A stock that has declined sharply could represent a good investment opportunity if it is a good business with solid fundamentals. Recently, Dean Foods (NYSE:DF) dropped around 10% after announcing its third quarter earnings results. Currently, Dean Foods is trading at $18 per share with a forward earnings valuation of 15.4.
In the third quarter, Dean Foods generated around $2.2 billion in sales, while its earnings per share came in at around $0.12 per share, excluding the gain from the WhiteWave (NYSE:WWAV) business divestment. The market turned pessimistic on the stock because its full year EPS guidance of $0.85-$0.91 was far below the analyst estimates of $0.98. However, there are three reasons that investors can still be bullish about Dean Foods.
First is the deleveraging efforts of the company. After divesting Whitewave and Morningstar, Dean Foods could generate as much as $2 billion in value for shareholders. The firm generated $589 million in cash from the sale of Whitewave, and it expects to use some of the proceeds to reduce its debt.
At the end of the third quarter, its leverage ratio was quite reasonable at 1.64 times net debt/EBITDA (earnings before interest, taxes, depreciation and amortization). Compared to WhiteWave and General Mills (NYSE:GIS), Dean Foods' current leverage ratio is much lower.
With trailing EBITDA of $256 million, WhiteWave's leverage ratio was about 2.5, while the net debt/EBITDA of General Mills was about 2.2. Recently, Dean Foods has had cash tender offers for up to $400 million of its 2016 and 2018 bonds. I expect that its leverage ratio will decrease with its deleveraging efforts, which will lower interest expense and boost the bottom line.
Cost cutting initiatives
Second, Dean Foods has been applying several cost cutting initiatives, including plant closures. In the past twelve months, the company has completed seven plant closures to improve its operational efficiency. By mid-2014, Dean Foods will close 10%-15% of its total network, equivalent to eight to 12 plants.
Like Dean Foods, WhiteWave is also focusing on cost reduction to improve its operating margin while maintaining its high growth. In the third quarter, WhiteWave experienced 10% growth in its revenue to $639 million, whereas its operating income rose by 13% to a record high of $66 million. EPS came in at $0.19, an impressive year-over-year growth of 21%. For the full year of 2013, WhiteWave wants to expand its 2013 operating margin by at least 50 basis points over last year. The capacity expansion projects could help WhiteWave increase its operating margin by 75 basis points a year over the next several years.
General Mills has also been implementing Holistic Margin Management, or HMM, targeting $4 billion savings globally this decade. The company reported that the plan was on track, delivering $1.4 billion savings since 2010. In 2014, although input cost inflation is expected to be around 3%, the HMM strategy could still drive margin expansion for the whole business. The company also intends to increase its dividend payment by 15% and reduce the average diluted number of shares by 2% in 2014.
Enhance cash return to shareholders
Third, the company has shown willingness to return cash to its shareholders via both dividend payments and share repurchases. Dean Foods has announced that it will pay a $0.07 quarterly dividend to shareholders in the first quarter of 2014. Thus, the annualized dividend payment would be $0.28, giving investors a 1.54% dividend yield.
Moreover, investors will also receive cash via share repurchases. Dean Foods has increased its share repurchase authorization up to a total of $300 million. As Dean Foods is worth $1.72 billion on the market, a $300 million share buyback could represent as much as a 17.4% yield to shareholders.
My Foolish take
With ongoing deleveraging activities, cost reduction initiatives, and increasing cash returns to shareholders, Dean Foods could deliver good value to long-term investors. Income investors could also consider General Mills as it currently pays a 3% dividend yield with a reasonable payout ratio of 51%, and it also has upcoming share repurchases.