Trading the Dean Foods (DF) Stub
The value of DF right now is composed of two items:
- The value of the dairy business that constitutes DF’s operations (Fresh Dairy Direct, mostly fluid milk)
- 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.
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.
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.
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,
HEDGEYE RISK MANAGEMENT, LLC