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Author: RexFolio Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 472  
Subject: LWAY not a sell, yet. Date: 2/11/2004 9:35 PM
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Greetings Fools,

Before I begin, let me disclose that I own LWAY shares. The question here is how much longer I'll be holding them, if the madness of the last two days continues.

Whenever a stock pops - as LWAY has by almost half its value in two days - it's at least worth the analysis to figure out where to exit.

The world now knows that Lifeway is a company with considerable growth momentum. Until about two days ago the stock traded at what I'll call a structural discount relative to its growth, likely attributable to its microcap status. However, the appreciation of the stock (as distinct from the price of the stock) historically tracked the company's growth fairly well. The events of the last two days suggest that the current price has eliminated the structural discount carried by the shares. Whether the stock will continue to reliably track the company's performance depends on how speculatively the stock trades from here as a result of the press attention.

I contemplated selling in the last two days. As part of that decision making process, I conducted an analysis of such industry peers (dairy products) as I could find, as well as a broader comparison to the food manufacturing industry. Of course I also examined Lifeway's fundamentals in isolation, but Rich has already cast a good amount of light on that, so there's no need to dwell on that further.

The closest "peers" I could dig up in the dairy products industry were: Dean Foods (DF), Dreyer's Ice Cream (DRYR), Stonyfield Farms (private), Horizon Organic (private), Wimm-Bill-Dann (WBD) (a dairy heavyweight in Russia that I started pronouncing as 'Wimbledon' after a while), and of course Group Danone (DA), Lifeway's major corporate shareholder.

The statistics that perhaps best reflect the comparison are the free cash flow multiple to enterprise value (EV/FCF), operating margin (OpM%), and recent revenue growth (RvG%). In some cases I've used a two or three year average to smooth out volatility effects. The numbers are not meant to be spot-on precise, as I'm just looking for a general picture of Lifeway's position in the industry. Take a look at the comparative numbers:

Company Name............(EV/FCF), (OpM%), (RvG%)

Dean Foods................. 22, 8%, 26%
Groupe Danone........... 30, 12%, 4%
Dreyer's...................... 88, 3%, 7%
Wimm-Bill-Dann......... NEG, 8%, 32%
Horizon Organic......... 37, 4%, 20%
Stonyfield Farms........ N/A, 10%, N/A
Lifeway................... 31, 24%, 16%

Note that the numbers for Horizon Organic are from 2003 filings, as the company was acquired and consolidated into Dean Foods in January. Note also that Stonyfield Farms is 80% owned by (surprise) Groupe Danone. Lifeway's EV/FCF number is accurate as of 2/11/04.

What stands out from the industry comparison above (aside from the frightening valuation of Dreyer's) is that Lifeway cannot be definitively dismissed as overvalued at its current price. Moreover, most every public company on the list except Lifeway carried debt in proportions ranging from noticeable to significant. Since one of the major justifications of debt is to juice returns on equity, the fact that Lifeway's 17% ROE handily beats Dean Foods at 13% and Groupe Danone at 2% is further evidence of quality management.

But the above detail covers only a few companies in the broader food manufacturing industry, so let's cast our eye a bit further. The following comparative statistics are taken from Morningstar:

[Statistic]: [Food Industry], [Lifeway]

P/E............................ 26, 30
Forward P/E................. 17, 26
P/B............................. 5.2, 5.2
P/CF.......................... 13, 30
P/S............................ 1.6, 5.5
ROA............................ 6%, 15%
ROE............................ 24%, 17%
Net Margin................. 7%, 18%
Fin Leverage............... 4.1, 1.2
3-YR Rev Growth......... 6%, 16%
3-YR EPS Growth......... 17%, 71%

Again, the implication from examining the above stats is that although Lifeway shares are by no means cheap any longer, neither are they overvalued to a significant degree. Generally speaking, Lifeway's higher profitability and lower financial leverage account for essentially all metrics where the industry bests Lifeway. Relative to the industry, although Lifeway shares aren't cheap on an absolute basis, their valuation at $20.00 is still in line with investors' willingness to pay up for the supposed steady revenue and earnings of consumer food companies.

But if Lifeway isn't overvalued today, where would it be overpriced and trigger a sell? Assuming 2004 EPS of $0.70 and free cash flow of $3 million, I think I'd become very uncomfortable if the stock traded well above $22 (6% above closing 2/11), which gives us a 2004 P/E of about 31 and an enterprise value of about $82 million after netting out Lifeway's current cash.

However, there are trading expenses and tax issues to consider. I'm not exactly a large shareholder, so the $30 it'd cost me to sell and perhaps re-enter at a safer price is a significant expense. Furthermore, if I sold now for a short-term gain I'd pay tax at my bracket of 28%, rather than the preferred long-term rate of 15%. The difference in my case would amount to 13% of my profits. From that perspective, if I sold at $22.00 I'd end up with $20.00 after expenses.

The final conclusion: if Lifeway hits $24 without good reason over the next month, my days as a shareholder will be over, at least temporarily.

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