some analysts predict.
Engles said if milk prices reach the "higher end" of forecasts they could hit profits from Dean Foods' Fresh Dairy Direct liquid milk division by up to US$10m. "This is roughly equivalent to $0.02 to $0.04 per share," he said.
However, speaking to Wall Street analysts on Wednesday (8 August) after Dean Foods announced its half-year financial results, Engles outlined factors he believed would mean the impact on dairy prices may not be as strong as some forecast.
Engles said US milk production had been "strong" in the first half of the year and he claimed "tepid" domestic demand had meant inventories of products like cheese, non-fat dry milk and butter were "high".
In the past, when milk prices had increased, Dean Foods had to also deal with higher fuel or resin prices, which Engles said were not factors this time. "We see a rising milk commodity environment, but we don't see the same sorts of inflationary pressures, at least to the extent we have in the past, with respect to other important inputs in the Fresh Dairy Direct cost matrix," he said.
Nevertheless, the issue of rising commodity prices was a topic raised by a number of analysts on the conference call. After a year in which commodity costs spiked, manufacturers were hoping for some respite in 2012. However, concern over the US corn crop has led to soaring prices and left investors wondering how food processors viewed the landscape and how they would look to absorb or pass on any higher costs.
Engles argued the US milk market was "a thin market that sometimes moves on the basis of emotion".
He said: "When you cut through the emotion and you look at supply and demand balance here, which I think is going to drive sort of the intermediate and long-term realities of milk prices, we are relatively long dairy commodities globally.
"The US position, in terms of its global competitiveness, is declining because its currency is strengthening. We have weak domestic takeaway of fluid and other dairy products in the United States. And frankly, we have a situation where increases or expectations for declining farm profitability are driven by the current corn crop.
"And what I'm often reminded of or think of is that you know what, we are going to have another corn crop next year. We may well have spikes in price in this marketplace as that emotion and the uncertainty around the corn crop and herd side plays out. But when you dig down and you look at the fundamentals, our view, at least today, what we know about the crops and grain prices and what we expect to happen with inputs over the back half of the year and the beginning of next year, when you take and you filter all that through, that we believe the supply and demand balance, on average, suggests that milk prices should move up but not explode to the upside. That's our view."
Dean Foods reported a half-year profit of $94.5m for the six months to the end of June, helped by a focus on costs.
The company, for example, cut SG&A costs from its Fresh Dairy Direct division by $50m in the first half of the year, CFO Shaun Mara said. Those reductions, plus others made in recent months, will help Dean Foods deal with the cost increases that come its way from higher corn prices, Mara said.
"We've put in ourselves in a position where we've actually made structural changes to our costs that allow us to absorb the prices a little better than we have in the past. I think we'll have some impacts, obviously, with milk prices going up to ability to pass on all those things from our pricing protocols. But I think in general, we're in a better position today than we were a year ago or two years ago," he added.
The US drought has also affected the soybean crop. Dean Foods sells a range of products made with soy, including under the Silk brand, and Engles was asked about the impact the reduced soybean yields could have on the company.
Engles said Silk has a "fundamentally different margin structure than our Fresh Dairy Direct milk business". He added: "The cost of raw materials as a percentage of selling price is just dramatically lower there."
