In an effort to delever from its massively indebted past, Dean Foods (NYSE: DF ) spun off its (arguably) most profitable and attractive segment: its plant-based foods business. While I am a fan of spinoffs, the move left parent company Dean Foods as a pure play on milk and dairy products, which have been coming under more and more margin pressure due to the rising cost of feed for the cows. Yet in the company's latest earnings release, Dean Foods showed investors its cost-control measures and pricing strategies had paid off with major revenue growth. Unfortunately for the company and its investors, it made a Wall Street no-no by forecasting under estimates. Wall Street antics aside, is Dean Foods coming around the bend?
The stock may have fallen nearly 10% upon release of the company's fourth-quarter earnings report, but there was plenty in the report to be positive about.
Dean Foods posted a very appealing 48% rise in adjusted earnings, or $0.40 per share. The figure easily blew away analyst estimates of $0.30 per share. A year ago, diluted earnings per share came in at a $0.05 loss as a result of the high input costs and low milk prices. This year that number rebounded healthily to $0.20 per share. Revenue rose just under 4% to $3.417 billion. Keep in mind, a year ago the company had the $2.7 billion Whitewave Foods (NYSE: WWAV ) business under its control. The health-oriented food company is now divested into its own public entity, though partially owned by Dean.
Investors need to remember that Dean Foods is in the midst of a transition -- going from three operating platforms to one. The Whitewave spinoff and the recent sale of the Morningstar division for a net of $887 million were decisions lauded by investors because they showed promise of a leaner, more efficient Dean Foods. But they seemed to have forgotten that without those two divisions, growth would slow. It's a sensible enough concept, I know, but Wall Street is not known for its logic and sensibility.
More changes ahead
Company management also announced it is looking toward a reverse stock split sometime this year, as early as May. In the past year, the company has erased over $2 billion in debt from its consolidation. Including the closed Morningstar transaction (which took place in the early days of this year), Dean Foods' leverage ratio is down to 2.85 from 3.71 at the end of 2012's third quarter. (Author's note: Dean Foods' management does not use the typical debt to equity ratio as their leverage ratio. As stated in the company's SEC filings, leverage ratio is calculated as "the ratio of consolidated funded indebtedness, less cash up to $100 million to the extent held by us and our restricted subsidiaries, to consolidated EBITDA for the period of four consecutive fiscal quarters." ) Since 2010, the company's initiatives have also brought interest expense down more than $100 million to $115 million per year.
Dean Foods may not have the fast-growing, higher-margin segments it did just a year ago, but management seems to be very effective at tightening up the ship for a leaner future. Further cost-cutting measures and a $25- million-per-quarter reduction in interest expense are on tap for 2013.
On the whole, Dean Foods had a great quarter -- keeping sales up in a very difficult environment (commodity prices and margin pressure). This, in my opinion, should be enough to convince investors of management's ability to effectively operate this business in tough times. Everyone looks good in up times; the important time to evaluate is when the business environment is suffering.
Management made one mistake, and it wasn't really a mistake: They gave tepid guidance under Wall Street expectations.
For 2013, the company is expecting mid-single-digit operating income growth while focusing on generating more free cash flow. The company has grown its market share in the fluid milk business over the last two years, but this year a lost bid for a private-label buyer may prevent Dean Foods from growing market share again this year.
As far as the numbers go, Wall Street was expecting more than Dean's 2013 EPS forecast of $1.00 to $1.10. 2012's was $1.39, but of course, included the other two business segments.
As usual, I find Wall Street to have missed the point on this earnings release. Dean Foods' management is very talented and has managed the deleveraging and consolidation process in a smart manner. The milk business is a tough one, affected by declining consumption and lower birth rates, but I believe this team knows how to navigate these waters as they have been for decades.
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