National brand strategy driving growth for Dean Foods

by Josh Sosland
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Dean Foods dairy products
Dairy giant sees progress ahead of leadership change.

DALLAS — Adjusted earnings at Dean Foods Co. were higher in the third quarter ended Sept. 30, helped in part by ebbing pressure on sales volumes. The company’s strong financial results were issued in the midst of a leadership transition and against a backdrop of speculation that Dean Foods may be subject to a takeover bid.

Net income at Dean Foods in the third quarter was $14,526,000, equal to 16c per share on the common stock, down 28% from $20,233,000, or 22c per share, in the third quarter of 2015. Net sales were $1,964,601,000, down 3% from $2,033,693,000.

Adjusted net income during the quarter was $33 million, up 18% from $28 million in the third quarter last year. Adjusted operating income was $69 million, up 11%. Included in the adjustments are a range of more than a dozen excluded items, including asset impairment charges, facility closing costs and mark-to-market gains/losses on derivative contracts.

Adjusted earnings per share were 37c, up from 30c in the third quarter last year. The 2016 results were in line with guidance of 32c to 40c, issued three months ago.

Third-quarter sales volume was down 1% from a year earlier, which was the smallest year-over-year decline in four years.

“I am extremely pleased with our third-quarter results, which reflect the strongest volume performance we’ve seen in years, a disciplined go-to-market strategy and continued focus on reducing costs,” said Gregg Tanner, chief executive officer. “Our entire organization is focused on executing our strategic plan, and you see that in our results.”

Ralph Scozzafava, executive vice-president and chief operating officer, summarized the company’s strategic focus as acquiring and building strong brands, a major shift for a company powerfully grounded in the business of processing, marketing and distributing milk, a commodity staple.

“We remain focused on driving growth through building incremental distribution, driving velocity and delivering innovation that expands our product portfolio, our brand footprint and our margins,” Mr. Scozzafava said Nov. 7 in a conference call with investment analysts.

The financial results and conference call followed by a little more than a week media reports of a possible takeover bid for Dean Foods. On Oct. 25, the Financial Times, citing numerous unidentified sources, said Hangzhou Wahaha Group, a Chinese food and beverage distributor, had approached banks to help finance a takeover of Dean Foods.

In trading on the New York Stock Exchange Oct. 25, Dean Foods’ shares surged 11% and have edged higher since then.

No light has been shed on the possibility of a deal since the press accounts first emerged.

“I would like to remind you of our long-standing policy to not comment on rumors or other speculative matters such as those recently reported by financial reporting outlets and financial analysts,” Mr. Tanner said in the conference call.

In its financial results, Dean Foods offered as background data an update on milk market pricing. Average Class I Mover, a measure of raw milk costs, was $15.11 per cwt in the third quarter, up about 12% from the second quarter of 2016 but down about 8% from the third quarter of 2015. The company is projecting fourth-quarter 2016 average Class I Mover of $15.96 per cwt, up 6% sequentially but still down about 2% year-over-year.

Third-quarter volume across all milk products was 651 million gallons, down 1% from 658 million gallons in the third quarter of 2015. Dean Foods said the third-quarter volume “represents the healthiest year-over-year volume performance the company has delivered in at least four years.” The company said volume trends should continue to improve in the fourth quarter.

Based on fluid milk sales data published by the U.S. Department of Agriculture through August, fluid milk volumes decreased 0.9% year-over-year in the third quarter of 2016 on an unadjusted basis.

In the conference call, the Dean Foods’ executives drilled deeper into data and how the company was faring. Leading the discussion was Mr. Scozzafava. In September, the company announced he will succeed Mr. Tanner as c.e.o., effective Jan. 1.

While overall volume was down 1% from a year ago, Mr. Scozzafava noted that white milk volume fell 1.8% year over year, while flavored milk volumes rose 5%.

Central to Dean Foods’ efforts to build its branded business in milk has been the DairyPure brand, which enjoyed a 1 percentage point share gain versus a year ago, boosted by national advertising and promotions, Mr. Scozzafava said. The brand currently enjoys a 14.8% market share. Mr. Scozzafava said the company is building out the brand through the introduction of DairyPure lactose-free as well as DairyPure creamers and half-and-half.

Over time, the branded milk strategy is expected to help Dean Foods with its net price realization. Pricing efforts have been under way for two years.

“As discussed on previous calls, we have been consciously and deliberately executing a commercial plan that while sometimes resulting in lower volume than our historical run rate, has allowed us to reset our gross profit algorithm,” Mr. Scozzafava said. “With our third-quarter results, you can again see our more balanced approach to volume growth and price realization.”

