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Hi everyone,

Dean Foods reported earnings earlier this week and the stock price saw a nice 8% bump, apparently because while it lost money, it didn't lose as much as expected. Actually that reaction seemed a bit odd, given the comments CEO Gregg Engles made.

Release: http://sec.gov/Archives/edgar/data/931336/000119312511037278...
Transcript: http://seekingalpha.com/article/253285-dean-foods-ceo-discus...
Slide deck: http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9M...

There were three big takeaways for me from this earnings release.

Milk cost outlook:
Quoting Engles: "On our last earnings conference call, we expressed the view that milk prices would fall throughout the first half of the year before climbing back to current levels by year end. Since then, however, prices have risen sharply, driven by global demand and poor weather in Australia and New Zealand. We now expect dairy commodity prices to climb throughout the first half before flattening out or declining slightly in the third and fourth quarters. We expect a rather dramatic move up in dairy prices during the first quarter and early second quarter, which we have already experienced in butter."

If you remember my buy article (and if you don't, here's a link: http://www.fool.com/investing/value/2010/12/21/rising-star-b...), part of the thesis was that raw milk costs were expected to come down in the first half of the year, before climbing back up. That's what management, analysts, and experts in the field had all expected prices to drop. However, higher oil prices here in the states (driving up the price of corn feed) and bad weather in places like Australia and New Zealand (whose cows are grass fed) is holding prices up.

There were a lot of questions about this on the call, as is to be expected given that milk costs are the single biggest expense for the company.

This led management to revise expectations and guidance given was below what the Street expected. Engles says that management is being conservative, modeling $20 to maybe $22 per cwt, but we'll just have to see.

Bottoming out:
What's been really hurting the company is the practice by grocers of reducing their house brand milk prices, using this as a means of getting customers in the door during the recession. According to Dean Foods, this practice seems to have bottomed out and might even be reversing. If so, this would be huge for Dean Foods as they've been squeezed both by price differences between branded and private-label milk, and by margins on making the private-label milk. One piece of supporting evidence is that branded milk volumes were higher than private label in Q4.

Engles: "We have, however, begun to see signs that the fluid milk category is stabilizing, albeit at historically low levels of profitability. Some retailers have taken early steps to reduce heavy private label promotions and our regional brand volume mix has begun to stabilize. Regional branded milk volumes outperformed private label on a year-over-year basis in the fourth quarter. Moreover, private label wholesale prices appear to have stopped declining, although we have not yet seen them rise. Volume, however, remains weak."

Reducing expenses and raising cash:
Counteracting the above, the company is continuing to make the business more efficient. Examples include making routes more efficient (saves on fuel costs), consolidating processing, and lowering head count (which, while saving the company, is unfortunate for those let go). Of the $300 million in (I believe) annual cost savings targeted over several years, the company's already delivered on $175 million and they're expecting to do the remaining $125 million this year.

Late last year, Dean Foods agreed to sell the yogurt business and will realize about $120 million after tax, which it will use to pay down debt.

There has been speculation that selling the WhiteWave-Alpro business would help. If management decided to do this, I'd be out of the investment in a heartbeat. WWA is the more profitable of the two divisions, and is growing strongly as many people like the alternative milks it produces.


That's what I got from this last quarter's release. It's going to be a tough year for Dean Foods, but if it can continue to reduce expenses and make itself more efficient, and if branded milk can begin to recover, then results will begin to improve. We'll just have to wait another quarter to see where things stand, which is the "watching the paint dry" part of investing. Boring, but potentially very rewarding.

Cheers,
Jim
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