More Sour News from Dean Foods

The dairy-foods outfit slashed its earnings outlook amid soaring commodity costs

Spikes in milk and other dairy prices have been taking a bite out of Dean Foods' (DF) profits. In its latest warning on Oct. 2, the maker of Silk soy milk, Horizon Organic milk, and International Delight coffee creamer slashed its earnings guidance for the third quarter and year. It also plans to cut 600-700 jobs, which will affect workers in its Dairy Group across the country.

The Dallas-based company lowered its EPS forecast to about 15 cents for the third quarter and to about $1.25 for 2007, blaming soaring dairy commodity costs. That's well below analysts' projections of 26 cents a share in the third quarter and $1.46 for the full year, according to Thomson Financial.

"Rapidly increasing and record high dairy commodity costs have created a very challenging operating environment and 2007 results have been well short of our expectations," said Gregg Engles, chairman and CEO of Dean Foods, in a release. "The third quarter has been particularly challenging as dairy commodity costs have risen sharply, hitting all time highs. This is by far the most difficult operating environment in the history of the company, reinforcing the importance of the long-term strategic initiatives we have underway."

The company expects that milk prices will stay high for the rest of 2007, thanks partly to strong export demand for non-fat dry milk powder. It said that "this extreme commodity environment" is causing its costs to rise, while sales in its Dairy Group have softened as consumers react to the record high prices. It's seeing a pronounced shift from branded products to private label in some of the company's regional brands.

Another problem: there's an oversupply of organic milk. This has been caused by dairy farmers rushing to convert their farms to meet organic regulations before a rule went into effect in June that made that process more stringent, according to the Associated Press.

Dean Foods said it expects more favorable dairy prices next year as more supply becomes available, but that the organic milk oversupply could hurt results for the rest of 2007 and into at least the first half of 2008.

The company also said it expects to take a restructuring charge in the third quarter for the job cuts.

The stock fell as much as 7% to $24.56 in the first few minutes of trading on Oct. 2, not far from a 52-week low. But then it recovered and closed with a slight gain to $26.41.

Some analysts didn't seem too surprised by Dean Foods' watered-down outlook. "While the reduced guidance is obviously disappointing, it was not entirely unexpected," wrote Robert van Brugge at Sanford Bernstein in a note. "The stock has sold off considerably in the past several months in anticipation of a potential miss."

Indeed, back on Aug. 7, the company issued a disappointing outlook for the third quarter and warned that it "may be able to hit the low end" of its prior guidance of $1.52 to $1.58 per share for the full year.

One analyst that seemed to anticipate more bad news was Terry Bivens at Bear Stearns. On Sept. 25, he downgraded Dean Foods shares to peer perform from outperform and lowered his earning forecasts, given that conventional milk prices were not easing and organic milk prices were still low. He also raised concern about the stubbornly high prices of non-fat dry milk. And he wondered if the company's Dairy Group had some operating issues in light of the Aug. 29 resignation of the group's president, Alan Bernon.

Still, the latest warning shows the problems in Dean Foods' conventional milk business appear to be more extensive and deeper than previously anticipated, said Standard & Poor's equity analyst Tom Graves. "It's facing not only significant commodity cost pressure, it looks like it's losing market share to private label brands," he said in an interview. He also noted that near-term EPS negatives include recapitalization-related interest expense and increased supply of organic milk.

Graves thinks that a recovery in the milk market will probably take longer than he anticipated, but he does see it improving by the second half of 2008. Graves kept his hold recommendation on the shares, but cut his earnings estimates and price target to $27 from $29.

Wachovia analyst Jonathan Feeney wrote: "We suspect things should get better from here -- although we still maintain a bit of caution as global milk production has yet to reach an inflection, while domestic yields remain uninspiring."

More optimistic is JP Morgan analyst Pablo Zuanic, who noted on Sept. 21 that the USDA set the October milk class 1 base price at $21.59, up 74% from a year ago but 1.5% lower than the September price of $21.91. "This is the first sequential decline in the class 1 price since February, in what has been a steep upward trend for milk prices," he wrote. He sees this as an inflection point, and expects milk prices to continue to gradually fall, as yields rise as a result of feeding more grains to cows and a growing herd further boosts supplies next year, he said.

That's good news for Dean Foods' conventional milk business, which makes up 85% of its earnings before interest and taxes, Zuanic said. The analyst had upgraded the stock to overweight from neutral on Aug. 7, saying the stock reflected all the bad news after touching a new low for the year of $25.84.

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