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Dean Foods: Got Upside?

Takeaway: At 5x EBITDA with an under leveraged balance sheet, we think DF has a conservative 20 – 30% upside from here.

This note was originally published June 07, 2013 at 16:20 in Consumer Staples

Our Consumer Staples team has been touting Dean Foods (DF) for the past couple of months and although the stock has moved, we believe there remains significant value and upside in the name.  Before getting into an updated valuation analysis, we wanted to tell you why we like this business (especially at 5x firm value / 2013E EBITDA).


Dean Foods: Got Upside? - dean


We think DF is a compelling business for the following reasons:

  • National scale – DF is the largest processor and distributor of fluid milk in the United States at more than 5x the size of its nearest competitor.  As such, it is a natural and synergistic acquirer of smaller competitors, especially given its ample free cash flow and low debt load.
  • Market share within the market – In 80% of its IRI defined geographies, DF has the #1 or #2 market share of branded milk.  This dominant market share will make it difficult for a competitor to compete on price, since DF typically has a volume advantage.  (DF national market share has been stable and ranged between 37.5% and 38.2% for the last nine quarters ending in Q1 2013.)
  • Strong management – We could drill deeper into this topic, but this is a management team that has shown an ability to execute, as evidenced most recently by the successful spin-off of WhiteWave and monetization of Morningstar. As well, management has met or exceeded expectations for the last nine quarters.  This was also in a period in which they reduced operating costs by $53MM, or ~9%, from Q1 2011 -> Q1 2013.

That all said, DF is still a commodity company, even if a branded one, so we do need to consider that fact when evaluating the business along with the highlights above.   In our view, the current valuation provides substantial downside protection and fully accounts for the commodity nature of the business.


In the table below, we provide an upside / downside analysis based on 2013E EBITDA and multiples of enterprise value / EBITDA.  Currently, we think the stock is at a price in which the risk / reward is compelling.  On the downside, absent a dramatic change in the milk market or poor management execution (unlikely), we think the reasonable downside is 4.5x EBITDA, or ~16% from current levels.


Dean Foods: Got Upside? - zz. 1


In terms of the upside, as noted we do acknowledge that this is a commodity company with only modest top line growth rates, but we do believe given the compelling business characteristics and high free cash flow yield reasonably justify a multiple in the 6.5X – 7.0x EBITDA range, which implies 32% - 44% upside from current levels.  From our perspective, a situation in which there is 2:1 upside / downside with fundamentals trending our way is a compelling investment.


The argument for the upper end of the multiple range of course is based on the generous free cash flow nature of this business.   While 2013 is a bit of an odd year given the corporate activity (notably the spin-off of WWAV), we believe that on a normalized basis DF will generate in the range of $140 - 150 million of free cash flow to the equity annually.  This implies a rough 8% free cash flow yield.  In combination, a 8% free cash flow yield and a debt-to-EBITDA ratio of just over 2x makes this a compelling LBO candidate.  (Moreover, the debt-to-EBITDA is closer to 1x if we net out the WWAV stake.)


In addition, DF’s publicly traded debt seems to validate our view of the stability of the cash flow, and potential to add more debt to the balance sheet in a LBO type scenario, as all three tranches are trading well above par and tight versus Treasuries.  In fact, 5-year DF paper is trading at only 210 basis points above comparable Treasuries.


The key pushback from many is that DF is a “value trap”, or a business in decline, so it is a cheap stock that can get cheaper.  Indeed, there have been a number of publicized articles recently that highlight that per capita milk consumption has been in decline since 1970.  Even if this is accurate, total volumes have shown a steady increase in recent years, which is more relevant for a market share leader like DF.  In fact, in the chart below we show that total volumes have increased by 20% over the last nine years.  Not stellar, but definitely the kind of growth and cash flow that gets a private equity firm licking the milk off their moustache!


Dean Foods: Got Upside? - zz 2


Daryl G. Jones

Director of Research



“One of our strategies moving forward is to shift to a balance between our legacy of being family-friendly and adult-focused guest experiences, referencing our legacy. There is no assurance that this shift will be successful or that it will not negatively affect our family guest experience.”

-          RRGB 2012 10-K, Risk Factors section



We are adding Red Robin Gourmet Burger to our Best Ideas on the short side.  The stock has gotten ahead of the company’s fundamentals and future growth prospects.


