According to a recent Wall Street Journal article, the milk industry sees itself in a crisis, beset on all sides by rising costs, various fad diets, and the rise of alternative milks like soy milk. Per capita milk consumption has been falling for decades, while other dairy products like eggs and butter have mostly held steady.
At the center of the sectoral decline is Dean Foods (NYSE:DF), which I've touched on in other recent articles. Dean is the biggest dairy company in the United States and is at least partially responsible for the problems currently facing the industry. The company has made a number of moves over the years that have changed the face of the industry and dashed some opportunities for investors while creating new ones.
Many of these problems that exist for milk also exist for other dairy products. Butter and eggs are about as tied to the cost of grain for feed as milk is, and have both been vilified at one time or another for their fat and cholesterol content. But while milk consumption fell 30% from 1975 to 2005, egg consumption fell just 7%, and butter consumption only 3%.
That's not to say that close-to-zero growth over 30 years is a good thing -- none of these industries is brimming with opportunities for investors. But milk is in a particularly bad situation. The egg industry, for example, isn't growing much at all, but it's also highly fragmented. Cal-Maine Foods (NASDAQ:CALM) is the industry's biggest player, but the company only controls about 19% of the market. That leaves a lot of room for shareholders to profit as the company grows through acquisitions.
Dean Foods, on the other hand, already controls nearly half the milk market. It accomplished much of the industry's consolidation in the late 1990s, when Suiza Foods acquired 40 smaller dairies to become the largest operator, and then merged with Dean, its nearest competitor, taking Dean's name in the marriage. Sales nearly tripled in the short time between the Suiza IPO in 1997 and the Dean merger in 2001, but they have barely doubled in the decade since. Growth from acquisitions is just too hard to come by now that Dean's nearest competitors include giants like Kraft Foods (UNKNOWN:KRFT.DL) and Kroger (NYSE:KR), and shareholders have suffered as a result.
Nearing its expiration date
Dean is also partially responsible for another problem facing the milk industry -- competition with alternative milks. In 2002, Dean acquired White Wave, the company that produces the widely popular Silk soy milk, seen by many as a healthier alternative. While it's probable that Silk would have done well on its own, Dean should take some credit for the success of its brand, which grew sales by 64% from 2007 to 2011, compared with just 10% for the company as a whole. In fact, basically all of the company's sales growth during that period came from White Wave.
After a spinoff in October, WhiteWave Foods (NYSE:WWAV) is now an operationally separate company, but Dean still owns 86.7% of the stock, allowing it to continue profiting indirectly until it distributes the shares to Dean shareholders in a few months. Given Dean's prospects, it will be less of a spinoff and more of a corporate re-enactment of Doc Holiday's final scene in Tombstone.
Dean currently has about $3.5 billion in long-term debt, more than its entire market cap, although part of the spinoff arrangement with WhiteWave is that the latter company has borrowed $1.155 billion from Dean and has also guaranteed all of Dean's debt. To further remedy its situation, Dean is selling its Morningstar division, one of the two remaining divisions after the WhiteWave spinoff, for $1.45 billion.
That leaves Dean with just one operating segment -- Fresh Dairy Direct, its most volatile. Fresh Dairy gets 74% of its sales from fluid milk, leaving the company deeply exposed to the continuing decline in milk demand and the volatility of its cost inputs.
The Foolish bottom line
Spinning WhiteWave off is a good move for shareholders, who no longer have to deal with having the rest of the company weigh it down. But once Dean distributes the WhiteWave shares and completes the sale of Morningstar, there will be little left for investors to be hopeful about.