Dean Foods: Moving Ahead Despite Challenges

| About: Dean Foods (DF)

Summary

Company needs to look actively for strategic acquisitions to support growth.

Dean Foods needs to focus more on improving its cost structure to support its earnings growth.

Operational execution stays vital for future performance.

Dean Foods (NYSE:DF) sells milk, cream, and ice-cream to big retailers. Deans Foods has been struggling to grow its revenues in the recent years because of structural changes in the industry, including high private label penetration and declining per capita milk consumption. Dean Foods' regular milk business is almost 70% private label. As the company has been facing challenges to grow its sales volume, it should continue to diversify its product portfolio, expand its distribution and build strong relations with retailers. In the milk category, the company recently lost its private label milk contract at Walmart (NYSE:WMT), which will adversely affect its sales volume. Going forward, the company needs to look actively for strategic acquisitions, to support its sales volume growth and address industry challenges. Also, as sales volume has been weak, it should consistently work to improve its cost structure to support its earnings growth, which will also bode well for the stock valuation.

Financial Performance and Catalysts

In the recent years, the company has been struggling to grow its sales volumes due to intense competition in the industry, especially from increasing presence of private label milk competitors. Also, declining per capita milk consumption and growing popularity of flavored milk and other milk alternates have been weighing on the sales volumes. For the 1QFY16, the company's sales volume were down by 3%; however, the company managed to register an earnings beat of 18% and its gross margin improved by 360bps, mainly because of lower dairy prices. Raw milk costs fell nearly 15% YoY in the quarter.

Moreover, the company lost almost 100 million gallons of private label milk contract at Walmart, as Walmart is opening its milk processing facility in Indiana. This will not only impact the company's sales volumes adversely but will also affect its margins, as lower plant utilization rates will lead to fixed cost deleveraging, and DF can also lose branded milk placement at Walmart. Recently, DF completed the acquisition of Friendly's Ice Cream, to support its growth. I believe the acquisition will augur well for DF's financial performance in the future years, as it will allow DF to expand its market presence, and strengthen its market position in markets where its brands are not well established in ice-cream category. Currently, almost 75% of Dean's ice-cream sales are concentrated in Midwest and Southeast regions, and the acquisition will give it market access to Northeast region for the first time. Also, the acquisition will positively affect its milk volume by 30-40 million gallons, which will partially offset 100 million gallon contract at Walmart.

As the industry environment remains competitive, the company should actively look for strategic acquisitions to support its growth, and work to expand its frozen brands. If the company expands its frozen brands' exposure, it will not only support its sales growth but will also positively affect its profit margins, as frozen brands have an operating profit margin of 13-15%, versus DF's operating margin of 5%. Moreover, it should diversify the business, strengthen its product portfolio, and should work to build strong relations with retailers to improve its future business performance.

Also, the company needs to increase its focus on improving its cost structure and try to make efforts to reduce costs at a faster pace than volumes decline. The company has a target to achieve cost savings of $80-$100 million annually; however, the cost savings are not significantly flowing through the bottom line. The company needs to make aggressive efforts to reduce its distribution cost. Also, the recent acquisition of Friendly's Ice Cream will allow the company to enjoy synergies, through consolidation of distribution and other operational functions.

Summation

The company is operating in an industry with tough business conditions, as competition is intense and per capita milk consumption is declining. The company needs to make aggressive and consistent efforts to support its sales volume, through diversifying its business and strengthening its product portfolio, to address the challenges. The acquisition of Friendly's Ice Cream will allow the company to increase exposure to high-margin and fast growing frozen brands categories, and will expand its market presence. In future, the company needs to look actively for strategic acquisitions, mainly in frozen brands division to strengthen its market position. And the company needs to focus more on improving its cost structure to support its earnings growth. As the industry conditions remain challenging, strategy to solidify its product portfolio and operational execution stays vital for its future performance.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.