Dean Foods: What did Santa wash down his cookies with?

unknown-4Dear Mr. Market:

Normally we write you a series of letters about the stock market or the economy. As we wrap up 2016, however, we decided to share an article that was recently published on Seeking Alpha. The proverbial ‘Santa Claus rally’ seems to perhaps have taken place before Christmas this year but what opportunities might there be going into 2017?

This interview reviews questions around a stock we’re interested in adding to some portfolios; Dean Foods (DF). Enjoy!

Summary

  • Despite trading at 52-week highs (and ~30% gain over the last three months), DF is still undervalued relative to peers.
  • As the clear market leader in fluid dairy, DF enjoys significant economies of scale – a critical advantage in a commodity-related business.
  • “Skating to wear the puck is going” with leading position in healthy dairy products such as TruMoo.
  • Friendly’s ice cream acquisition was immediately accretive, highly complementary, and further cemented its growing position in branded ice cream.
  • Takeover rumors that surfaced in October provide a floor for the stock.

What is one of your highest conviction ideas right now?

As plain and simple as a glass of milk might sound, we really like Dean Foods (NYSE:DF) right now. With a new year upon us and investors scouring for names that might benefit with a new administration, sometimes the best answer is to look at leading companies that are not in the spotlight but right in your fridge!

Can you provide a brief overview of what the company does?

Dean Foods is a leading U.S. processor and distributor of milk and other dairy products. The company has been around since 1925 and is headquartered in Dallas, TX. DF is surprisingly much larger than its next closest competitor but if you ask most investors to name any companies in this space they may not have a grasp of the landscape. Several of DF’s products are sold under licensed brand names and they have over 50 private-label brands in grocery stores nationwide. DF delivers their products via one of the most extensive direct store delivery (DSD) systems in the U.S.

What led you to take a position?

We actually owned DF several years ago and then sold the position. The catalyst for the sale was the divestiture of WhiteWave Foods Co. (NYSE:WWAV) in July of 2013. From a fundamental standpoint some of the same pricing concerns, intense competition, and inflationary concerns were swirling around the company as they are now. Ironically enough, talks of another potential acquisition also recently surfaced with a report in October of Hongsheng Beverage being potentially interested in buying DF.

Your investment decision-making process involves being value or growth agnostic – what value and growth qualities does DF have?

In our opinion, the greatest advantage of being style agnostic is that it allows you to scan the entire universe for companies and also avoid any preconceived biases. Albeit possibly warranting an entire discussion on its own…the value versus growth debate will always remain, but in general we believe value stocks will outperform over longer periods of time. There is of course always a reversion to the mean but 2016 has clearly seen value trounce growth.

DF just released its third quarter earnings and from a growth perspective it continues to perform well. The company actually has a healthy long-term earnings growth rate of 12%. From a valuation perspective, we believe this is where DF should attract some attention. We believe the company was extremely undervalued in August and early September and even after about a 31% bump since then, we think the stock has much more upside. S&P Capital IQ currently has a fair value calculation of $26 for DF.

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