DF - Dean Foods

[ArminvanBuyout]

Is anyone looking at Dean Foods?

 

They're the largest fluid milk processor in the US with around 36% market share and they would be in a prime position to benefit from the decrease in raw milk prices, which are near an all-time high.

 

They've also been cleaning up their balance sheet by paying off debt with the proceeds from the sale and spin-off of Morningstar Farms and WhiteWave, respectively.

 

Lastly, they're currently going through a restructuring phase where they're closing up milk production facilities and reducing head count.

 

There's also a write-up on VIC that brought me onto the idea and was very helpful in my path to learn more about the business.

 

PS. This is my first post on the forums!!!  ;D and I'm excited to learn more about investing 8)

[Myth465]

Why do you like it, what do you think its worth?

 

Also welcome to the board.

[ArminvanBuyout]

The main part of my thesis relies on the cost of raw milk decreasing over the next year or two. With increased international production of raw milk, it's certainly possible and quite likely (at least in my opinion) that the price of Class I raw milk will decrease, thus helping out margins.

 

If I'm completely wrong on my prediction of raw milk prices, there is also downside protection. From my understanding, the company is currently operating in the worst case scenario, as the industry is in secular decline, and milk prices are near an all-time high. As the low-cost competitor, DF will ride out the storm and will outlast it's competitors.

 

That's mainly why I like this company.

 

In terms of valuation, I haven't really looked into that yet.

 

Are you looking at the stock?

[Myth465]

Havent looked at it. Wanted to see if you had some numbers in mind.

I think you have a pretty good idea of what the key drivers behind the return will be, just have to model out the numbers.

 

 

[ArminvanBuyout]

http://www.ams.usda.gov/AMSv1.0/getfile?dDocName=STELPRDC5107711&acct=dmktord

 

Class I raw milk prices for May.

 

A big decline which in prices which is always welcomed.

[alpha]

Anyone following the dairy industry? Does it make sense for a big retailer to purchase DF as their own private label?

 

DF is heading near 52w low. If you back out intangibles and goodwill book value is closer to ~1.20, current reporting has it around 3.31.

 

Although their sales are declining it's still the largest dairy distributor with ~35% of the market. How much should their distribution infrastructure be discounted for a quick sale?

[DTEJD1997]

Anyone following the dairy industry? Does it make sense for a big retailer to purchase DF as their own private label?

 

DF is heading near 52w low. If you back out intangibles and goodwill book value is closer to ~1.20, current reporting has it around 3.31.

 

Although their sales are declining it's still the largest dairy distributor with ~35% of the market. How much should their distribution infrastructure be discounted for a quick sale?

Incredible sales leverage!  Something like $85/share.  If they could capture 1% of sales in profit, that would be $.80 to $.90/share.

 

I am not so sure it would sense for retailer to buy DF.  Suppose that KR bought DF....WMT and AMZN and others might not want to carry their products?  HOWEVER, what if the acquirer made the competitors a deal they couldn't refuse for dairy products? 

 

With an improved balance sheet DF could lower prices a bit...and every penny helps.  I wonder if there would be some distribution/logistics to be gained if KR or WMT bought & integrated their operations?

 

If an acquirer could wring out even 1% in earnings, the acquisition would pay for itself very quickly.

 

Interesting idea!

[Viking]

I think a big issue is over capacity (too much milk being produced in the US). And milk consumption is declining. And Walmart, Kroger and Costco are trying to get price concessions from their largest suppliers (to compete with Amazon). And Dean has too much debt.

 

Saputo may be looking at Dean Foods. This would be good for the industry; Saputo would be focussed on profitability. This might result in some capacity reduction (plant closures) which would allow supply and demand to rebalance.

 

Interesting situation.

[Cigarbutt]

The US fresh milk industry fundamentals are interesting indeed but I would be very surprised if Saputo (or Agropur) get involved in a going-concern type of transaction. Saputo has already stripped Morningstar (extended shelf space products) from Dean, Danone eventually acquired the other valuable segment and Dean has been left with the melting ice cube. Agropur has been active with expansion in the US but has been careful to avoid (mostly, apart from some private label production in some regions) fresh milk direct retailer exposure.

 

For various reasons (huge topic), the industry has remained stuck in an over-capacity situation with demand for fresh milk slowly but inexorably going down. Add to that the typical pressures that players like KHC are facing (brand value erosion, diversified consumer preferences and choices and growing retailers' negotiating power).

