Has Dean Foods Gotten Too Big to Succeed?

Through more than 40 acquisitions, Dean Foods (DF) Chief Executive Officer Gregg L. Engles built the nation's largest dairy processor. Now he may have to start dismantling his creation.

Dean's stock is off about 60 percent this year, making it the worst performer in the Standard & Poor's 500-stock index. The Dallas-based company's earnings are getting squeezed by big-box stores and supermarket chains looking for price concessions. At the same time, Dean is having to contend with big jumps in prices of key commodities such as raw milk, butterfat, soybeans, and sugar.

Combined, these trends are crimping the company's cash flow and may make it difficult for Dean, which is carrying around $4 billion in debt, to stick to the terms of its loan agreements, says Vicki Bryan, an analyst with Gimme Credit in New York. Dean's ratio of long-term debt to equity stands at 260 percent, the highest of any food or beverage company in the S&P 500. "I expect them to opportunistically divest assets," says Bryan. "It's going to be tough under market conditions to get an optimal price." Company spokeswoman Liliana Esposito declined to comment.

Dean's net income has declined year-on-year in each of the last four quarters. Earnings have come in short of analysts' estimates twice in 2010. And the company has said that conditions won't improve in the first half of 2011.

A graduate of Yale Law School, Engles, 53, is described on Dean's website as "the primary architect" of the consolidation of the U.S. dairy industry. It all started with a dairy in San Juan, Puerto Rico, which Engles and a group of investors purchased in 1993 and took public three years later. In 2001, Engles acquired Dean, a company in Franklin Park, Ill., with roots in the evaporated-milk business. More recent purchases include WhiteWave, a maker of Silk soymilk, in 2002; organic milk maker Horizon Organic in 2004; and, in 2009, Alpro, which produces soy-based products in Europe. Dean's annual sales have soared, climbing from $150 million in 1994 to $11 billion last year, according to a Securities and Exchange Commission filing.

Credit Suisse (CS) analyst Robert Moskow says Dean's strategy of driving down costs to undercut smaller, less efficient milk processors and force them to scale back capacity has not yielded results. At the same time, Dean is facing pressure from retailers who are discounting milk to attract penny-pinching consumers while demanding price breaks from suppliers. Also, more shoppers are buying cheaper private-label milk products instead of Dean's brands. "Our industry is going through a wrenching ordeal," said Engles in a conference call on Nov. 9, after the company reported a 51 percent drop in third-quarter net income.

To cut costs, Engles has closed five plants since 2009. Still, Michael Benoit, an analyst at Chicago's Talon Asset Management, believes Dean is in a "downward spiral" and may not be able to trim expenses fast enough to counter a steep rise in commodity prices. Says Benoit: "We are passing on Dean because we think it's structurally impaired."

Engles has begun selling off some of the pieces of his empire. Dean booked a $6.4 million after-tax gain from the sale of Rachel's Dairy, an organic yogurt maker based in the U.K., to France's Groupe Lactalis in August. Last month General Mills (GIS) agreed to buy Dean's Mountain High yogurt business for an undisclosed price.

One business that would likely draw bids is WhiteWave-Alpro: Earnings at the unit, which produces soy-based drinks, continue to rise. In a Nov. 10 report, Sanford C. Bernstein (AB) noted that a sale of WhiteWave-Alpro could cut Dean's debt nearly in half. In the November call with analysts, Engles said that the unit "is managed quite separately" and would therefore be easy to hive off.

Some of Dean's shareholders might be relieved to see a buyer step forward amid concerns that the company's fortunes may not turn around. The stock surged more than 8 percent on Aug. 31 after the website Briefing.com reported "chatter" about a bid from France's Groupe Danone. Danone CEO Franck Riboud has since told the press he's not interested in getting into the milk business. Alan Thompson, a derivatives trader for the Timber Hill division of Interactive Brokers (IKBR), which owns Dean shares, says: "Until some European player or other conglomerate swoops in, the fundamental picture remains bleak."

The bottom line: Faced with an earnings squeeze, Dean Foods CEO Gregg Engles may need to sell off assets to pay down debt.

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