A new day at Dean Foods

by Josh Sosland
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With its faster growing WhiteWave and Morningstar units no longer part of the Dean Foods Co. operating business, the company has shifted the way it views what had been its least dynamic segment — the Fresh Dairy Direct business.

“We’ve evolved from a company that had three totally distinct and different businesses and different business platforms into an enterprise solely dedicated and focused on our core dairy business,” said Gregg A. Tanner, chief executive officer, on May 23, during the company’s annual meeting. “In fact, we’ve adopted a vision to be the most admired and trusted provider of wholesome great tasting dairy products at every occasion.”

The upbeat view stands in contrast to how the F.D.D. division generally was characterized over much of the past decade by Dean Foods management. As recently as November 2012, outgoing c.e.o. Gregg L. Engles framed the fresh dairy business principally by its relative lack of growth prospects. Discussing the possibility of selling the company’s Morningstar dairy products business, Mr. Engles said, “We believe Morningstar is a business that has inherently higher growth rates and higher returns on capital than the F.D.D. business.”

The Morningstar business was sold in January 2013 for $1.45 billion to Saputo Inc. Three months earlier, Dean completed an initial public offering of its WhiteWave specialty beverage business, selling 20% of the business. On May 23, 2013, most of Dean’s remaining ownership of WhiteWave was spun off to Dean Foods shareholders (Dean continues to own 20% of WhiteWave, even after the spinoff).

What’s left?

In looking to explain how its new corporate vision translates into exciting potential for Dean, Mr. Tanner twice in recent months has held up its TruMoo flavored milk brand, first introduced in August 2011, as emblematic of what is possible at the company. Noting that the brand has outperformed the overall flavored milk category, he said TruMoo now is three times larger than its next largest national competitor.

“TruMoo was recently named the fourth most successful new consumer packaged goods product launched in 2012 by I.R.I.,” he said in a May 9 conference call. “That is out of 1,900 new products that were introduced. Now our national brand such as TruMoo gives us the ability to innovate and market on a national scale.”

More recently, Mr. Tanner said TruMoo has been reformulated to contain 35% fewer grams of sugar than its largest rival, lower fat and no artificial ingredients. It also does not contain high-fructose corn syrup.

“We are extremely pleased with the success of our TruMoo portfolio and have very high expectations for this brand to continue to grow in the years to come,” he said.

Beyond the success of TruMoo, Mr. Tanner said the merits of the decision to spin off Dean’s other divisions already have been broadly affirmed.

“Clearly 2012 was an extremely successful year for Dean Foods,” Mr. Tanner said at the company’s annual meeting. “The results of our focus were very clear. We grew material cost reductions across the business, we grew share and gained customers and we effectively priced to offset rising commodity costs, resulting in significantly increased profitability. We’ve also delivered tremendous value for shareholders by creating over $1.2 billion in equity value or an improvement of over 50% since the announcement on Aug. 7 of our intent to spin off WhiteWave Foods.”

In addition to changing the profile of the Dean Foods business, the company has strengthened its balance sheet considerably, Mr. Tanner said.

As of March 31, Dean’s long-term debt was reduced to $1.8 billion with another $721 million in other long-term liabilities. The combined long-term obligations of $2.5 billion were down 36% from a year earlier. Looking more completely at the balance sheet, Dean Foods said net debt was down by more than $2.6 billion over the past year with a debt-to-EBITDA ratio of 2.13.

Got profits?

As a stand-alone company in the fluid milk industry, Dean Foods benefits from what the company describes as a number of “attractive attributes” while also facing “some well documented challenges.”

On the plus side, the company describes fluid milk as “nutritious and healthy” with excellent household penetration — more than 90% of U.S. homes. As a result, fluid milk is a very large category (the largest by certain measures) with about $20 billion in annual sales.

“This category’s size and pervasiveness, plus the limited shelf life of the product, make it an important category for retailers and consumers, as well as a large long-term opportunity for the best positioned dairy processors,” Dean said in its most recent 10-K, filed earlier this year with the Securities and Exchange Commission.

On the other side of the ledger, Dean acknowledged the milk business is mature and fragmented and has grappled with scant growth and unimpressive profit margins.

“According to the U.S.D.A., per capita consumption of fluid milk continues to decline,” the company said. “Due in part to the current economic climate, which continues to be challenging for broad segments of the population, and historically high retail prices, the fluid milk category has posted declining volumes over the last several years. In addition, the industry experienced retail and wholesale margin erosion in 2010 and 2011, as conventional milk prices increased steadily in recent years; however, during the fourth quarter of 2011, milk prices decreased slightly and continued to decline through the first half of 2012. Retailers did not fully reflect such declines in shelf pricing, which partially restored the historical price relationship between branded and private label milk and allowed our regional brands to compete more effectively during that period. Milk prices rose significantly during the second half of 2012; however, we were able to effectively adjust our pricing to offset these costs. Additionally, our volumes continued to outperform our peers throughout the year.”

As a standalone company, countering the weak margins has been a principal focus for Dean and will remain so, the company said. In particular, Dean said it will “continue to emphasize price realization, volume performance and disciplined cost management in an effort to improve gross margin and drive
operating income growth.”

Also contributing to its progress has been organizational changes aimed at cutting selling and general and administrative costs. While the efforts have yielded encouraging results, the sailing for Dean has not been entirely smooth.

The company, through a request for proposal, lost a part of a significant customer’s business earlier in the year. Dean said the loss will show up beginning in its second-quarter results but downplayed its impact.

“We expect to accelerate our ongoing cost reduction efforts in 2013 to minimize the impact of these lost volumes,” Dean said in the 10-K.

Mr. Tanner was more upbeat still in comments at the annual meeting.

“We believe that as we move past this volume loss, we will return to our long-term trend of gaining share due to the strength of our network, our advantaged cost structure, effective pricing, our strong brands and a significantly strengthened balance sheet, and a focus on service, quality and customer relationships,” he said.

To improve margins and potentially reduce debt further, the company has initiated an aggressive cost reduction program that includes the closing of between 10% and 15% of its production plants to eliminate fixed costs and reduce a number of distribution routes. As of Dec. 31, 2012, the Fresh Dairy Direct business of Dean Foods operated 79 manufacturing facilities in 32 states.

The decision to reduce the capacity represents a continuation and expansion of moves the company already has taken in recent years. In the period between 2010-12, plants were closed in Michigan, Maine, Kentucky, Georgia and South Carolina, largely accounting for $73.1 million in charges.

Also during 2012, Dean eliminated 120 corporate positions connected with the Fresh Dairy Direct business that, together with other actions taken at the corporate offices resulted in charges of $32.2 million.
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