Volatile Food Stock Could Soon Be a Bargain

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Dean Foods (NYSE: DF) recently spun off a portion of its WhiteWave Foods (NYSE: WWAV) dairy subsidiary and intends to make the division fully independent in 2013. Finalized in October 2012, WhiteWave's initial IPO was priced at $17 per share and involved 13 percent of the division's total outstanding shares. It valued WhiteWave at nearly $3 billion. 

Dallas-based Dean Foods has three principal divisions that collectively bring in gross annual revenues of nearly $13 billion. However, the company has suffered year-over-year revenue drops recently, including a slide of 8 percent in 2011. It employs 24,000 people worldwide and manages popular dairy brands like Land O' Lakes, Morningstar and Silk. Dean earned nearly $400 million from the initial spin-off.

Meanwhile, WhiteWave is Dean's most profitable brand. It sells high-end dairy products as well as dairy alternatives like soymilk and soy cheese. According to recent financial reports, the division's profit margins are double those of Dean's other two holdings. At first glance, WhiteWave also appears to offer significant prospects for growth: In the past five years, its net income has increased by over 50 percent. This growth can be traced to rapidly-increasing demand for healthy alternatives to dairy products as well as an innovative distribution model that involves substantial bulk sales to warehouse clubs, restaurants and food-delivery services.

After an initial offering at $17 per share, WhiteWave's stock price quickly dropped to near $14.50. Although it has since recovered some of its value, the steep drop is evidence of investors' doubts that the company can sustain its breakneck pace of growth. Dairy companies historically trade at low multiples. For instance, many analysts believe that Dean's seemingly modest current forward PE of 13 is uncomfortably high.

Dean is clearly betting big on WhiteWave's prospects. It used the proceeds from the initial offering to pay down some of its medium-term debt facilities. In 2013, it plans to distribute the bulk of the remainder of WhiteWave's shares to current Dean Foods shareholders on a proportional, tax-free basis. In essence, Dean shareholders will receive corresponding numbers of WhiteWave shares for free. Due to an obligatory six-month holding period that went into effect on WhiteWave's first official trading day, this distribution won't happen until at least March. 

Shareholders who elect to accept the distribution would be entitled to retain their stakes in both companies. Dean Foods will retain 20 percent of WhiteWave's outstanding shares indefinitely to capitalize on the newly-independent company's growth prospects. At the same time, it appears to be narrowing its focus to the brands that make up its core Fresh Dairy Direct segment. Its recent announcement that it plans to sell Morningstar to Canadian food conglomerate Saputo is further evidence of this shift in strategy.

Of course, most investors are less interested in the growth prospects of a leaner Dean Foods than they are in the breakout potential of a dynamic and financially-healthy WhiteWave. Indeed, there are some solid trends working in WhiteWave's favor. First, former Dean Foods CEO Gregg Engles has agreed to work as WhiteWave's first CEO. This represents a major vote of confidence in the new company and indicates that it will initially retain close ties with its former majority owner. 

Secondly, demographic and cultural trends favor the new company. As North Americans adopt healthier eating habits, the market for soy-based products and other dairy alternatives will continue to grow. Health-conscious customers tend to be more affluent and have exhibited surprising receptiveness to elastic pricing. Since its upmarket customer base allows it to charge higher markups than its competitors, WhiteWave may well trade at higher multiples than its former parent. 

Lastly, WhiteWave's new-found independence frees it to invest more heavily in developing new brands, acquiring smaller companies that produce sought-after specialty products, and expanding into new geographic and demographic markets.

WhiteWave does face some risks. Many seasoned market players have taken substantial short positions in the new stock. Since its float is guaranteed to remain small until the end of the first quarter of 2013, this alone should be enough to give interested investors pause. With such low liquidity, the stock has exhibited alarming volatility: Since it began trading, its intra-day price has swung by more than 4 percent on several occasions. At 22, WhiteWave's forward PE is also high relative to traditional beverage companies; however, compared to other organic and alternative food companies like Annies (NYSE: BNNY), the PE is low. Annies produces organic meals and snacks for a similar demographic and they have a forward PE of 34.  WhiteWave and Annies also have similar profit margins and are expected to have similar growth in the next few quarters. 

Finally, the unorthodox structure of the coming WhiteWave stock distribution could create a temporary share glut as Dean Foods shareholders dump their new WhiteWave shares on the open market. In the short term, the resultant price drop could be painful for current WhiteWave longs, however, the drop could create a bargain for investors thinking of buying.


mthiessen owns shares in Dean Foods. The Motley Fool owns shares of Dean Foods Company and WhiteWave Foods. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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