Why Avoiding Dean Foods Is in Your Best Interest

Dean Foods has been under pressure due to rising milk prices, and the trend could continue.

May 29, 2014 at 1:59PM

Increasing milk prices have pressured Dean Foods (NYSE:DF) this year and pushed the stock close to 52-week lows. The company has missed analysts' estimates in each of the last four quarters, and its recent first-quarter results weren't any different. The increase in milk prices has led consumers to adopt plant-based milk alternatives from companies such as Hain Celestial (NASDAQ:HAIN) and WhiteWave Foods (NYSE:WWAV), hurting Dean in the process. 

Dean Foods commands 36% of the milk market in America, so an increase in milk prices will definitely affect the company in a big way. This was reflected in a 7% year-over-year decline in milk volumes in the first quarter. However, the company expects some relief going forward. But will Dean be able to make a comeback? Let's find out.

Margin woes
Dean Foods started the year with substantial margin pressure in its milk business as the price of Class I raw milk soared to new highs. Prices were 22% higher from the year-ago period, a sharp increase from the 12% jump that it had seen in the last quarter of 2013. Also, fluid milk volume remained soft as prices continued to rise. In addition, its first-quarter adjusted operating income declined to $7 million from $74 million in the year-ago period.

Dean experienced additional softness in its volumes during March and April. The weakness might continue going forward as management anticipates this price rise to persist in the second quarter as well. Moreover, costs associated with plant closures along with a loss of volumes are other headwinds for Dean.

Will the turnaround strategies work?
Management is trying to counter these problems through strategies such as accelerated cost reduction, increasing prices to pass through input-cost inflation, and improving volumes. An increase in milk prices might help Dean to rescue its margins, and management is confident that its business will turn around in the second half of the year. 

The company is pleased with the performance of the TruMoo brand and is looking forward to diversifying the brand further. Dean has received a positive response from consumers and retailers while promoting its seasonal flavors. It was also pleased with the regional launch of TruMoo Protein and plans to expand distribution nationally later this year.

In an effort to curtail costs, Dean Foods plans to shut down 10% to 15% of its plant network, which means that it will close approximately eight to 12 plants by mid- 2014. Going into the second quarter, management expects the gross margin performance to improve due to its cost initiatives.

However, Dean Foods is concerned about fluid milk volume weakness and the continued pressure from high raw-milk costs that are affecting its gross margin. According to management:

We believe the market environment continues to be a difficult one with several factors continuing to impact our earnings progression, particularly over the first half of 2014. However, later in the year, we expect earnings to improve. 

The threat of plant-based alternatives
Volume weakness is a key indication of a change in customer preferences. As milk prices have risen, demand for plant-based milk alternatives has increased. According to WhiteWave Foods, plant-based milk demand grew 20% in the U.S. last quarter, and this trend is expected to continue going forward. WhiteWave says that this category is being driven by almond milk, which accounts for around two-thirds of total plant-based milk sales.

So, WhiteWave is looking to tap into this demand by increasing its offerings in the segment. It will be adding flavored almond milk to its portfolio along with varieties that include superior protein and fiber. WhiteWave saw a 52% jump in sales of its Silk almond milk brand in the first quarter, illustrating the traction that the company is gaining in the market. 

On the other hand, Hain Celestial is aggressively pushing its WestSoy brand, which it claims to be the leader in non-dairy soy beverages. Hain's Rice Dream and Soy Dream brands are the other milk substitutes. Going forward, it plans to introduce several coconut milks, nut milk blends, almond milks, and rice milks under the Dream brand. Since soy milk accounts for the remaining one-third of the plant-based milk market, Hain Celestial is trying to make the most of this by introducing more products. 

The bottom line
The emergence of milk alternatives has made the going difficult for Dean, the largest milk processor in the U.S. Although the company is trying to turn around, management anticipates that its troubles will continue for some time. So, it would be prudent for investors to wait on the sidelines and see if Dean's strategies are working.

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Shirish Mudholkar has no position in any stocks mentioned. The Motley Fool recommends Hain Celestial and WhiteWave Foods. The Motley Fool owns shares of Hain Celestial and 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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