Dairy products producer Dean Foods (NYSE:DF) disappointed the markets with a sour quarterly performance last week, and though the stock dropped nearly 10% on the news, it's since bounced back as the plan for getting moving again resonates with investors.
Despite being the largest dairy products company, its share of U.S. fluid milk sales volume declined to 36.4% from 37.8% during the second quarter. Not only is it having to contend with falling consumption, but competition is heating up too. It's coming from other dairy producers like the one that beat it out earlier this year for a private-label contract with an unnamed "significant customer," as well as from its own customers, who are themselves becoming vertically integrated in a bid to produce their own dairy products.
Last year's purchase of Bareman's Dairy by grocery store chain Meijer came as a complete surprise to Dean considering it had supplied the supermarket with its store-brand milk for more than 50 years. But vertical integration by grocers is not unheard of in the grocery industry, as Kroger operates 15 dairies and two ice cream plants to supply its private-label products and Safeway owns Lucerne Foods, which makes its own-label dairy goods.
But happening as it did just as Dean was losing customers made a tough situation worse. In February Dean said one of its top customers had put out an RFP for dairy products that it ended up losing to an unnamed rival, which ended up impacting second-quarter results.
The dairy industry is suffering from overcapacity because the USDA says milk consumption continues to decline. Per-capita consumption is down 23% since 1975 while whole-milk sales are down 58%, even as sales of 2% and 1% milk have risen. Over the past few years Dean Foods has put out to pasture about 10% to 15% of its capacity to meet the lower demand, and it expects to idle a similar percentage going forward. The market-share grab the dairy producer engineered hasn't quite worked out as planned.
Dean anticipated that by grabbing share and gaining private-label contracts, it would be able to force smaller dairies to reduce their capacity. It estimated the industry had anywhere from 25% to 30% more than was necessary, but as it's worked out, it's been Dean that's had to cut back operations. It explains that because there are so many one- or two-dairy operators out there, if they reduced capacity they would actually go out of business. Might have been nice to think of that beforehand.
Still, Dean plans on wringing more efficiencies out of its remaining facilities, though that's something all companies that are cutting back production say they're going to do. Having IPO'd its growing WhiteWave Foods division last year and sold off its Morningstar business to start off 2013, Dean is more focused than ever on its milk business, but it's one that operates on margins thinner than skim.
New product introductions and relying upon sweeteners to boost sales has helped the dairy industry stem the decline in volumes somewhat, and Dean itself is rallying around its TruMoo brand of chocolate milk to lift it up going forward (the chocolate milk contains 35% fewer grams of sugar than its largest rival, has less fat, and contains no artificial ingredients and no high-fructose corn syrup). Dean Foods has also substantially improved its balance sheet, reducing total long-term liabilities from more than $2.8 billion last year to less than $1.7 billion in the current quarter.
Sales losses are always hard and excuses are easy to give, but you won't find this dairy products producer crying over its spilled milk.
Fool contributor Rich Duprey owns shares of Dean Foods and WhiteWave Foods. The Motley Fool owns shares of Dean Foods 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.