Dean Foods Company Spoiled by Higher Prices

But you won't hearing them crying over it, as cost-cutting initiatives will kick in later this year.

May 12, 2014 at 12:25PM


Source: Dean Foods.

Slowing sales, higher costs, tougher competition, and the loss of a major outlet all conspired against Dean Foods (NYSE:DF) to milk it dry in the first quarter. Not only did all of its profits evaporate (and then some), but it slashed full-year guidance, as there appears to be no letup in the spoilage. 

Like many retailers, Dean partially blamed the "snow in winter" effect for pushing its performance lower, but said it was all the snow days kids had off in the quarter that caused it to lose school lunch milk sales totaling $4 million, or $0.03 per share. While that will level out with the spring thaw, record-high prices will continue to be a drain on performance.  

Class I raw milk prices hit new all-time highs, rising 22% in the quarter from the year-ago period, driven higher in part by demand from China for milk powder. Last year, it increased total dairy imports by 42% as distrust of local processors remains high due to contamination and scandals over the past few years that resulted in the death of dozens of infants and adults while sending thousands more to the hospital.

At the same time, dairy consumption in the U.S. continues its downward trend. Fluid milk sales fell 2.6% last year, according to the USDA, with the largest segment, 2% milk, falling by a like amount. Although flavored milk rose nearly 9% from 2012, it represents just 1% of total fluid milk products such that it can't have any real impact. But since flavored milk is one of the only segments seeing growth, it explains why dairy processors don't want to publicize that it's often artificially flavored with aspartame, as they fear it will send sales into a nosedive.

Prod Choc

Source: Dean Foods.

Milk sales in 2014 aren't faring any better, either. Sales are down 2% as of the end of February, the latest data available, and even flavored milk is off 1.8% year to date. Dean Foods also has to contend with greater competition from private-label dairies, even more so these days since it lost Wal-Mart's business last year, which accounted for a 6.7% drop-off in revenues this quarter. If you exclude those sales, Dean's volumes actually rose 1.1%, so it's clear just how important the mass marketer was to its operations.

As dismal as the quarter was -- and next quarter is likely to be, for that matter -- Dean expects the back half of 2014 to strengthen. It previously engaged in various rounds of cost-cutting and plant closings to reflect the lower-demand environment, and those actions should start to bear fruit later this year.

While Dean enhanced shareholder value by spinning off its soy and organic milk business into WhiteWave Foods in 2012, that was a higher-margin business than its fresh dairy operations that it focuses on now. It also sold its Morningstar Foods frozen food unit to Canadian operator Saputo for $1.45 billion last year, making it a much more narrow business that will rise and fall on the vagaries of the dairy market.

In short, the worst should be behind Dean Foods, and investors like myself who've seen its shares fall by a third over the past year won't be crying over spilled milk if it can now use the opportunity to further build on its leadership position. It owns over 35% of the fluid milk category, a preeminent place that should allow it to win new volume. With successful new products like TruMoo chocolate milk, it can milk the flavored milk category's popularity for all it's worth.

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Rich Duprey owns shares of Dean Foods Company and WhiteWave Foods. The Motley Fool recommends and owns shares of WhiteWave 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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