NYSE:DF Dean Foods Company

Sector financial performance:

This company has been grouped in fluid milk sector of dairy industry, which has been mature with a flat growth for years.

Data indicates that the demands for fluid milk in US seem to have been declining in the past several years as indicated by continuingly decreasing sale volume of some of typical companies in this sector. And this is consistent with data provided by the U.S. Department of Agriculture ("USDA") that per capita consumption of fluid milk continues to decline. It may also be related to change in traditional distribution channels of those companies and increasing competition from private label market.

While the average sales volume have been declining at about 2-5% annual rate in the past several years, it seems the profit and cash inflow of the companies in this sector have been determined to larger extent by the margins than sales volume because of large volatility in raw materials’ price even though the average gross margins and operating margins are relatively low as a mature industry. By the federal regulation, the minimum dairy commodity price such as class I milk changes monthly. The changes in raw milk costs can partially be transferred by the companies of fluid milk to the price of their private label products immediately but not for their branded products. Therefore, for those companies the large fluctuation in price of raw milk can be reflected directly to its margin and the income for branded products, which are the major resources of those companies. This is reason behind what we see from the companies’ performance in the past several years as the average class I milk’s price went down.

Raw milk price are related to the whole diary environment and get involved with many uncertain factors. Therefore, we are not trying to predict the changes in their price and as well fluid milk companies’ financial performance given that the demands have been declining. However, what we know is that the decreased demands have been concentrated on white milk but not on advanced processed milk such as flavored milk. We think this is consistent with what is happening in other sectors of food industry as consumers’ preference for premium products, which are able to provide high quality and better taste, has been the major trend in today’s food consumption industry thanks to the new changes in demography, economy, and life styles of young generation.

According our data, the sector‘s average enterprise price/EBI ratio is 38 currently, a signal of confidence on profitability of this company while shrinking demand. It is also a signal that gross margin is at low level at which it will have no positive reflection on the changes in sales and this company is using its spending on advertising and SG&A inefficiently.

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Company performance:

Due to unfavourable dairy and retail environment and increasing competition in private label market, we have seen that demand for products of companies in this sector has been declining in the past several years as indicated by decrease in sales volume. In addition, the continuing decrease in raw milk price (except for 2017) and thus the product price of milk also contributed to decrease in sales.

For first three quarters of fiscal 2018 compared with 2017 (ended 20180930)

Net sales (organic) decreased about 7% due to decrease in volume and decrease in price (-11% for class I).

For fiscal 2017 compared with 2016 (ended 20171231)

Net sales (excluding acquisition) decreased about 1% due to decrease in volume offset by increased price (11% for class I).

It seems the demand for fluid milk products of this company has been declining in the past several years as indicated by the sale volume numbers, which has decreased by 2%-3% annually. However, the decreased average sales prices resulted from significantly decreased diary commodity price should be blamed for the decrease in sales of 5% and 14.5 in 2016 and 2015 respectively. As the price of dairy commodity price rebounded after entering 2017 and thus the average sales price did the same, this sales number increased in the first 6 months of 2017 while offset by the continuing decreasing sale volume.

Decrease in demand and volume apparently put pressure on profitability of this company. However, it seems that the favourable raw milk’s price in the past several years actually helped offset the impact from decreasing volume on its margin. When dairy commodity cost decreased in 2016 and 2015, while offset by the decreased sales volume this company’s gross margin actually went up. When the cost of dairy raw materials went up (class I went up 11%) in 2017, we see a lower gross margin.

This company’s financial ratios present a typical performance for fluid milk sector. Its current gross margin, operating margin, and cash inflow margin are about 22%, 1%, and 0%. It has a 38% debt/asset ratio and 25% interest/EBITDA ratio currently.

Stock price  

Our valuation methods and analysis indicate that this company has an enterprise price/EBI of 38 currently. We think it might be currently relatively slightly overvalued by the market.

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