A Sniff Test Before Earnings

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Dean Foods (NYSE: DF) reports earnings on November 8. Despite the plan to pay off part of its $3.65 billion in debt with $391 million in proceeds from the spinoff of its most profitable and fastest growing unit on November 2the outlook may be turning sour on this dairy producer.

White Wave Foods Company (NYSE: WWAV) was priced at $17 a share and spiked to $19, only to close below the offering price. Parent Dean Foods will still hold 86.7% of White Wave for at least six months, approximately 150 million shares.

But what's left after the sale of White Wave, their hottest division, maker of Horizon organic milk and the nut and soy based milks and beverages? The company still has two divisions left, Morningstar, which makes shelf life cream, whipped cream, and cultured dairy products like sour cream and cottage cheese. The other division is Fresh Dairy Direct consisting of milk, milk products, eggs, fruit juices and drinks, iced teas, and waters. Stifel Nicolaus doesn't like what's left and downgraded from buy to hold on October 26.

Dean Foods' stock rose like cream to the top, up 62.40% over the last year. It hit a high of $19.17 on October 22. While the stock had doubled from its low of $9.17 last November, lately the short interest has almost doubled from 4.36 million to 7.35 million (4.70%) as of October 15.

There are proponents of the stock like Jim Cramer who said on October 30 that it's a hold and its "valuation is too cheap."  A Seeking Alpha article agrees and values the company at $20 plus. Average analyst price target is $19.35.

Are The Numbers Frothy?

The diluted EPS is -7.91 and the profit margin is -11.16%, not to mention the quarterly revenue growth of -5.30% year over year. Some shareholders may be looking forward six months to get some of the White Wave share profits when the company sells off part or allof its stake. The forward P/E is 12.83.

What will Dean Foods say on Thursday? Likely, management will be upbeat about the White Wave spinoff and also address the sale of its Morningstar division which is rumored to have a few buyers at the ready like Apollo Global Management, Michael Foods, and Grupo Lala, a Mexican dairy. It will be difficult to predict which way the milk producer will turn after earnings as historically this company's earnings are quite volatile. Just in October the share price rose from $15 to $19.17 in a week and dropped to $16.50 the next. What a stock for day traders.

On November 5, Fitch ratings upgraded Dean Foods' debt ratings based on the continuing debt reduction and mentioned more deleveraging "with a possible divestiture of Morningstar." They also think profits are improving in the Fresh Dairy Direct division which accounts for almost three quarters of net sales.

Obviously, Fitch believes earnings may be sweet. However, negatives were included in their assessment like the low operating margin in the Fresh Dairy Direct unit and specifically mentioned that "volatile earnings profile."

Yes, milk is one of those items that fly off the shelves as emergency situations approach, like water and batteries. It's practically as essential as gasoline to drive the economy and costs a little more per gallon. As a necessity consumers may grumble about price hikes in milk and gas but will continue to buy them. So, recent surges in commodity costs like corn will likely be offset and are already baked into analysts' expectations.

Since numbers from White Wave will still be included in this earnings release forward guidance will be particularly important. Dean Foods had some solid earnings earlier in the year but the situation has changed dramatically now with another unit in play after the White Wave IPO. One Seeking Alpha writer is neutral about the new IPO but Fellow Fool Joel Eggerding is not so sanguine about White Wave's prospects.

No argument here that the organic space is on a multi-year tear but Whole Foods Market, which reports the day before, or The Hain Celestial Group may be a much better way to play organic than Dean Foods, especially before hearing what they say on the call. Like pulling the freshest milk from the back of the dairy locker you want to hear the freshest news, check the label, and still take a sniff test about what management says.

leglamp has no positions in the stocks mentioned above. The Motley Fool owns shares of Dean Foods Company, Hain Celestial, and Whole Foods Market. Motley Fool newsletter services recommend Hain Celestial and Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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