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  1. Analysis
September 11, 2019

Dean Foods left with little wiggle room after ruling out sale

Seven months after launching a strategic review, US dairy giant Dean Foods is to go it alone under a new chief executive rather than engage a buyer. Simon Harvey takes a look.

By Dean Best

Seven months after launching a strategic review, struggling US dairy business Dean Foods opted to go it alone under a new chief executive rather than seek a buyer. Perhaps it was the only option for a company that generates more than half of its sales from liquid milk, a flagging category in a dynamic consumer landscape. Simon Harvey takes a look.

For a US dairy business that’s seen revenues almost half over the past decade, it was perhaps little surprise Dean Foods decided to continue with its own transformation strategy instead of trying to find a buyer for what is predominately a liquid-milk manufacturer.

That’s not to say Dean Foods definitely didn’t try to find one as part of its strategic review, an aspect that wasn’t divulged when the company announced on Friday (6 September) it would pursue a stand-alone operating plan under the leadership of new chief executive Eric Beringause, and one the business said will “provide the best opportunity to enhance long-term shareholder value”. 

But with all the negatives stacking up against it, one has to question if it was the right decision. What input Beringause had in coming to that conclusion may never be known, although he only joined Dean Foods at the end of July at a stage when the review instigated by his predecessor Ralph Scozzafava would have been well underway. 

Scozzafava had flagged the option of a complete sale of the business or even a joint venture back in February. But perhaps Dean Foods couldn’t find a buyer willing to take on the risk of owning a company that posted its biggest annual loss in seven years in 2018, and operating in a category losing favour among consumers seeking more exciting and value-added eating options.

“The former CEO was trying to make it ready for a sale or divestment of some of its low-profit areas and maybe sell all of it, but it seems there was no one really interested in buying,” Preben Mikkelsen, a dairy industry analyst with his own firm, PM Food & Dairy Consulting, tells just-food. “The new CEO will try and make a new strategy to save the company but it’s too little too late.” 

Mikkelsen also ruled out the option of a joint venture because he believes Dean Foods is not “interesting enough” to attract a partner. “It’s too dangerous,” he says. 

However, that’s not a view shared by John Watson, the owner of UK-based Watson Dairy Consulting, who says the chosen course is the right one as it gives Dean Foods more time to “carry out a root-and-branch review of the business whilst keeping options open”.

“Taking the route of a sale or joint venture leaves everything up in the air and potentially reduces the company’s value whilst losing more direction and money, particularly in the current cycle of volatility in the dairy sector mostly due to global oversupply, which is currently being addressed by the industry.”

But then how low can a company go in value to make it attractive enough for a potential buyer or not as the case may be? Dean Foods shares were trading at US$1.59 on the New York Stock Exchange on Tuesday having lost more than 350% over the past year. And the firm has been forced to refinance debt after its most recent financial loss. 

Former CEO Scozzafava alluded to the challenges in last year’s annual report: “While it is true that overall milk consumption has declined, the importance of the milk category is clear. However, it is also clear that the dairy industry landscape has changed, and we need to operate our business in new and different ways.”

He continued: “We’re working on the right things to improve our business and performance but are not happy that the rewards of our efforts are not readily visible in our financial results.”

The owner of the DairyPure milk brand and TrueMoo flavoured milks posted a net loss of US$327.4m last year based on revenues of $7.8bn, a far cry from the $11.8bn in sales it registered in 2007, and a further sign of the challenging operating environment.

Milk sales accounted for 67% of total revenues, down from 74% in 2011, but up from 62% in 2007.

To its credit, Dean Foods has been closing plants across the US to cut costs but factories still numbered 60 last year from into the 100s around a decade ago. However, the count is still too high and the company needs to make more effort to consolidate, says Mikkelsen.

“They need to concentrate, restructure and invest heavily in modern liquid-milk plants,” Mikkelsen says. “Compare with Arla Foods, which is the other major liquid-milk producer in the world that’s been been closing down a lot of dairies and made one large dairy. The same thing Dean Foods should have done at some strategic point and then they may have been down to about 15 or 20 highly-efficient dairy plants.”

It could also be argued Dean Foods has too many brands, which numbered around 60 last year distributed across 50 states. Mikkelsen says one of the major drawbacks for the company is it doesn’t have a recognised national milk brand and is too focused on regional or localised brands.

