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Dean Foods Slips to Neutral

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We have downgraded our long-term recommendation on Dean Foods Company (DF - Free Report) to Neutral from Outperform, based on the uncertainty surrounding raw material prices. The company projects Class I raw milk prices to increase significantly in the second-half of fiscal 2012. As a result, the company guided lower Fresh Dairy Direct’s operating profits.

Nevertheless, Dean Foods raised its overall earnings per share guidance for fiscal 2012 to $1.18 - $1.28 per share from $1.10 - $1.20 forecasted earlier, on account of a solid second quarter bottom line performance. For the third quarter of fiscal 2012, the company anticipates earnings to range between $0.25 and $0.30 per share.

Dean Foods’ second quarter earnings per share almost doubled to 36 cents -- beating the Zacks Consensus Estimate of 31 cents -- driven by its stringent focus on cost control. The company’s net sales dipped 5.3% year over year to $3,125.5 million and missed the Zacks Consensus Estimate of $3,241 million. The decline was primarily a pass-through of lower dairy commodity costs, offset partly by strong top-line performance at WhiteWave-Alpro.

Of late, fluid milk processing profits have been hit by increasing money-offs on private label milk distribution as well as weak sales volumes. In order to counter these headwinds, Dean Foods has implemented strategies like price realization by passing input cost inflation to customers, cost cuts and boosting volume performance. These fundamental steps have facilitated it to step up and rebuild the company's profitability.

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, Dean Foods intends to move aggressively toward streamlining its cost structure.

The company has taken strategic steps to optimize its capital allocation and concentrate on core business activities. Consequently, during fiscal 2011 the company divested its underperforming business unit operations of dairy processing facility in the Southeast, and expects more closures in the near future.

On the flip side, Dean Foods business is heavily dependent on commodities such as raw milk, soybeans, diesel fuel and others. The company is anticipating a rise in Class I raw milk prices in the second half of fiscal 2012, which may negatively impact the operating income of Fresh Dairy Direct segment in the range of $5 million to $10 million or $0.02 to $0.04 per share.

Additionally, 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. and ConAgra Foods Inc. (CAG - Free Report) .

Dean Foods currently has a Zacks #3 Rank, implying a short-term Hold rating on the stock.

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