After a Sharp Decline, Is Dean Foods a Good Bet?

Dean Foods' (NYSE: DF  ) stock price has been heading the wrong way in 2014, with a notable drop in early February caused by a financial update that included an expected loss in the coming quarter.  The company continues to be plagued by declining fluid milk consumption in the U.S., a trend that was corroborated by the USDA in a May 2013 report.  Despite Dean Foods' near-term troubles, though, the company has vastly improved its financial fitness lately. It has implemented a business downsizing scheme that included selling and spinning off its Morningstar distribution and WhiteWave Foods (NYSE: WWAV  ) organic dairy units, respectively.  So, is Dean Foods a good bet at its depressed price?

What's the value?
Dean Foods is the largest domestic processor and distributor of fluid milk products. This is a low-margin commodity business that requires significant scale in order to generate profitability.  The company spent much of the past 20 years pursuing horizontal and vertical expansion. This included moves into related areas like ice cream and creamers as well as a push into the organic milk sector via acquisitions.  However, the rising weight of its debt load, in combination with investor impatience, led Dean Foods to abort its expansion strategy in 2012 and refocus on the traditional dairy business.

In fiscal year 2013, Dean Foods' results were less than optimal, as it reported declines in both revenue and adjusted operating profit.  The main culprit for the poor performance was a sharp rise in raw milk costs, a data point that management blamed on higher emerging-market demand for milk from farmers.  On the upside, Dean Foods' more efficient operations, relative to its pre-restructuring structure, allowed the company to remain profitable despite the challenging operating environment and further invest in growing product areas, like its TruMoo flavored milk brand.

Trying to find a tailwind
Dean Foods is undoubtedly cheap, with a valuation of roughly six times its adjusted EBITDA. However, it has the wind in its face as it tries to overcome declines in domestic fluid milk consumption. As such, investors will likely find better returns in the sector with a niche player, like WhiteWave Foods. Despite the growth struggles of the overall milk industry, the company has found volume growth by focusing on organic and plant-based product lines. This strategy has allowed WhiteWave to pick up industry market share due to the products' perceived health benefits vis-a-vis traditional milk products.

Unlike Dean Foods, WhiteWave Foods' performance was strong in fiscal year 2013, as evidenced by a 10.3% top-line gain that was aided by solid volume increases across its product portfolio, led by a scorching 58% increase for its almond milk offering.  More important, the company's focus on premium product categories has provided it with the flexibility to raise prices. This has led to an operating margin significantly above Dean Foods' razor-thin level. The net result was a strong level of operating cash flow that funded strategic initiatives like the company's recent acquisition of Earthbound Farms, the largest domestic seller of organic produce.

In addition, the strong financial results have allowed WhiteWave Foods to continue developing its creamer franchise, a key product area and the source of roughly one-third of its overall sales. In fiscal year 2013, the company enjoyed double-digit growth in its creamer segment. This was thanks in part to its ability to expand its flavored product portfolio, which includes partnerships with popular brands like Cinnabon and Cold Stone Creamery.

In the current fiscal year, WhiteWave Foods is looking for additional growth in the creamer segment. It recently announced an at-home creamer product partnership with coffee heavyweight Dunkin' Brands, owner of the Dunkin' Donuts franchise. The deal extends Dunkin' Brands' leading coffee franchise into the refrigerated section, allowing its millions of customers to enjoy Dunkin' Brands' coffee flavor in their own home brews. More important for WhiteWave, the deal brings a big brand name into its product portfolio, which will hopefully provide ancillary sales momentum for its full roster of products.

The bottom line
Dean Foods is lightly valued, which is a reflection of both near-term and long-term challenges in its traditional dairy business. While value investors might see a diamond in the rough with Dean Foods, they might be waiting awhile for a higher valuation, which would likely coincide with a return to positive overall milk consumption trends. As such, WhiteWave Foods seems to be a better bet, with a more diversified, niche focus in the milk business and a solid position as a supplier to the growing at-home coffee market.

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