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Looking for Love in all the Wrong Places - Playing the DF "Stub"

Trading the Dean Foods (DF) Stub


The value of DF right now is composed of two items:

  1. The value of the dairy business that constitutes DF’s operations (Fresh Dairy Direct, mostly fluid milk)
  2. DF’s economic interest in Whitewave Foods (WWAV)

On October 31, 2012 WWAV completed an IPO of 23 million shares of Class A common stock (IPO price of $17/share) – prior to that offering, WWAV operated as a wholly owned subsidiary of Dean Foods (DF).  DF owns 150 million shares of WWAV Class B common stock, representing 86.7% of the economic interest in WWAV and 98.5% of the voting interest.


Back in February, DF announced that it would spin-off additional shares of WWAV (tax-free) in May of this year (following the April 23rd expiration of the lockup period of the WWAV IPO underwriting agreement), retaining a 19.9% interest in the company.  Ultimately, DF plans to monetize/spin the remainder of its ownership interest at some point in the future.


Different Businesses, Different Growth Profiles


Whitewave Foods is a faster growing business with 40% of its sales in U.S./European plant-based food and beverages (soy, almond) – a very much on trend category with respect to health and wellness.  Another 24% of the company’s sales are in North American premium dairy (organic, and the like, again, on trend) with the balance (36%) in North American coffee creamers and other beverages.  Taken together, Whitewave is in a position to grow revenues in the 7-9% range and garner a premium multiple as a branded staples company.  Currently, WWAV is trading at 22.9x ’13 EPS.


The Fresh Dairy Direct business, on the other hand is a zero to low-growth commodity/private label business that manufactures just about everything in your supermarket’s dairy case – milk (74% of the business), ice cream, creamers, etc.   The per capita decline in milk consumption in the U.S. is a multi-decade trend, and despite the importance of the category to consumers and retailers, it is a low-margin, low ROIC business with significant commodity exposure.


The long-term growth profile at WWAV is clearly superior to that of DF, but what is the implied valuation of the Fresh Dairy Direct Business (the DF “stub”) currently?


DF less WWAV


The current enterprise value of the Fresh Dairy Direct Business at DF is approximately $3.223 billion.  Net debt (excluding the debt at WWAV consolidated on DF’s balance sheet) is approximately $2.312 billion and the equity value of DF (less the value of the 86.7% ownership interest in WWAV) is $911.4 million.  The $911.4 million equity value represents a per share value of approximately $4.89 per share.  The stub has traded in the range of $3 per share to $5 per share since the WWAV IPO.


Looking for Love in all the Wrong Places - Playing the DF "Stub" - DF Stub


Let’s get this out of the way to start – we have never been a big fan of the fluid milk business at DF.  As mentioned above, the category is in secular decline and it is a low margin, low ROIC business with those low margins significantly exposed to commodities.  Additionally, EBIT will decline this year due to the loss of a significant customer.  With that as our admittedly unpleasant backdrop, let’s talk about what can work for the company going forward.


Looking for Love in all the Wrong Places - Playing the DF "Stub" - Per capita milk consumption

To begin with, even with the decline in the base business in 2013, we are forecasting $0.45 per share in FCF in 2013 ($410 million in EBITDA), so the stub is trading right around 10x FCF (7.9x EV/EBITDA) – and we are forecasting that the FCF per share can grow to nearly $1.00 in 2016 even assuming no growth in the base business.  The company is in a position to reduce corporate costs (stranded overhead from being a larger organization prior to the spin) from $183 million to $120 million over the next four years (the 2013 EBIT base is $256.6 million).  Further, CAPEX should decline from the projected $150-$175 million level this year to approximately $125 by 2016.  Finally, interest expense of nearly $100 million in 2013 should slowly decline as the company pays down debt.  Combined, these factors can contribute to close to 6% EBIT growth and double-digit growth in FCF absent any top-line growth or margin expansion.


The concern with any commodity sensitive business is margins, and even if DF sees a repeat of 2011 (a period where management cited “irrational competition”), the non-operating items can shield the FCF to the point where our upside may be reduced or eliminated, but we still see the $0.40- $0.50 per share as sustainable.


With respect to commodities, DF has leverage to lower corn prices (consistent with our macro team's view) as milk prices are linked to corn prices.  The drought in New Zealand has caused cheese prices outside the U.S. to rise and may lift U.S. milk and cheese prices as the year progresses (negative for DF), but by and large, the outlook for milk prices for the balance of 2013 (as indicated by the cost curve below) remains benign.


Looking for Love in all the Wrong Places - Playing the DF "Stub" - Milk Cost Curve

How to play it?


DF probably doesn’t make much sense for long-only buyers today – as shown above, the bulk of the value of DF is in WWAV’s value, and WWAV can simply be purchased on its own.  The value of the fluid milk asset lies in the DF stub, but from a long-only perspective that value can be realized in one of two ways – DF stock rises disproportionately relative to WWAV to appropriately reflect what we consider to be a “correct” multiple for the fresh dairy direct business (simply being long DF makes sense in this case) or WWAV’s share price declines as DF’s share price stays the same (or declines less, relatively), expanding the implied value of the asset.  In the latter case, an investor would have been absolutely correct in the thesis and either lost money or failed to profit from the trade.  As it currently stands, buying DF standalone to get the fluid milk asset is like buying a box of cigars to get the box – there is a better way to do it.