 

When looking at various scenarios along the income statement vs potential free cashflow generation, it is possible that there may be short spurts of temporary profitability but the operational and financial leverage in the present structure, given the current industry significant over-capacity dynamics, the trajectory is convincingly going down until a new equilibrium has been reached. Another factor to consider (in the margin analysis) is that rationalization efforts (closing processing plants) will result in higher transportation costs (fresh milk is expensive to transport and is perishable).

 

I've followed the dairy industry for a long time and would say that what is happening to Dean has a smell of poetic justice. In the late 90's, Suiza and Dean (which merged in the early 2000's) aggressively consolidated the dairy processing market and squeezed the milk producers. Through an amazingly complex set of Byzantine rules, producers became relatively protected and now the zombie processors are getting squeezed by retailers that have consolidated and built purchasing power.

 

The Dean Foods long-term story is a story of capital mis-allocation and IMHO present management is crying over spilled milk.

[supertutti]

crying over spilled milk.

 

Well done!

[Cigarbutt]

This one has had some ups and downs since the last post but, today, has entered the chapter 11 corridor.

They describe advanced discussions with an interested buyer and there may be other parties involved during the bankruptcy.

On a weighted probability basis, I would say the equity will be very likely wiped out.

There was a lot to learn here over the last few years and one of the lessons is that kicking a can down the road, sometimes, just makes it bigger.

The pension situation (and the potential haircuts to be considered), given what happened to management compensation over time, is also kind of horrific.

[Viking]

Cigar, i worked in this industry for 15 years (Canada). Deans is the posterchild of how to do it wrong. My former employer, Saputo, is an example of how to do it right. Interesting that back in April it was rumored that Saputo was looking at buying Deans. Saputo made its big move in Canada when it bought Dairyworld Foods in 2001 (right before it was going to go bankrupt). Within 3 years of the Dairyworld purchase Saputo had hit a home run. Very good operators. What made it work is fluid milk in Canada is an oligopoly with the players, for the most part, not engaging in destructive competition.

 

Fluid milk in the US is experiencing the perfect storm: declining consumption, minimal brand value, far too much capacity, too many strong competitors (large coop, strong regional players etc), power shifting to retailers from manufacturers in packaged goods (who want their own label which increases costs) etc.

 

Whoever buys Deans is going to likely have to shutter a bunch of capacity. Brutal for employee morale. Likely will also result in lots of negative press as no one wants the facility in their backyard to be affected. And the farmers will want their pound of flesh.

 

What not too like?

[Cigarbutt]

^Saputo has indeed been a strong operator with vision.

After spending some time on the recent supplemental disclosure, I think Saputo may submit a bid.

https://www.sec.gov/Archives/edgar/data/931336/000110465919062024/tm1922535d1_ex99-2.htm

On top of what you mention, the early pages of the sec document complete the perfect storm picture. It seems that big retailers going for extra low prices and using milk as a loss leader, leading to even more price pressures on commoditized milk, may have been the last nail in the coffin.

 

So, I think that Saputo may submit a bid, that is likely to be too low (even if appropriate versus the deep curtailment in production necessary to bring back some kind of reasonable equilibrium) because the leading bidders will be the ADF cooperative who will factor, in their bid, some value related to the fact that Deans was their largest customer and the coop will likely choose to maintain excess production in order to lessen the impact on their 'members'. This is lining up to be the typical case where an entity emerges from an incomplete restructuring, with still too high leverage only to re-enter distress shortly (within 1-3 years) after so maybe Saputo will (wait for) get a second 'chance'.

The above may be an argument to look at the bonds which have badly spoiled recently but the DIP financing terms look pretty offensive.

[Viking]

For many years Saputo was very Buffettesk in the price it paid for aquisitions. Dairyworld Foods is just one example. It looks to me like they had to pay up a little more for the large aquisitions made the past couple of years where their focus seems to be strategic fit. If buying Deans helps fill out their US ambitions (provides synergies with their cheese/industrial operation then they may be more aggressive.

 

Do you know how good operators ADF cooperators are?

[5xEBITDA]

Bonds aren't really interesting unless between 5-10 cents...preferably towards 5. No one is gonna pay top dollar for this stuff.

[Cigarbutt]

...

Do you know how good operators ADF cooperators are?

I cannot answer this question satisfactorily but here are some thoughts.

