We downgrade our recommendation for Dean Foods (DF) to Neutral, meaning the stock will perform in line with the broader market.
Earnings for the last quarter beat the Zacks Consensus Estimate by a penny, supported by the company’s cost management initiatives. However, consolidated sales suffered due to the pass-on of lower dairy commodity costs to consumers in the form of lower prices and reduced sales volume in the WhiteWave-Morningstar segment.
Dean Foods has taken definitive actions to improve shareholder and consumer value and extend its low-cost position while focusing on boosting branded product business. The company continues to generate healthy cash flow from operations allowing investments in product innovations, acquisitions and brand development.
In the mature yet consolidating dairy industry, management is expanding through strategic acquisitions and streamlining costs by closing down facilities. The company’s acquisition of Alpro (European leader in branded soy-based beverage and food products) is driving sales growth for WhiteWave-Morningstar.
However, Dean Foods continues to operate with a highly leveraged balance sheet and faces intense competition and volatile commodity and fuel prices, which warrants a cautious approach toward the stock. While the company recently raised earnings guidance for fiscal 2009, the management is concerned about the continued competitive activity in fluid milk operations and is cautious about diminished commodity favorability in the foreseeable future.
The dairy industry is mature and growing slowly with a slow-to-flat growth rate. In recent years, the retail grocery industry has experienced significant consolidation and, as a result, competition has intensified among dairy product suppliers. Dean Foods experiences stiff competition, especially at the processor level in all major product lines and geographic markets. The company’s major competitors are Nestlé, ConAgra (CAG) and Kraft Foods (KFT).
While Dean Foods remain focused on effective pass-through of changes in dairy input costs, we feel near-term visibility of rising raw milk prices may drag earnings and margins in the upcoming reporting periods. Dairy prices are expected to show an upward trend through 2010.
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