It's Not Easy Being Wimm-Bill-Dann

By Stephen D. Simpson, CFA | September 03, 2008 AAA

It's not easy for a company when the cost of its inputs is increasing by more than 20% and there's only so much of that it can pass along to the final consumer. It's not easy for a company when the government has an established policy of using pre-existing tax, environmental or anti-monopoly laws in an exceptionally punitive fashion for the benefit of the ruling party's agenda. It isn't easy for a company when international investors are worried about your home country becoming militarily more aggressive.

Simply put, it isn't easy being Wimm-Bill-Dann (NYSE:WBD) these days.

With all of the above applying to this diversified Russian provider of dairy, juices and baby food, perhaps it's no wonder that the stock is barely hovering above its 52-week low.

Numbers Holding Up
I will grant that the stock market discounts expected future financial results, but the performance so far is still quite good. In the most recent earnings report, the company reported that revenue grew 26% in the second quarter, with growth in dairy, beverages and baby foods of 24%, 19% and 63%, respectively. Operating income rose 10% and EBITDA for the quarter rose more than 21%. (To learn more about this valuable performance measurement tool, read EBITDA: Challenging The Calculation.)

Now, it's time for the bad news. Growth slowed on a sequential basis and volumes were weak in both dairy (down about 9%) and beverages (flat). What's more, Wimm-Bill-Dann buys raw milk and juice concentrate for its products and prices of those products are rising sharply (raw milk prices were up 49% in the first half of this year). While the company has had some success in pushing along higher prices to the consumer, there's a limit to how far it can go, and there's always a risk of consumers trading down to save money.

Enter the Government
Navigating economic cycles is bad enough, but Wimm-Bill-Dann has added issues in dealing with the government. At the end of this year, a new law in Russia will force producers to stop using milk powder in drinkable milk (unless they label it "milk drink" instead of "milk"). No one knows how consumers will respond to "milk drink" on the shelves.

Second, and admittedly speculative, is the risk that Putin will seek to fight rising Russian food prices by means far less conventional than monetary or fiscal policy. In particular, investors should be wary of any official announcements of government "investigations" into pricing in the dairy, beverage or baby food markets. Investors in stocks like Yukos, Mechel (NYSE:MTL), and BP (NYSE:BP) may recall that "investigations" in Russia can have a rather different connotation than in Western countries.

A Real-Life Fear Factor
So, what's the bottom line with Wimm-Bill-Dann? On one hand, this company has the leading share in dairy in Russia, with Danone in second place; and this market is growing strongly. Wimm-Bill-Dann also offers a level of candor and disclosure that is superior to many American companies. In this company we also have a business that has been producing very solid returns on capital and trades at a pretty reasonable valuation.

On the flip side, there are the aforementioned problems with inflation and the risk of government interference. There's also an issue with competition, as Coca-Cola (NYSE:KO) and Pepsico (NYSE:PEP) are buying their way into the Russian juice market and Danone sits just behind the company in market share in the dairy business.

Bottom Line
Even with the prospect of larger players getting more involved in Russia, it's hard for me not to like the idea of Wimm-Bill-Dann shares around this level. There's no question that there are risks here, but the opportunities are substantial and the whole point of owning a diversified portfolio is to mitigate some of the idiosyncratic risks of individual stocks.

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