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Dean Foods Is Not Sour

By Michael Lewis – Feb 13, 2014 at 3:28PM

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Though the stock is flirting with record lows, Dean Foods is enduring extremely difficult industry conditions. As things improve, so will the company.

Dean Foods (DF) missed the bottom-line analyst estimate by $0.01 and met expectations on revenue when it reported fourth-quarter earnings on Tuesday, yet the Street sold off nearly 8% of the company's market value. More depressingly, shares are near a record low as management delivered a pretty lifeless forecast for the coming periods. Dean Foods is seeing volume declines and potentially all-time high input costs. Does this make the company a definite no-go, or is the market experiencing another bout of myopia? Let's take a closer look at the recent earnings for clues.

Sour results
For investors looking for a silver lining behind Dean Foods' unappealing headline numbers, the pickings are slim. Marking its fourth consecutive quarter of earnings misses, the country's largest dairy purveyor simply cannot cut costs enough to compensate for soaring expenses. Passing the price hikes on to customers is effective, but only to a degree. If Dean makes the milk too pricey, shoppers will simply seek alternatives.

Fourth-quarter numbers weren't awful compared to what the Street expected, but the damage is more evident when you look at full-year 2013 versus 2012. Dean Foods had an adjusted operating income of $228 million in the just-ended year. In 2012, that number was $256 million. Fluid milk volume shipments dropped 9% year over year, though the bulk of that was due to one lost customer (admittedly, a very big one). When excluding that customer, though, volumes still dropped 0.6%. With SNAP benefits (food stamps) recently cut, management sees further pressure on demand.

All in all, there is a nightmare scenario for Dean Foods' 2014: skyrocketing input costs and decreasing demand. Luckily, there are a few good things to keep in mind.

Saving the ship
Dean Foods has a few good things that should keep the company floating through this difficult period. For one, as part of its deleveraging and cost-cutting effort, Dean Foods is an extremely efficient, cash flow-oriented business. Further addressing its business challenges, the company is closing eight processing plants. While that's hardly good news, it reaffirms management's dedication to running a tight ship.

The aforementioned deleveraging (net debt is $881 million, with a leverage ratio 2.21 times funded net debt to EBITDA) leaves Dean Foods comfortable on the liquidity front. Even though rising costs and expenses will put a damper on cash flow, the company won't have trouble meeting its obligations.

At 10 times forward estimated earnings and a dirt-cheap trailing EV/EBITDA of 3.18 times, Dean Foods is very attractively priced if you believe things will recover in the long term. Fluid milk volumes appear to be declining across the board, but Dean Foods continues to pick up market share. As the business gets harder for smaller shops, the company could grow well beyond its current 35% market share.

At these levels, Dean Foods is in turnaround territory. Management is extremely active and working to get the company through macro-level headwinds. Once these conditions pass, the underlying strength of the company should shine once again.

Michael Lewis has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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