leaderoftheback (73.78)

re LWAY discussion board, Milk Class I and Class II Pricing

May 16, 2011 – Comments (1) | RELATED TICKERS: LWAY , DF

I'm posting this reply on my blog because the milk pricing system is a bit of a mystery to most.  It's relevant to LWAY and Dean Foods, both of which are of interest to me.  See the LWAY board for context, and by all means add your own comment there.

-Thanks

Thanks Howard.
First off, this is what confuses me regarding LWAY statements. Milk was up about 2% in Jan '11 vs. Jan '10. I believe that the dollar amount may be different, but the percentage would be similar. Milk was certainly not down 5% (although the difference between higher 2010 Class I and lower 2011 Class II would be 5% lower). More importantly, since January, milk prices are pushing 15% higher, whether they be paying Class I or Class II.

Regarding milk class and price- Here how it more or less works:
All milk starts off "Class I." Most farms send their milk to a co-op. The co-op (theoretically) endeavors to sell all its milk to processors at the Class I price, which will yield the most money back to the farm. Class I milk is plain old drinking milk; what you get in a half pint at school or a gallon bottle at the supermarket. What the milk co-op can't sell as Class I (due to demand) would be sold at a lower price as Class II. Class II pricing is for milk that's going to be turned into sour cream, yogurt, etc. By definition, if LWAY were going to process raw milk into drinking milk, they have to pay the Class I price. But since they are making a processed dairy product, they can buy the milk at the Class II price. If the co-op has any raw milk left (and there always is), it gets sold at the Class III rate (for cheese, etc). Same milk, lower price. I suspect that if kefir were a drinking cheese rather than a drinking yogurt, they'd press for Class III buying power. There's a market-beating product idea for you, Howard: (juicy processed processed american cheese food...mmm...let's call it...Whiz Cheese! ).

If the whole world decided that milk should be drunk by every person 3 times a day, LWAY might not get the milk they need and the price of cheese would skyrocket. You'll have to use your imagination to guess if the market really works that way. I'm sure to some extent it does. But there are market-warping issues...Class IV- which includes powdered milk (especially for export) might create demand on the low end, forcing higher prices up the line to Class I. I personally believe that it is this very dynamic (weaker dollar = export pricing advantage) which is keeping dairy prices up. It's just a guess, though.

-Randy