“They have been more focusing on expansion,” Mikkelsen says. “They have been buying all over the US. They have brands for the east coast, south, mid and west.”

And it’s very much reliant on private-label business too, despite Dean Foods noting the competitive retail landscape where customers are “competing aggressively” for market share. Private label, which unlike the UK is only just gaining traction in the US, generated 50% of Dean Foods’ sales last year versus 40% in 2007.

Nevertheless, private label forms one of the five prongs of Dean Foods’ enterprise-wide cost-productivity plan dubbed ‘Deliver Operational Excellence and Transform Go-to-Market’ strategic pillars launched under former CEO Scozzafava.

Winning in private label is one of them, along with “building and buying strong brands”; “operational excellence”; “enhancing future capabilities”, and transforming the way the company goes to market.

However, the business is still very much centred on fresh milk despite a clutch of recent acquisitions. Last year, Dean Foods bought a majority stake in Good Karma Foods, which makes flaxseed milk and yogurt alternatives, and Uncle Matt’s, a US organic juice manufacturer. In 2016, it formed a joint venture with CROPP for the cooperative’s Organic Valley brand of dairy products.

Nevertheless, those acquisitions have so far failed to reduce the predominance of fresh milk. Ice cream made up 15% of sales last year, fresh cream 6% and creamers 3%. 

“They’ve killed it themselves,” Mikkelsen says when asked whether fresh milk is a dying category in the US. “The market is shrinking. It seems Dean Foods has jumped head first into this zero-sum game where they have got to be the biggest loser because they don’t have any strong brands. They have some brands but more than half of their liquid-milk production is for private label.

“They have been neglecting to do a lot of things for years. Dean Foods has been very, very good at acquiring companies but very, very bad at integrating companies for 30 years. Then they have just been taking over whatever was for sale in the liquid-milk brands in the US.”

By choosing to remain with the status quo for the time being, Dean Foods could be playing for time before the right buyer comes along and at the right price. Mikkelsen named global dairy giants Danone, Lactalis and Saputo as firms that could potentially be interested, either via a straight purchase or parts of the business.

He adds that it would be a “game changer” if a buyer in the US bought Dean Foods with the financial and marketing power to transform it into a nationwide milk brand.

Watson’s view is that discounting a sale or joint venture clears the air for all involved, especially shareholders. But that said, there’s still no indication of what strategic path new CEO Beringause will take. Mikkelsen believes that, ultimately, Dean Foods will end up in the hands of a new owner.

Watson says: “The company and its customers, suppliers, shareholders and employees require clear direction and focus, and it is my view that the new CEO of Dean Foods is providing it with just that. It is clear that he, with his team and advisers, have considered very carefully all the options and has decided the best route for the company is to maximise value through an operational review. My view is that he has made the optimal decision for the business.” 

To change and consolidate, as well as invest in a national brand, would require capital Dean Foods doesn’t really have unless it can sell off assets and get a decent return to reinvest in the business. The company has already employed an initiative to realise $150m in cost savings by the end of next year.

So would it make sense to diversify into other dairy areas? Mikkelsen thinks not. “If you go more into the yogurt business – like Danone, General Mills or Chobani – that would be tough to enter that segment. If you go into commodities, well there you have huge companies which are very low-cost producers like Dairy Farmers of America, California Dairies and Land O’Lakes.” 

At the end of the day, Dean Foods has effectively been up for sale for years, according to Mikkelsen, but no buyer has ever been found. So what more can Beringause do other than stay the course when capital is limited to make further profitable and value-added acquisitions, and when other areas of the dairy market are already dominated by other players?

And if you divest less profitable parts of the business, how much capital can you reap by doing that, Mikkelsen asks, adding the company has lost market share, while Dean Foods’ profits “are not worth writing about”.

If potential buyers are waiting in the wings then the share price is obviously not a attractive enough yet but how much lower can it go?

“I feel the new CEO’s task is really a hard challenge,” Mikkelsen says. “His priority needs to be to reduce costs where ever you can. You have to sell off something to generate capital because Dean Foods is in a capital problem.

“It’s just a matter of time before you will see a really interesting development for Dean Foods that they will be taken over by another company. That’s my expectation because it seems to me it is placed between a rock and a hard place with nearly no room to manoeuvre.” 

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