Jerry Hutcheson and Faloh Investment
Dean Foods Company (DF) is a supplier of high-quality, locally-produced dairy products. Our forecast for their future is very bullish. There are several trends to support this. Let’s get into why we rate Dean Foods a buy.
Primarily driving the long thesis is a combination of steady or declining raw milk prices and our forecast for reduced fuel surcharges on freight. These two factors will combine to improve profit margins:
In addition, management is showing sensitivity to consumer trends toward organic and grass-fed. Brands such as Organic Valley Grass-fed Milk emphasize this and greatly contribute to higher margins as customers move up the shelf toward quality products. This healthy choice trend is large and growing as evidenced by big corporate activity in this sector, such as Kraft Heinz’ (KHC) $200-M purchase of Mark Sisson’s Primal Kitchen brand.
The Trend for Strong Brands & Higher Nutrient Density Foods
The issue of clean food for health and wellness has never been more important. There are constant conflicting arguments in the media telling us that one thing is healthy, and another is not healthy. Then in a few years this changes once again. The need to have stable, long-term brands that enforce this theme of consistency and health is paramount. Dean Foods has beverages for the health-conscious consumer who chooses standard milk over soda or beer, and the healthy organic shopper too.
We have seen Mr. Market push Dean Foods from $15 per share down to $4.64 per share. The reduced corporate expenses as a result of recent asset consolidations indicate to us that we are finally getting to the bottom of the trend. We see a bullish projection of Dean Foods going to over $8.00 per share.
There has been quite a bit of consolidation in their expense area as management has completed asset rationalization with seven plants closed during the 3rd Quarter of 2018. Closing the plants cost several million dollars which contributed to the company’s above-normal expenses for the period:
The company’s trailing-twelve-month loss is $16M, almost wholly accounted for in the one-time costs for plant closure and severance.
The Dairy Industry
Other general industry trends are also driving greater-than-expected growth. While simple dairy products such as milk are fairly level after a long decline in per-capita consumption, indulgences in the dairy industry are on the upswing. Dean Foods meets this trend with Organic Valley high-end cheeses and the always-popular sour cream. These areas carry more margin and contribute meaningfully to Dean Foods’ bottom line. Another trend worth noting is the health movement toward choosing food with high-nutrient density, dairy delivers fat, protein, and calcium.
The cheese category continues to see expansion. We see this as a positive driver for Dean Foods. With the upswing in keto diets and paleo diets (as the following Google Trends report indicates), you are going to have consumers looking for sources of fat such as milk once again.
Keto diet trend:
Whole milk is trending 50% higher since 2014 (the chart does a poor job showing the magnitude of this change):
While in the past there was a trend toward low fat – low-fat yogurt, low-fat milk, even no-fat everything – the trend has clearly shifted. In terms of yearly sales, whole fat milk and whole fat yogurt are up 9.1%. In the indulgences category, such as ice cream, the trend is positive as well as consumers are less likely to flee items containing the saturated fat boogie man.
Having established, wide-scale distribution is a key advantage for the company to pick up this return to healthy eating in the national population. Some of Dean Foods’ brands have been around going back to the 1920s such as the well-known T.G. Lee. Their longevity is a testament to their ability to see through all types of hardships as well as upturns in the market, and their deep distribution network.
Valuation And Downside Risk
Fundamental health trends and reduced corporate costs, thanks to assets rationalization, are substantial tailwinds for the company’s bottom line.
The simple economics of falling raw milk prices boosts this bullish tempo even more.
Dean Foods will most likely exceed revenues of $5.5 billion in 2019 based on its 3rd Quarter sales of $1.89B.
At our forecast 1.5% profit margin, thanks to the averaging down of raw milk prices and fuel charges, we have a target market capitalization of $825M at 10 times forecast earnings compared to today’s capitalization of $425M at $4.66. On a price per share basis, the implied upside from $4.66 is 88% for our price target of $8.79.
The primary catalyst for the market is going to be a return to profitability.
Downside risk remaining in this business stems from the long-term debts of $887M. If fuel price or raw milk surges we will be likely to see the company continue to report a small quarterly loss, which will stall any bullish price action.
This Article is not intended to provide tax, legal, insurance or investment advice, and nothing in the article should be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security by Faloh Investment. You alone are solely responsible for determining whether any investment, security or strategy, or any other product or service, is appropriate or suitable for you based on your investment objectives and personal and financial situation. You should consult an attorney or tax professional regarding your specific legal or tax situation.
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Disclosure: I am/we are long DF. 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.
Additional disclosure: Long a combination of equity, calls, and puts.