Investors can buy DF and short 0.806 shares of WWAV (about 100 shares for every 125 of DF owned) – recall that DF will spin out a portion of its ownership of WWAV, retaining a 19.9% interest - 34.4 million shares of its current ownership position of 150 million, so DF will distribute 115.6 million shares of WWAV to DF’s 186.1 million shares outstanding, or 0.62 shares for every share of DF held.  The net result is that a portion of the short position will be covered on the distribution, and presumably the value of the remaining stub can expand to more appropriately reflect its value over time and the prospect that we see for FCF and EBITDA growth.  Alternatively, investors can short only the amount that will be covered on the distribution.  In that case, holders of DF subsequent to the distribution will still be able to participate in WWAV’s superior growth profile through DF’s remaining 19.9% interest.


Finally, we have spoken recently about the demand for small and mid-cap staples names within the context of our analysis of PF and MKC.  We expect that DF will see money flows subsequent to the distribution as the long-only buyers that we mentioned as being disinterested in getting shares of WWAV now become interested in DF on its own.  Also, highly-levered, slower growth assets have been in the market’s sweet spot of late, and DF certainly qualifies in both regards.


We believe that, over time, the DF stub can trade at 12-14x our 2014 FCF estimate of approximately $0.60 per share, or close to $8 per share.  On the downside, the business isn’t great (as explained above), and it is small cap without tremendous liquidity.  However, in a staples world where virtually everything has a consistent bid and has worked, the DF stub is like a new issue, and we saw what happened with PF.


Call with questions,





Robert Campagnino

Managing Director





Matt Hedrick

Senior Analyst 


Today we sold our position in the iShares Russell 2000 Index ETF (IWM) at $93.00 a share at 10:26 AM in our Real-Time Alerts. We originally bought IWM on 4/1/13 at $92.92 a share and #timestamped it in our Real-Time Alerts. With the S&P 500 at the top end of our immediate-term TRADE risk range, we'll sell some beta up here so that we can buy it back again on the next pullback. 



Volatility And The S&P 500

We can examine volatility via the CBOE Volatility Index (VIX) and determine how to trade the S&P 500 (SPY) based on where both indices are at in present time. For instance, last Friday (as you can see in the chart below), the VIX was overbought and the S&P 500 was oversold. When that happens, we'll be looking for an entry point to buy the S&P 500. Today, we see the complete opposite happening; the S&P 500 is up and the VIX is down, so we may be looking at a pullback in S&P soon.


Volatility And The S&P 500 - VIXSPXWORKING

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VIDEO: Don’t Call The Top


Hedgeye CEO Keith McCullough appeared on CNBC’s Fast Money Halftime Report today to discuss the market swooning over last week’s dismal jobs data. Keith bought the S&P 500 after the data on a pullback and discusses how buying dips on the S&P 500 and sticking with a process is the way to go. People who  try to call the top of the market will ultimately be proved wrong and need to realize there’s a bull market in the US dollar and US stocks and a bear market in commodities.


Fast forward to 7:45 into the video for Keith’s take on the market.


HOUSING: Strong Mortgage Volume

For the first half of 2013, expectations for mortgage volumes were on the low end of the spectrum. Today's Mortgage Bankers Association (MBA) numbers downplay the underlying strength of the housing market. Although total mortgage volume for the first quarter of 2013 dropped 6% quarter-over-quarter, it remains up 6.8% on a year-over-year basis. The same goes for purchase and refinancing volumes, which are up 14.4% and 8% year-over-year, respectively.



HOUSING: Strong Mortgage Volume - HOUSING6



Despite a slight increase in rates (up 0.1%) for Federal Housing Authority loans on April 1st, overall demand remains strong. Housing data continues to show improvement and low mortgage rates should help motivate buyers from both an affordability and action standpoint. 


HOUSING: Strong Mortgage Volume - HOUSING1


HOUSING: Strong Mortgage Volume - HOUSING2


HOUSING: Strong Mortgage Volume - HOUSING3


HOUSING: Strong Mortgage Volume - HOUSING4


HOUSING: Strong Mortgage Volume - HOUSING5


Brian McGough On JCP


Hedgeye Retail Sector Head Brian McGough appeared on CNBC yesterday to discuss the ousting of embattled JCPenney (JCP) CEO Ron Johnson. McGough was one of the first people on Wall Street to note that the timing of the firing was a bad choice for JCPenney as it had yet to fully execute on Johnson’s plan of “stores within a store.” The company is also low on capital and the decision to bring former CEO Mike Ullman back into the mix was confusing at best noted McGough. You can watch Brian’s full appearance on CNBC in the clip posted above. Fast forward to the first minute of the video for his take on JCP.


McGough was also quoted extensively throughout various news outlets yesterday; we’ve rounded up the various stories for you to check out:


J.C. Penney board comes under fire for CEO switch (via Reuters) 


Wall Street hits record high (via TVNZ)


JCPenney Board Of Directors Gets Call To Resign After CEO Ouster (via HuffPo)


J.C. Penney ousts CEO, Mike Ullman returns (via The Star Online)


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Penney same-store sales down 10% in 1Q, Dow Jones reports (via Chicago-Tribune)


J.C. Penney ousts CEO Ron Johnson (via MarketWatch)