Dean Foods: a Retrospective

Dean Foods’ (DF) stock price broke the buck at the end of June after peaking at a little over $43 per share in the early months of 2007. Its debt is trading at distressed levels and what was once a $6.2B company back in 2007 is now worth less than $100MM.

It’s easy to cherry pick a company that’s heading for bankruptcy and say “Oh I wouldn’t have invested in that” or “I would have gotten out back in 20XX.” The reality is that Dean Foods is a prime example of a company that provides a basic good whose consumption one could easily assume would increase with population growth, rising wealth, and inflation.

But Dean Foods is yet another example where you would have been dead wrong.

The simple answer for Dean Foods’ demise is that Americans are drinking less milk. As the chart below shows, fluid milk consumption was 247 pounds per capita in 1975 and steadily dropped to 149 pounds per capita by 2017.

Per Capita Milk Consumption

What’s interesting is that the thesis that underlies consumer staple companies like Dean Foods for the dairy category is intact. While liquid milk consumption is on a steady downward trend, higher-value dairy products, such as yogurt and cheese, which require more processing to get to an end-product, and hence a higher price, have more than offset the decline in liquid milk.

Per Capita Dairy Consumption

The trend away from liquid milk and towards value-add dairy products worked against Dean Foods. Dean Foods competed to supply grocery stores’ own brands while also marketing their own. Grocery store margins are razor thin and they continue to be compressed. Compounding Dean Foods’ problem is that WalMart, one of Dean Foods’ key customers, built its own milk processing plant last year.

Fundamentals + Technicals

When buying shares in individual companies there are two main ways to practice risk management:

  1. Small position sizes
  2. Use basic technical analysis

As the chart below from FastGraphs shows, investors never really gave Dean Foods much credit for its business. The “normal” p/e ratio for the company was only 9.3x (blue line) over the past 20 years while a conservative p/e multiple for the overall market is often considered to be around 15x (orange line).

DF FastGraph

Look at the above chart carefully. It’s a high-level view of stock price versus an estimate of what the company should be worth based on TTM normalized earnings. Back in the early 2000s the stock was trading well below the “normal” p/e ratio as well as the market p/e ratio all while experiencing positive price momentum. The upwards trend was understandable as the company put up some impressive earnings growth numbers for the first couple of years.

Then things started to fall apart in 2007 as earnings dropped 43%. If you were using a trend filter you would have sold your shares and sat on the sidelines.

Dean Foods: Value Trap for a Value Investor

Coming back to my first point that Dean Foods was possibly a good target for a value investor: look at the earnings increase in 2008 and 2009 in the FastGraphs chart above. The stock price had been decimated from all-time highs, it was well under the estimated fair value, and earnings were increasing again. This is often the catalyst that will move an out of favor stock back upwards. A lot of investors would have jumped in at this point. However, those that combine both fundamental analysis with technical analysis would have waited to pull the trigger until they started seeing some positive price momentum, which didn’t occur until 2011.

However, in 2011 when price was showing positive momentum the shares were above the fair value of the market. While shares can keep going up and stay above “fair value” for awfully long periods of time (think Amazon for most of its existence), it’s much safer to have an undervalued stock with positive price momentum than a possibly overvalued stock with positive price momentum.

But as we keep going forward in time, price stayed above fair value based on earnings until investors finally gave up on the company in 2017 and the final slide brought it down below a buck per share.

Investing and trading in stocks that go bankrupt

Looking at stocks that go bankrupt, and how they got there, is a useful exercise for every investor. The best thing to do is apply your normal investing/trading approach and see where you would have gotten in and where you would have gotten out. I think for a lot of investors and traders it would have been attractive in the early 2000s and probably would have shown up on a watch list starting in 2009 given the uptick in earnings. It ticked all the boxes from a product and “reason to exist” perspective but what was missed by a lot of investors, including me, was the consumer trend away from milk consumption and towards other dairy products and the negative impact it would ultimately have on Dean Foods. Missing this trend is why you have risk management practices in place:

  1. Small position sizes.
  2. Wait for price to agree with you.

Remember: there’s a very fine line between being early and being wrong. Let fundamentals help you with what to buy and let price help you with the timing.

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