Since the 30's, the dairy market has been hyper-regulated and is not well positioned to deal with a shift that will continue to occur and that involves greater bargaining power from retailers down the supply chain and consolidation of producers with processors may not be enough by itself to restructure the industry. Consolidation to larger operations will continue to occur and may lag resulting in a value trap for the whole industry. My understanding of the DFA is that part of it is made of members who would tend to follow the consolidation game with changing focus from local fresh milk 'units' to butter, cheese, yogurt, other longer shelf-life products and ingredients exposed to more global forces but another part of the members would likely prefer to maintain the status quo which implies the maintenance of poor policies that excessively support smaller and inefficient producers. Also, the DFA has become a new intermediate with an associated cost. So, my take is that the DFA will tend to keep its head in the sand and will tip more to a stabilization of operations than towards a true disruption. The dairy industry has been benefiting from excessive regulatory easing, there are way too many indebted zombie producers and there will be a price to pay, a price, I think, that Saputo will skip.

Bonds aren't really interesting unless between 5-10 cents...preferably towards 5. No one is gonna pay top dollar for this stuff.

Isn't this amazing as bonds traded near par just about a year ago?

[5xEBITDA]

Bonds aren't really interesting unless between 5-10 cents...preferably towards 5. No one is gonna pay top dollar for this stuff.

Isn't this amazing as bonds traded near par just about a year ago?

 

It is! It has really been a confluence of negative macro and micro events that just make this one so tough...and now with $700 million + pension liabilities getting in the way of a straight, non-bankruptcy, sale it looks like the bonds are priced for capacity liquidation which isn't going to be pretty. Once DFA (if they close) takes their chunk of flesh the stub will be sold facility by facility which will be a mess. 

[Cigarbutt]

^Yeah, this will be fun to watch.

In case somebody is interested, a blueprint for a successful restructuring had been suggested by a restructuring adviser who, it seems, was slightly too optimistic.

https://turnaround.org/sites/default/files/1.%20Jan%202019%20-%20Dean%20Foods%20-%20Paper_0.pdf

The report touches on DFA operations as a 'comparable', discusses interesting past insider problems with celebrities and presents useful data points that are helpful for a watershed type of analysis. The picture has evolved towards a more specific type of price discovery.

An interesting take-away however (a take-away which is only briefly mentioned or alluded to in the report) has to do with the inadequacies of debt covenants along the way, a topic (if you remember, 5xEBITDA) we had discussed some months ago with longhaul as the opening poster.

But who cares about covenants when times are good?

The subtitle of the report: "A strategy to milk a shrinking industry"  :)

[Spekulatius]

^ LoL, the milked the business until the cows came home. Then they went teats up.

[wabuffo]

a blueprint for a successful restructuring had been suggested by a restructuring adviser who, it seems, was slightly too optimistic.

 

"restructuring adviser" in this case is a bunch of MBA students and their final project report!  LOL. 

 

Not that MBA students don't have any insight....or can't quote Buffett, etc....

 

Must've been an assigned case study - these Columbia MBAs also looked at it and pitched the debt (p. 22).

 

https://www8.gsb.columbia.edu/valueinvesting/sites/valueinvesting/files/Graham%20%26%20Doddsville_Issue%2036_vF.pdf

 

wabuffo

[5xEBITDA]

The Spring 2019 issue of G&DVille has an [MBA] student write-up on the DF bonds, interesting to see how it played out from their recommendation at 66. Pg 22 - 23.

 

https://www8.gsb.columbia.edu/valueinvesting/sites/valueinvesting/files/Graham%20&%20Doddsville_Issue%2036_vF.pdf

 

 

[Guest cherzeca]

this will be an asset sale out of bankruptcy.  wont be pretty for dean bondholders

[wabuffo]

interesting to see how it played out from their recommendation at 66. Pg 22 - 23.

 

last trade at $19.75.  oops.

 

wabuffo

 

[Cigarbutt]

this will be an asset sale out of bankruptcy.  wont be pretty for dean bondholders

If you have the time or the inclination, would appreciate an additional comment.

Is your assessment based on asset sales out of bankruptcy in general or is it specific to Dean Foods assets?

 

It looks like there is potential for a stalking horse bid. Significant write downs are expected but the company had established an extensive and comprehensive distribution footprint and infrastructure, whose value, I would submit, is not recognized in the tangible assets, as the initial posters that rekindled the interest for this name, mentioned above, before things went downhill.

 

There is clearly a leverage problem here but there is a level where the underlying business would make sense for a buyer. I guess it depends on the meaning of 'pretty'.

[alpha]

I was wrong on this one (luckily I divested during a recent high)

 

In hindsight the Saputos CEO's commentary should have been warning that no buyers would step up... next time I will listen to Cigarbutt  ;D