Dean Foods to Offload Morningstar

Leading processor and distributor of milk and other dairy products, Dean Foods Company (DF - Analyst Report) is looking for buyers for its Morningstar business. The investors appreciated this decision of the company, which reflected in its share price that closed 5.46% higher at $16.23 on September 27, 2012, from the previous day’s close price of $15.39.

Dean Foods has appointed investment bank Evercore Partners Inc. (EVR - Snapshot Report) to crack a deal for maximizing shareholders’ value as well as ensure future success of the business. The company has not disclosed any information relating to the amount it is expecting from the transaction. However, the deal is likely to fetch around $1 billion.

Morningstar sells branded and private label other dairy products under brands such as Country Fresh, Dean’s, Garelick Farms, Mayfield and Oak Farms. During fiscal 2011, this segment contributed approximately 10% to the company’s total net sales.

Dean Foods has always been committed to explore strategic alternatives that enhance shareholders’ value. Last month, concurrent to its earnings results for the second quarter of fiscal 2012, Dean Foods announced to issue IPO of its wholly-owned subsidiary, The WhiteWave Foods Company. The company intends to dilute its 20% stake in the subsidiary and obtain around $300 million. The proceeds are expected to be used for lowering its debt level. As of June 30, 2012, the company has total long-term debt outstanding of $3,552 million.

The dilution process is anticipated to complete during the fourth quarter of the ongoing fiscal and will lower the company’s year-end leverage ratio to nearly 3.5x debt to EBITDA, as defined by its credit agreements.

Our Recommendation

We believe Dean Foods has taken strategic steps to optimize its capital allocation and concentrate on core business activities. Following this, during fiscal 2011, the company divested its underperforming business unit operations of dairy processing facility in the Southeast. We may see more closures in future towards creating value for shareholders.

Moreover, Dean Foods continues to make headway in its efforts to achieve the lowest cost position in the industry. The company has benefited from its continued focus on cost reduction initiatives across the businesses, including headcount reductions.

It has already achieved its targeted total cost savings of $300 million in fiscal 2011 under the cost reduction program started in 2009. Further, we expect in fiscal 2012 the company will continue to move aggressively toward streamlining its cost structure and may save in line with or more than the fiscal 2011 savings.

On the flip side, in recent years, the consolidation of the retail grocery industry has led to increased competition among dairy product suppliers. In such a situation, Dean Foods faces stiff competition at the processor level, in all major product lines and geographic markets. The company competes mainly with Kraft Foods Inc. (KFT) and ConAgra Foods Inc. (CAG - Analyst Report).

Currently, Dean Foods holds a Zacks #2 Rank, implying a short-term Buy rating on the stock. However, we remain slightly cautious on the stock and uphold our long-term ‘Neutral’ recommendation, waiting to see further catalysts before becoming more positive on the stock.