Dean Foods Company
/ (DF-NYSE)/ Equity Research / DF | Page 2
Current Recommendation / NEUTRAL
Prior Recommendation / Underperform
Date of Last Change / 11/20/2014
Current Price (03/03/15) / $16.34
Target Price / $17.00
Dean Foods reported dismal fourth-quarter 2014 earnings and provided a cautious outlook for 2015 due to uncertain industry dynamics. The company revealed that high raw milk prices persistently dragged down its bottom-line throughout the fourth-quarter. While the company is encouraged by the decline in raw milk prices since Dec 2014, it remains a concern about the volatile dairy commodity environment. Further, the company’s volume performance continues to be impacted by higher input costs. However, Dean Foods expects 2015 results to improve substantially from 2014 given the successful elimination of structural costs from its system and the numerous benefits that are expected to follow lower raw milk costs. Moreover, the company’s ongoing strategic initiatives focused on improving price realization, cost productivity and volumes at margins, position it well to generate enhanced returns.
SUMMARY
/ Equity Research / DF | Page 2SUMMARY DATA
52-Week High / $19.5652-Week Low / $12.70
One-Year Return (%) / 10.57
Beta / 1.22
Average Daily Volume (sh) / 2,685,047
Shares Outstanding (mil) / 94
Market Capitalization ($mil) / $1,538
Short Interest Ratio (days) / 3.72
Institutional Ownership (%) / N/A
Insider Ownership (%) / 3
Annual Cash Dividend / $0.28
Dividend Yield (%) / 1.71
5-Yr. Historical Growth Rates
Sales (%) / -6.1
Earnings Per Share (%) / -24.3
Dividend (%) / N/A
P/E using TTM EPS / N/A
P/E using 2015 Estimate / 19.7
P/E using 2016 Estimate / 15.0
Zacks Rank *: Short Term
1 – 3 months outlook / 3 - Hold
* Definition / Disclosure on last page
Risk Level * / Above Avg.,
Type of Stock / Mid-Blend
Industry / Food-Dairy Prds
Zacks Industry Rank * / 115 out of 267
OVERVIEW
Based in Dallas, TX, Dean Foods Co. is a leading processor and distributor of milk and other dairy products in the U.S. as well as a leading manufacturer of various specialty food products. The company operates primarily on a local basis, competing mostly with local and regional operators.
Following the sale of its Morningstar business and separation of WhiteWave-Alpro business into the newly formed The WhiteWave Foods Company, Dean Foods operates with only one operating segment i.e. Fresh Dairy Direct.
Fresh Dairy Direct consists of branded and private label fluid milk, ice-cream, creamers, juices, teas, bottled water, and other products. The products in this segment have a shorter shelf life and are distributed through the company's national refrigerated direct store delivery (DSD) system.
REASONS TO BUY
Ø Strong Brand Portfolio – A Competitive Edge: Dean Foods enjoys a leading position in the food and beverage industry owing to its strong portfolio of brands, which serve as a competitive advantage and at the same time compliment its customer base. Through its brands the company also leverages the national scale of its distribution network. Additionally, being one of the low cost producers the company is well-positioned in the industry and strives to further extend this advantage through cost reduction activities across its business.
Ø Concentrating on Core Business Activities to Drive Long-Term Growth: Dean Foods has taken strategic steps to optimize its capital allocation and concentrate on core business activities. In the face of industry headwinds, the company’s strategic measures are primarily focused on three controllable factors – price realization, cost productivity and volumes at margins that will aid in delivering appropriate returns. The company underwent a major transformation into a core dairy products company in 2013 with the sale of Morningstar business and spin-off of The WhiteWave Foods Co. These transactions freed up over $2 billion in shareholder value and are expected to provide significant financial flexibility going forward. Additionally, the sale of interest in WhiteWave is also expected to facilitate individual growth of both Dean Foods and WhiteWave.
Ø Continued Focus on Cost Reduction to Improve Profitability: Dean Foods continues to make headway in its efforts to achieve the lowest cost position in the industry. The company has benefited from its constant focus on cost reduction initiatives, such as lowering of headcounts across businesses and closure of plant network. The company’s efficiency efforts for 2013 and 2014 targeted the planned closure of 10%–15% of its plant network (8–12 plants) by mid-2014. In 2014, the company successfully completed its goal of closing 12 manufacturing facilities as part of its accelerated network optimization plan. These plant closures along with the realization of other cost reduction actions are expected to gradually lower Dean Foods’ per-unit production rate and distribution costs, which will ultimately benefit its bottom-line results.
REASONS TO SELL
Ø Fluctuating Raw Material Prices and Uncertain Industry Trends Impact Outlook and Estimates: Dean Foods’ business is heavily dependent on commodities such as raw milk, soybeans, diesel fuel and others, the prices of which often fluctuate. Hence, any rise in their prices will hurt the company’s margins. Raw milk prices have been continuously increasing since Aug 2013. In fourth-quarter fiscal 2014, raw milk cost of Class I Mover registered a year-over-year increase of 18% and touched the second quarterly high of $23.59 per hundred-weight, marginally below the all-time quarterly high of $23.66 per hundred-weight. Though raw milk costs have started to decline since Dec 2014, the company is concerned about the sustenance of significant cost declines across the U.S. dairy commodity complex over the mid-term, as the dairy commodity environment remains volatile and unpredictable. Moreover, reaction of retailers and consumers toward the ongoing raw milk cost declines remain uncertain, making it difficult to ascertain whether such reductions will improve the overall health of the fluid milk category, and if so, then what will be the magnitude and timing of this improvement. As a result, the company has provided only first-quarter fiscal 2015 guidance, which indicates disappointing volume trends ahead. These factors instilled a downtrend in the Zacks Consensus Estimate for fiscal 2015 and 2016.
