Dean Foods In a Losing Struggle With Sour Dairy Market

by Lawrence Meyers | October 8, 2011 6:00 am

As I pondered the vast assortment of eggs, milk, yogurt and other dairy products sold by my local supermarket, I also pondered the wisdom of investing in dairy. Since I couldn’t actually purchase cows for milking, chickens for fresh eggs, or bacterial processing gizmos to create yogurt, I figured there must be some way to take advantage of all the dairy that gets consumed around the world.

So I came across Dean Foods (NYSE:DF[1]). It’s kind of an uber-dairy producer. It manufactures, markets and distributes cream, ice cream mix, creamers, yogurt, cottage cheeses, sour creams, whipping creams, butter, cheese, eggs and — yum! — milk shakes. The company doesn’t restrict its sales to supermarkets, either. It sells to distributors, foodservice outlets, educational institutions and governmental entities. It even dabbles in fruit juices, fruit-flavored drinks, iced teas, water, plant-based beverages (like soy, almond and coconut milks), soy food products and creamers. Sixty-three percent of Dean Foods’ dairy product mix is fresh milk, and 60% of its dairy sales are from retailers. So, basically, it’s not for the lactose intolerant.

A business like this faces a lot of challenges. Dairy is a mature industry. Growth is nonexistent. Milk consumption is declining, according to the U.S. Department of Agriculture. Competition is fierce. Smaller players try to maintain volume to cover costs. There’s so much competition that dairy producers must bid to get their products into stores. Retailers are fighting over customers themselves, so they lower prices on things like milk, which requires dairy companies to bid lower to get the shelf space. Thus, both the dairy company and the supermarket see margins get squeezed. Yikes!

As a result, Dean Foods and other dairy producers are focusing more on cutting costs, since that’s something they can control — to a certain extent. For the past 20 years, Dean Foods also has relied on growth via acquisition of some 40 dairies.

Sound like a tough business to be in? It is. Earnings fell from $240 million in 2009 to $91 million in 2010, with the company reporting a $20 million loss in Q4. Things have been improving a bit this year. Backing out nonrecurring charges, the company has earned $115 million. Cost-cutting would be a good idea. Cost of revenue and SG&A expenses have been rising faster than revenue growth for several years.

The company also is heavily laden with debt, to the tune of $3.89 billion at an interest rate of about 6%. That’s a big chunk of operating earnings that goes to debt service. There is some good news in that the company generates free cash flow. Unfortunately, that’s gone from $460 million in 2008 to $400 million in 2009, then down to $233 million in 2010 and — gulp! — only $59 million so far this year. Things are going from bad to worse. The company only has $116 million in cash on hand.

Analysts see annualized growth over the next five years averaging 11%, but that’s after this year’s expected fall from 80 cents per share to 69, then a recovery in 2012 to 88 cents again.


I have to be honest. I love milk shakes, but I am not loving Dean Foods’ stock. It’s trading at almost 13 times this year’s earnings, and the financial situation is not looking good. I would not buy the stock at this price, and aggressive investors might even consider shorting. If free cash continues faltering, Dean will limp along at best. At worst, it might sour entirely.

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