Company Overview

  • 468 full-service casual dining restaurants – 335 co-op and 133 franchised
  • 5 limited service Red Robin Burger Works concepts
  • Core concept is “family-focused”
  • Seeking to strike balance between family legacy and “adult-focused experiences”
  • FY13 estimated revenue growth of 4% to over $1 billion
  • Operating margins, ROE, ROA, some of the lowest in casual dining
  • 2.99x Debt/EBITDA
  • 22% debt/Total Assets




The stock has outperformed by almost 60% over the past year and its strong performance versus peers has continued as earnings growth estimates have stagnated. 







Current Setup

  • Stock surging on increased expectations for a successful Red Robin “brand transformation”
  • Additional investment will be required to secure brand transformation
  • Capital spending unit growth is being accelerated in 2013
  • Industry is still experiencing a secular declining traffic trends
  • Guidance is for EPS an EPS recovery in 2013 and 2014
  • Traffic negative in 1Q13 and comparisons get difficult for the balance of 2013
  • Restaurant margins have improved 290bps over the last 2 years



Traffic Problem is Biggest Fundamental Red Flag

The company is in desperate need of a “brand transformation” to stem the decline in traffic





Capital Allocation


Capital allocation is one of the most important metrics for casual dining companies. In terms of RRGB’s capital spending, the following bullets and charts offer insight into the effectiveness of the company’s capital allocation decisions.

  • Capex has been growing for three years
  • Expected to increase 17% in 2013
  • ROIIC likely to decelerate in 2013
  • Unit growth accelerating with Red Robin, mid-size, and new Burger Works concepts




RRGB HAS TOO MANY BALLS IN THE AIR - rrgb ebitda vs capex growth



Repeating Others’ Mistakes


The foot print expansion is leading to declining returns for the company. The question that we, and others, have about the strategy is why so many different initiatives need to be pursued at once. Specifically, the company is growing Red Robin in two different sizes, expanding its Burger Works QSR concept which seems to be producing mixed results, and trying to transform the consumer’s perception of Red Robin as a brand. In our view, this amounts to the company taking on more tasks than it can complete effectively while managing its capital prudently.


Brand transformation is difficult to achieve, for several reasons. Below are some of the concerns we have about RRGB’s particular strategy.

  • Moving away from core customers carries risk
  • Bar remodel had limited impact
  • Guiding to strong returns in “full transformed” units (only?)
  • Red Robin brand perception is entrenched, significant messaging required to adjust
  • Bar Works off to a difficult start as real estate and financial performance refinements ongoing



  • Difficult SRS comparisons
  • Lowest revenue quarter of the year as incremental expense continues to build
  • Expenses in 4Q likely to grow significantly thanks to new costs
    • Brand transformation expenses
    • Incremental pre-opening expenses for new units
    • Beef prices post a risk to margins, particularly in 3Q
    • Industry sales benchmarks continue to be sluggish


Valuation and Sentiment


Short interest in RRGB has been coming down since 2008 but remains the fourth highest in casual dining at 10.5%. The valuation that consensus is awarding the stock has risen sharply in recent months. The sell-side is fairly cautious on the name with 37.5% of analysts rating the stock a “buy”, 50% “hold”, and 12.5% “sell”.


RRGB HAS TOO MANY BALLS IN THE AIR - rrgb valuation over time






Howard Penney

Managing Director


Rory Green

Senior Analyst

Morning Reads on Our Radar Screen

Takeaway: A quick look at stories Hedgeye's research team are reading this morning.

Morning Reads on Our Radar Screen - radar


Keith McCullough – CEO

Kuroda Stares Down Bond Volatility With Stimulus Unchanged (via Bloomberg)

Shenzhou-10: China launches next manned space mission (via BBC)


Howard Penney – Restaurants

Krispy Kreme Sloppy Joe Sandwich Debuts At San Diego County Fair (via Huffington Post)

Nestle’s Nespresso to Face New Mondelez Copycat Capsule (via Bloomberg)


Daryl Jones – Macro

Is This Who Runs Prism? (via TPM)

Is The Eurozone Crisis Set To Flare Up? (via streettalklive)

Turkish Police Retakes Square Amid Clashes (via Bloomberg)


Kevin Kaiser – Energy

Encana Taps Former BP Executive as CEO (via WSJ)

Polar Petroleum, Frozen (via The Aleph Blog)

Josh Steiner – Financials

Bank of America’s Laughlin Says Accord Talks Were Tense (via Bloomberg)

Fannie Mae Shareholders Challenge U.S. Takeover in Suit (via Bloomberg)

Early Look

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LULU: They Blew It

Takeaway: LULU needed to shore up confidence after 1Q product issues. They blew it. There's margin risk. Maybe not a short. But definitely not a long.

