Dean Foods (DF), based in Dallas, Texas, is the largest dairy processor in the United States, with over 25,000 employees and annual sales of around $13 billion. The company, dating back to 1928, has been formed through a series of acquisitions, most coming in the past 20 years. It currently has two principal divisions: Fresh Dairy Direct-Morningstar and WhiteWave-Alpro.
Fresh Dairy Direct-Morningstar, accounting for about 84% of the top-line mix, encompasses the conventional fluid milk operations (products are sold under more than 50 local and regional brands), as well as the ice cream and private-label extended shelf life businesses. And the smaller WhiteWave-Alpro segment (16% of the sales mix) markets and sells nationally branded products, most notably Horizon Organic milk, Silk plant-based soy, almond, and coconut beverages, and International Delight and Land O'Lakes creamers.
Dean shares have fared poorly over the past few, turbulent years, much to the chagrin of investors. In fact, this mid-cap food issue has been under almost constant pressure since peaking just north of $50 a share in early 2007, and now trades closer to the $10 mark. This is due, we think, to a sharp erosion of fresh milk margins (and overall profits), caused by rising milk input costs and compulsory price concessions to grocery chains across the country that have taken to using milk as a "loss leader" to attract customers. In addition, at a time when risky assets have fallen out of favor and deleveraging has come into vogue, the stock appears to have been penalized for the company's heavy debt load.
Still, the fundamental picture looks to be improving. And, as presently valued, we think that beaten-down Dean shares have all the makings of a great comeback story. In the coming quarters, margin pressures on the mainstay fresh milk business should gradually ease, as key input costs decline, pricing concessions on private-label contracts become less austere, and retail volumes pick up.
Grocers, like SUPERVALU (SVU), Kroger (KR), and Safeway (SWY), have begun to relax aggressive milk-related advertising campaigns. And wholesale milk input prices have been trending lower for some time now, due to heightened industry production and slack demand for dairy products at home and abroad. These factors should almost certainly boost margins at the company's Fresh Dairy Direct-Morningstar segment as we head into 2012, a likelihood that does not appear to be reflected in the stock price at present.
The expected easing of pricing pressures, meanwhile, should allow hard-won cost savings to flow more directly to the bottom line, something that investors have been anxiously waiting for. While contending with a frosty operating environment, Dean has been pretty active on the cost-cutting front in the hopes of enhancing its earnings power over time.
Indeed, the company, behind a veteran management team, has been aggressively trimming the fat on both the cost of goods sold and selling, general, and administration lines. This is in addition to an earlier $300 million productivity initiative that was primarily focused on reducing procurement costs, driving efficiencies across the refrigerated direct-store delivery network (better fleet utilization was a priority with fuel costs moving up), and consolidating/streamlining production facilities. That effort, though largely unheralded and overshadowed by pricing headwinds, has helped Dean to become one of the lowest-cost processors in the industry, and it ought to support meaningful market-share advances over the long haul.
Beyond the extensive commodity-oriented fluid milk operations, the state of which seems to dictate sentiment towards these food shares on Wall Street, the company maintains several nontraditional dairy lines, including the Silk soymilk and Horizon Organic businesses. These high-margined branded segments, which continue to perform well at retail and, thanks to a growing public enthusiasm for healthy living, look to have plenty of room to expand, are becoming increasingly important and valuable assets.
In fact, if results at Fresh Dairy Direct fail to perk up as we envision, Dean, as a last resort, may opt to sell its noncore, and drastically undervalued, in our view, WhiteWave-Alpro unit. Based on the ample operating income that this division generates, we think it could fetch in excess of $3 billion. If a transaction of this nature was completed, the funds would enable the company to pare its high financial leverage and interest obligations. We do not see this scenario playing out, however, and expect the soy and organic businesses to play a big role in Dean's long-awaited recovery.
Adding It All Up
Though times have been tough for Dean and its weary shareholders, we think that there is a lot to like about this name, given the still-substantial cost savings opportunities, the brightening outlook for fresh milk margins, and the emergence of WhiteWave-Alpro as a powerful growth driver. The stock looks fairly inexpensive, too, trading at only about six times our 2014-2016 share-net estimate of $1.75. With this in mind, we recommend Dean shares for risk-tolerant investors in search of a speculative turnaround play. They just might quench your thirst.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.