Asked to elaborate on the company’s pricing approach, Mr. Scozzafava said private label pricing is “almost automatic,” utilizing a cost pass-through mechanism.

“From a brand perspective, just trying to be really consistent with pricing so that the consumer can find a similar price every day at retail,” he said. “And then maintaining some discipline with ourselves throughout the process so that we can make sure that we are maximizing really two things; not just volume, but it’s the blend of volume and margin. Trying to find that balance is something we’ve been fairly good at; a lot of analytics go into it.”

Mr. Scozzafava further simplified the approach Dean is taking with its flagship milk brand.

“Our intention really with DairyPure is to manage it like any other national brand, any other leading brand that you would see in any other category, to enable consumers to rely on a price at retail at a given value,” he said. “And they can rely on it week in and week out, as it’s really a routine purchase for them.”

As the brand strengthens, he said DairyPure “by definition” will be able to command price premiums versus private label and competitive brands.

He placed DairyPure in an early stage toward establishing a national branded presence. By contrast, the company’s flavored milk brand TruMoo “is pretty far along in its evolution,” with a 20% market share.

Over time, the retail price spread between different brands is not always enlightening information, Mr. Scozzafava said.

“As customers, retailers, become either aggressive or not in the category, they fund that themselves,” he said. “So I think that’s a different dynamic.”

Mr. Scozzafava also described a shift in the channel breakdown of fluid milk sales. While overall volume was down 1%, I.R.I.-based data showed a 2% decline, he said. In this weaker segment, Dean Foods enjoyed a 60-basis-point share gain to 35.1% from 34.5%. Food service sales have been strong, he said.

Ice cream volume jumped 14% in the third quarter versus a year ago, fueled principally by the company’s recent Friendly’s ice cream acquisition.

“Excluding Friendly’s, we are very pleased that despite Blue Bell’s reentry into the marketplace earlier this year, our legacy ice cream brands, Mayfield and Dean’s, delivered volume that was nearly flat versus year ago, essentially maintaining the robust share gains that we won in 2015,” Mr. Scozzafava said.

The ice cream market enjoyed a 2% volume gain year-to-date, versus the same period in 2015. Dean Foods holds a 10% market share.

In 2017, Dean Foods will introduce new formulations across numerous ice cream varieties sold under the Mayfield and Dean’s brands, and packaging will “get a fresh look,” Mr. Scozzafava said.

“We will also launch a number of new flavors under these brands, including Mississippi mud pie and lemon icebox pie ice cream, along with our indulgent Big Chippers ice cream sandwich cookies,” he said. “Now under the Friendly’s brand, we will introduce a new larger size of the very popular sundae cup line, as well as introduce a brand-new product line called Naturally Friendly’s, an on-trend, natural line of great Friendly’s ice cream with no artificial colors or flavors.”

For the final period of the year, the company is forecasting adjusted earnings of 37c to 45c per share.

“For the fourth quarter, with improving volume performance, in addition to continued pricing and cost discipline, we expect the fourth quarter to be our eighth consecutive quarter of year-over-year adjusted operating income improvement,” Mr. Tanner said.

Asked about the company’s relationship with Wal-Mart Stores. Inc., Mr. Scozzafava was upbeat. In March, Wal-Mart announced plans to build a dairy processing plant set to be operational by the summer of 2017.

The timetable may be optimistic, judging by comments from Mr. Scozzafava.

“We don’t see any impact sitting here today for 2017, just based on the physics of having to get a plant up and running and doing all those things,” he said. “Then when you look at the margin profile of the private label business there from a financial standpoint, a minimal impact is really what we expect going forward. And that is out well beyond 2018 and so on.”

Currently, 16% of Dean Foods volume goes through Wal-Mart.

“We enjoy a good business with them,” Mr. Scozzafava said. “They are a dynamic retailer, as you know. They are extremely good at what they do, and we like the interaction with them. They make us better and we like to think that we make them better in the categories where we compete. So we will continue to partner with Wal-Mart. We have a big business with them, although certainly not as large as some other C.P.G. (consumer packaged goods) companies that you might benchmark against. They fit in our portfolio very nicely, and we anticipate that we will have a strong relationship and a very good business going forward.”

In the nine months ended Sept. 30, net income at Dean Foods was $87,098,000, equal to 96c per share, versus a loss in January-September 2015 of $26,988,000. Sales were $5,692,217,000, down 6% from the same period in 2015. Adjusted net income in the first three quarters was $110 million, up 34% from $82 million.

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