This note was originally published June 10, 2013 at 21:02 in Retail

Conclusion: LULU had to do one thing and one thing only this qtr -- instill confidence in the investment community that the recent product issue was a one-off, and it that management is on offense. Unfortunately, LULU blew it. Its quarter was hardly squeaky clean, the outlook is cloudy, and the CEO tendered the most surprising resignations we've seen in retail in a while. This remains a great global growth story in retail -- one of the best, actually. But there's margin risk to the downside. That matters at 33x earnings. It might be a lousy short. But we'd avoid it long.


LULU: They Blew It - lulu1



In the wake of the Luon pant fiasco throughout the first quarter, there was one thing and one thing alone that LULU needed to do with this print -- and that's instill confidence with the investment community that the right team is steering this ship, and that the issues that caused the stumble are temporary and not a sign of more systemic issues at the company. Unfortunately, the company dropped that ball with the announcement that Christine Day is resigning her post of CEO after 5 1/2 years on the job.


Quite  frankly, we were stunned by the announcement. For investors, this is the corporate equivalent of being bitten by your Golden Retriever. There was no warning. Usually when something happens so suddenly, it is the Board's decision, but this one sounds like it was all Christine. Could it be that the Luon pant debacle took its toll on her? Perhaps. But she already canned LULU's Chief Product Officer in April, and the company is in the process of broadening its executive team.  We'd be surprised if her departure was due to this issue alone.


Our sense is that Ms. Day -- who is held in extremely high regard by the investment community -- simply sees that the next leg of growth will be tougher to come by. To her credit, she saw the company through the period in '09 when it was a $3 stock and drove it up to $80. That's $11.2bn in value creation -- or a 27-bagger for those keeping score.


While LULU had several wins this quarter, like golf, tennis, men's and e-commerce, in the end, this quarter was hardly squeaky clean. Aside from the Luon issue, the company noted certain misses from a styling perspective, higher expected landed costs in 2H due to factory/production issues, SG&A deleverage through 2H14 as LULU ramps up its East Coast distribution center, and difficulty in finding store locations to facilitate Hong Kong expansion.


We still think that LULU is one of the few iron-clad brands in retail that can put up 20%+ organic top-line growth on a consistent basis for the next 3-5 years (the others are RH, FNP, UA and KORS). But unlike these other brands, we think that LULU has risk to the downside in its mid-20s margin as the company spends more to facilitate its growth. If we compare it to UnderArmour (or FNP or RH), for example, we see that UA has only an 11% margin, and even it is stepping up spending on the margin to maintain top line growth. We think that LULU will maintain a significant premium to UA, NKE, RH and FNP. But in doing so we still think that the risk is to the 20% range as margins (and even high teens) look to find a final resting place.


This still nets us a respectable 20%-ish EPS growth rate by any stretch (25% top line growth less 500bp due to margin erosion). But with the stock trading at 33x earnings (per the after-hours sell-off) we find it really tough to get excited about on the long side.

CALL AT 10:00am; What's Next For Europe?

CALL AT 10:00am; What's Next For Europe? - whereseuropeDial 06.11.13


We will be hosting a conference call TODAY, June 11th at 10:00am EDT titled "Where Does Europe Go From Here?"




Highlight the best investment opportunities in Europe and assess the overall economy of the region.  




  • Contextualizing the fundamental and structural headwinds in the region
  • The key actions of the ECB and its impact across markets
  • European bifurcation will remain, with clear winners and losers
  • Updates from the periphery and other risks investors should be aware of
  • Our investment outlook across asset classes over the intermediate term



  • Toll Free Number:
  • Direct Dial Number:
  • Conference Code: 187759#
  • Materials: CLICK HERE


If you would like more details about this call please email .





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