Is Dean Foods Better Than Its Earnings Make It Seem?

Numbers can lie -- but they're the best first step in determining whether a stock is a buy. In this series, we use some carefully chosen metrics to size up a stock's true value based on the following clues:

  • The current price multiples.
  • The consistency of past earnings and cash flow.
  • How much growth we can expect.

Let's see what those numbers can tell us about how expensive or cheap Dean Foods (NYSE: DF  ) might be.

The current price multiples
First, we'll look at most investors' favorite metric: the P/E ratio. It divides the company's share price by its earnings per share -- the lower, the better.

Then, we'll take things up a notch with a more advanced metric: enterprise value to unlevered free cash flow. This divides the company's enterprise value (basically, its market cap plus its debt, minus its cash) by its unlevered free cash flow (its free cash flow, adding back the interest payments on its debt). Like the P/E, the lower this number is, the better.

Analysts argue about which is more important -- earnings or cash flow. Who cares? A good buy ideally has low multiples on both.

Dean Foods has a P/E ratio of -1.4 and an EV/FCF ratio of 21.0 over the trailing 12 months. If we stretch and compare current valuations to the five-year averages for earnings and free cash flow, Dean Foods has a P/E ratio of -12.1 and a five-year EV/FCF ratio of 13.5.

A positive one-year ratio under 10 for both metrics is ideal (at least in my opinion). For a five-year metric, under 20 is ideal.

Dean Foods has a mixed performance in hitting the ideal targets, but let's see how it compares against some competitors and industry-mates. 

Company

1-Year P/E

1-Year EV/FCF

5-Year P/E

5-Year EV/FCF

Dean Foods NM 21.0 NM 13.5
Kraft 19.1 24.4 20.7 25.8
Sara Lee 23.2 >100.0 23.3 30.1
ConAgra Foods 15.0 10.7 13.3 23.2

Source: S&P Capital IQ; NM = not meaningful due to losses.

Numerically, we've seen how Dean Foods' valuation rates on both an absolute and relative basis. Next, let's examine...

The consistency of past earnings and cash flow
An ideal company will be consistently strong in its earnings and cash flow generation.

In the past five years, Dean Foods' net income margin has ranged from -12.1% to 2.2%. In that same time frame, unlevered free cash flow margin has ranged from 2.2% to 5.3%.

How do those figures compare with those of the company's peers? See for yourself:

Source: S&P Capital IQ; margin ranges are combined.

Additionally, over the last five years, Dean Foods has tallied up four years of positive earnings and five years of positive free cash flow.

Next, let's figure out...

How much growth we can expect
Analysts tend to comically overstate their five-year growth estimates. If you accept them at face value, you will overpay for stocks. But while you should definitely take the analysts' prognostications with a grain of salt, they can still provide a useful starting point when compared to similar numbers from a company's closest rivals.

Let's start by seeing what this company's done over the past five years. Unfortunately, due to losses, Dean's EPS growth rates aren't meaningful. But here's how its peers have fared:

Source: S&P Capital IQ; EPS growth shown.

And here's how it measures up with regard to the growth analysts expect over the next five years:

Source: S&P Capital IQ; estimates for EPS growth.

The bottom line
The pile of numbers we've plowed through has shown us the price multiples shares of Dean Foods are trading at, the volatility of its operational performance, and what kind of growth profile it has -- both on an absolute and a relative basis.

The more consistent a company's performance has been and the more growth we can expect, the more we should be willing to pay. We've gone well beyond looking at a negative P/E ratio, and Dean's free cash flows have been much stronger than its earnings. That's due largely to a non-cash goodwill impairment in 2011. In fact, its five-year EV/FCF ratio is quite low. Maybe that's why my fellow Fool Jim Mueller has been bullish on Dean for over a year now.

As another data point, our CAPS community rates Dean a middling three stars (out of five). At the very least, Dean holds promise above what its negative earnings would indicate. But all this is just a start. If you find Dean Foods' numbers or story compelling, don't stop. Continue your due diligence process until you're confident one way or the other. As a start, add it to My Watchlist to find all of our Foolish analysis.

I wrote about a stock that's flying under the radar in our brand-new free report: "The Stocks Only the Smartest Investors Are Buying." I invite you to take a free copy to find out the name of the company I believe Warren Buffett would be interested in if he could still invest in small companies.

Anand Chokkavelu holds no position in any company mentioned. Click here to see his holdings and a short bio. The Motley Fool owns shares of Dean Foods. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 07, 2012, at 8:05 PM, burnaka wrote:

    DF numbers do not tell the whole story, or even part of the story. They have dealt with two anti trust law suits, which affected eps and FCF. They have also dealt with the highest input costs in their history. Last year dairy even outpaced gold in the commodity arena.

    They also finally took the bull by the horns and did a billion plus goodwill write down, which again distorts all the numbers.

    They did 300 million of cost savings and the high input costs eroded that benefit. They soy division had been doing so well, they had to outsource to keep up with demand. They just completed and are on line with a 100 million new soy plant. That is capex that goes to the eps. line on only 195 million shares. Peak at earnings projections....

    The bottom line is this. What goes down, goes up, and what goes up goes down. Well input costs are heading back to historic lows, when DF was at historic highs.

    The all time highs on milk in put is tanking, and a global over supply of milk with help DF margins get back to more historic numbers.

    The soy division which includes organic milk is still growing, the new soy plant will add to their margins. Read no longer outsourcing. Organic milk and soy annual growth about 9-10% will approach half of companies profit by year end. Read less reliant on milk as a commodity.

    Milk consumption is declining, and DF is managing to hold volumes flat, they are taking market share, and bottle over half the nations milk.

    To sum up, IF DF trades at the food industry average pe of 17-18, DF should get to 18-20 dollars.

    Regardless, the input environment is the best it has been for DF since the 2007 time frame. Now DF will not get back to that lofty 50 dollar range, but could double by mid 2013. That will be about how long it will take the dairy industry to fix the massive glut they created in dairy supply. Read over supply good for DF.

    They have lowered debt by about 1.5 billion in the past two years, have no immediate issues, and with this windfall in fcf will bring debt down from near 3.5 billion to around 2.8-2.9 by year end.

    Once debt is lowered enough, they most likely will spin off the organic/soy division, called Alpro. I see that division with a current value of 8 dollars, making df even today undervalued. Fair value today 16.

    I am a long term DF share holder and have dealt with DF for many many years. This is my bullish call on DF, which by the way out performed nearly 97% of the S&P in 2011.

    Oh there have been several upgrades in the past 4-5 months, the best is yet to come. With the collapse of input costs, they price target will move UP.

    Last year GS called 18 by 2013, I think they move that up too.

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