Ø Competitive Pressure: In recent years, the retail grocery industry experienced significant consolidation, and as a result, competition has intensified among dairy product suppliers. Dean Foods experiences stiff competition, both geographically and particularly at the processor level, in all major product lines. The company could suffer significantly from the loss of any large regional grocery chain. It not only competes with various dairy processors for shelf space but also with various beverages and nutritional products. The company’s major rivals include Kraft Foods, Nestlé and ConAgra.
Ø Risk of Dealing Business with Few Customers: Dean Foods is heavily dependent on a handful of customers, including large discounters, supermarkets and warehouse clubs. This considerably reduces the company’s pricing power against these retailing giants, thereby exerting pressure on margins and limiting profitability.
RECENT NEWS
Dean Foods Falls on Dismal Q4 Earnings & Cautious '15 View – Nov 10, 2014
Dean Foods Company posted dismal fourth-quarter and 2014 earnings and provided a cautious outlook for 2015 due to uncertain industry dynamics.
The company revealed that high raw milk prices continually dragged down its bottom-line results from the beginning till the end, i.e., fourth-quarter of 2014. Dean Foods posted adjusted earnings of $0.08 per share from continuing operations in the fourth quarter, down nearly 56% from adjusted earnings of $0.18 in the year-ago comparable quarter. Moreover, earnings fell short of the Zacks Consensus Estimate of $0.10.
On a reported basis, the company posted earnings of $0.06 per share from continuing operations, contrary to a loss of $0.40 in the year-ago comparable quarter.
Quarter in Detail
Dean Foods’ net sales increased approximately 4.3% year over year to $2,395 million from $2,295.5 million in the prior-year quarter but came below the Zacks Consensus Estimate of $2,435 million. Total company volumes declined 2% in the quarter to 683 million gallons versus 699 million gallons in the prior-year quarter.
Raw milk costs remained high during the quarter, which resulted in volume declines in the fluid milk category, thereby impacting the overall category results. The Class I Mover registered a year-over-year increase of 18% and touched the second quarterly high of $23.59 per hundred-weight, marginally below the all-time quarterly high of $23.66 per hundred-weight.
However, the company notes that raw milk costs have started to decline from Dec 2014, continuing into 2015. The Class I Mover in Jan 2015 was down $3.95 per hundred-weight to $18.58 per hundred-weight, while it decreased further by $2.34 per hundred-weight to $16.24 per hundred-weight in Feb 2015.
Adjusted operating income fell 46.3% year over year to $25.7 million for the quarter compared with $47.9 million in the prior-year quarter. The year-over-year decline in operating income was primarily due to higher raw milk prices. However, operating profit improved $16 million or about $2.3 a gallon sequentially, driven by the company’s continued progress in price realization.
Full-Year Synopsis
For 2014, the company’s adjusted loss came in at $0.14 per share as against earnings of $0.86 per share in 2013 and wider than the Zacks Consensus Estimate of a loss of $0.12 per share. Revenues for the year increased 5.4% to $9,503.2 million but missed the Zacks Consensus Estimate of $9,533 million.
Financial Position
The company ended the year with cash and cash equivalents of $16.4 million, long-term debt including current maturities of $917.7 million and shareholder’s equity of $627.3 million. During 2014, the company generated $152.9 million of net cash from continuing operations. On an adjusted basis, the company generated about $25.3 million of free cash flow in 2014.
At the end of 2014, the company's funded debt to earnings before interest, taxes, depreciation and amortization (EBITDA) ratio, as defined by its credit agreements, was 4.48 times, in compliance with its maximum leverage covenant ratio of 5.25 times. This indicates the company’s adequate financial flexibility to service its debt.
Outlook
Looking at the year ahead, Dean Foods expects 2015 financial results to improve substantially from 2014 in light of the successful elimination of structural costs from its system and the numerous benefits that are expected to follow lower raw milk costs.
However, the company remains cautious due to the sustenance of significant cost declines across the U.S. dairy commodity complex over the mid-term, as the dairy commodity environment remains volatile and unpredictable. Moreover, the reactions of retailers and consumers toward the ongoing raw milk cost declines remain uncertain, making it difficult to ascertain whether such declines will improve the overall health of the fluid milk category, and if so then what will be the magnitude and timing of this improvement.
Additionally, the company expects a rise in the competitive environment to impact results as it operates in an industry with over-capacity and declining commodity costs.
As a result, Dean Foods has only provided specific guidance for the first quarter of 2015 and held back its forecasts for the full year. It expects volumes to decline in the low to mid-single digits range in the first quarter, while adjusted earnings is anticipated in the range of $0.12–$0.22 per share.
Moreover, the company expects capital expenditures of about $150 million in 2015.
VALUATION
Dean Foods is trying hard to optimize its financial performance through a string of measures for enhancing its growth prospects. The company is focusing on improving its structure by dipping investment in sections of the company that no longer contributes significantly to its growth. Apart from this, the company is also focusing on cost containment initiatives to improvise margins. However, we believe the uncertain commodity environment and competitive pressures will continue to weigh on the company’s performance.
Currently, we have a long-term Neutral recommendation on the stock. Our target price of $17.00 is based on 20.5x 2015 EPS.
Key Indicators
Earnings Surprise and Estimate Revision History
DISCLOSURES & DEFINITIONS
The analysts contributing to this report do not hold any shares of DF. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts’ personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts’ compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1126 companies covered: Outperform - 15.5%, Neutral - 75.6%, Underperform – 8.2%. Data is as of midnight on the business day immediately prior to this publication.
Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company’s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock’s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively.