Shares of Dean Foods
How it got here
The rise of Dean Foods is really a return from the depths rather than a continuing story of profitability. In 2011, the company reported three quarters of negative earnings per share, coupled with an $8.39 loss per share in the third quarter, when the company wrote down over $2 billion of goodwill.
Management and investors are hoping that the first quarter's return to profitability is a sign of things to come rather than an anomaly. First-quarter sales rose 5.3% to $3.2 billion and net income rose 62% to $37.9 million, or $0.21 per share. An improvement in milk prices as well as a slowly improving economy is helping results.
Not all food suppliers have had the same rough time Dean Foods has had in the milk business. More diversified suppliers B&G Foods
Dean Foods' extremely low margins also have a lot to do with it. If there's the slightest change to the balance of supply and demand, Dean Foods feels it and it can quickly bring about losses. That's why the company's profit margin looks so bad compared to competitors' right now.
Return on Assets
Source: Yahoo! Finance.
You can see that Dean Foods is starting from such a low base that as operations turn around, the stock has a lot of room to rise. It may not match competitors' price/sales ratios, just because Dean Foods will inherently have lower margins, but with earnings rising quickly, a 12.5 P/E ratio isn't too expensive.
So, can Dean Foods continue to rise from here? I think it can if the economy continues to recover and consumers don't begin to trade down, cut back, and stop buying dairy products the way they did before, when Dean Foods began to struggle. But that's a big if right now with Europe on the verge of collapse and margins remaining thin.
The CAPS community doesn't have a lot of confidence either, giving the stock a three-star rating (out of five) right now. Even 16 of our All-Stars think the stock will underperform the market.
How high can Dean Foods fly? If the stock doubled in the next 12 months it wouldn't shock me, just based on how far the stock has fallen and how much upside operations have. But I think bigger, more diverse food companies are a better bet right now because the margin for error is too small and the downside too big.
Fool contributor Travis Hoium does not have a position in any company mentioned. You can follow Travis on Twitter at @FlushDrawFool, check out his personal stock holdings or follow his CAPS picks at TMFFlushDraw.
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