Dean Foods' Outlook Hazy

May.31.11 | About: Dean Foods (DF)

We maintain a long-term neutral recommendation on Dean Foods Co. (NYSE:DF). The company 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.

To counter the ill effects of declining milk processing profits from increased money-offs on private label items and weak sales volume, Dean Foods is taking prudent steps, which include price realization through passing input cost inflation to customers, cost reduction initiatives and increasing volume performance. These fundamental steps will facilitate in stemming the rot and rebuilding the company’s profitability.

Dean Foods continues to make headway in its efforts to achieve the lowest cost position in the industry. Management has reduced head counts by 600 positions across all areas of businesses, which resulted in significant cost savings in the first quarter of 2011. The company is aggressively streamlining its cost structure with $125 million in cost savings targeted for 2011 and $300 million over a period of three-to-five years.

Also, Dean Foods recently amended its Senior Secured Credit Agreement with lenders in an effort to enhance financial flexibility and improve operating performance. Recently, the company has extended the maturity of 86% of total borrowings under its Revolving Credit Facility and Term Loan A to 2014 from 2012. Moreover, the maturity of 60% of total outstanding borrowing under Term Loan B has been extended from 2014 to 2016 or later. Moreover, the company has received the pending receipt of $180.0 million from the sale of its Mountain High yogurt operations, which will be used to retire debt.

Additionally, the acquisition of Alpro is expected to drive sales growth of the WhiteWave-Alpro segment. Alpro is the European leader in branded soy-based beverage and food products with strong brands like Alpro soya and Provamel. Demand for soy and organic foods has increased rapidly due to growing awareness among consumers about their health benefits. The acquisition of Alpro gave the company a significant opportunity to expand into new markets across the European Union.

On the flip side, in recent years, the retail grocery industry has undergone substantial consolidation, resulting in intensified competition among dairy product suppliers. Dean Foods experiences stiff competition, especially at the processor level, in all major product lines and geographic markets. Dean Foods competes not only with various dairy processors for shelf space, but also with beverage and nutritional products companies. The company competes head to head with Kraft Foods Inc. (KFT).

Moreover, Dean Foods is heavily dependent on a handful of customers, which include large discounters, supermarkets and warehouse clubs. This considerably reduces Dean Foods’ pricing power against these giant retailers, thereby exerting pressure on margins and limiting profitability. The company’s profitability would also be thwarted by the loss of any large regional grocery chain.

Besides competition and customer concentration, Dean Foods’ recent decision to divest its milk processing and related businesses situated in Waukesha, Wisconsin will certainly hurt its top line, as the company has more than 60% of market share in the region. The divestment decision is a part of antitrust dispute settlement agreement between the company and the U.S. Department of Justice and the states of Wisconsin, Illinois and Michigan.

Dean Foods currently has a Zacks #3 Rank, implying a short-term hold rating on the stock.