Over the past 12 months, Dean Foods (NYSE:DF) investors have been starving for some good news. During the span, the stock has lost roughly 26% of its value. Some of the losses have been due to a food/beverage industry that has been ravaged by weak volumes and compressed margins. But Dean Foods management hasn't exactly handled the situation as well as they could have.
The stock closed Friday at $15.81. Shares are down more than 7% on the year to date, trailing the sector's 7.2% gain. Dean Foods reported second-quarter earnings Monday. And with shares down almost 10% on the announcement, more investors have turned sour on the stock. But is it for the right reasons?
Second-quarter revenue arrived at $2.4 billion, up 9% year over year, topping last year's mark of $2.2 billion. This was good enough for beat of more than 3%. Wall Street was looking for revenue of $2.32 billion, or just 4% year-over-year growth.
During the quarter, the companies grew its share of U.S. fluid milk volume to 35.9%, up from 35.7% sequentially. I think this was an impressive accomplishment, considering that the entire industry suffered 4% decline in volumes during the quarter. This, according to data from the USDA. This means that Dean Foods actually stole market share from some of its rivals.
Although the company suffered volume declines (on an adjusted basis) due to the loss of a large customer in 2013, the number show that things are not as bad as perceived. What's more, even when looking at Dean Foods' 0.3% volume decrease in fluid milk, this was still an outperformance relative to its peers.
On an operational basis, Dean Foods reported a loss from continuing operations of $4 million, or 1 cent per share, compared to second quarter 2013 diluted loss of 61 cents per share. On an adjusted basis, the loss was 14 cents per share, compared to second quarter 2013 adjusted earnings of 26 cents per share. Wall Street was looking for a loss of 6 cents.
Gregg Tanner, the company's CEO said,
"The second quarter was even more challenging than we had originally anticipated. This is by far the most difficult operating environment in the history of the company, reinforcing the importance of the initiatives we have underway."
Chris Bellairs, the company's CFO, added,
"As a result of the extreme dairy commodity environment, we face unprecedented challenges, including softening category volumes, mix shift out of our brands and significant cost friction."
The executives are right. But I don't believe this quarter materially changes the long-term opportunities ahead of Dean Foods, especially with the company growing share in key markets.
Recall, it's been over a year since management announced it was selling its Morningstar Foods division to Saputo (OTCPK:SAPIF) for $1.45 billion. Later, Dean Foods' board of directors agreed to spin off the company's stake in WhiteWave Foods Company (NYSE:WWAV). The value potential in these moves will take more time to be extracted. Investors only need to be patient.
From my vantage point, Dean Foods, whose stock is now trading at a P/E of 4, deserves a much higher multiple. These maneuvers have positioned Dean Foods as a pure play in milk and other lower-end dairy products. What's more, Dean Foods' remaining businesses are now easier to understand. Management's job today is to outlined how the company's long-term strategy will reward investors in the years ahead.
The other thing to note is, there aren't many businesses, especially in the dairy industry, that are generating the quality cash flow that Dean Foods just delivered. In the second quarter, consolidated net cash from continuing operations totaled $25 million. Net cash flow advanced to $28 million in the first six months of 2014.
All told, this wasn't a great quarter by any stretch. But it was far from the disaster the stock reaction would lead to believe. With shares trading under $15, Dean Foods has all of the making of a potential turnaround story. On the basis of growing cash flow and fiscal 2015 estimates of $1.06 per share, these shares should reach $18 to $20 in the next 12 to 18 months.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The article has been written by Wall Street Playbook's retail sector analyst. Wall Street Playbook is not receiving compensation for it (other than from Seeking Alpha). Wall Street Playbook has no business relationship with any company whose stock is mentioned in this article.