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Thursday, February 10, 2011

Dean Foods (DF)

Dean Foods is the largest distributor of milk and milk products in the united states. It's currently selling just above 10 yr lows. It's 52 week range is 7.13-17.00. The stock has had a pretty decent rally since its low in December.

Dean Foods operates in two segments, Fresh Dairy Direct-Morningstar and White Wave-Alpro. Fresh Dairy Direct-Morningstar is the largest US producer milk, creamer, and cultured products. White Wave-Alpro produces and sells branded milk, soy, and plant based products. Together, they have helped Dean Foods command 40% of the US milk market.

Historically, DF has had operating margins of around 6%, however, a combination of higher demand and the never ending helicopters full of free money Ben Bernanke has been dropping on the economy has driven up input costs of milk. This has squeezed Dean's margins to <3%. Making matters worse, retailers have refused to raise the retail price of milk and in fact have been using milk as a loss leader to lure shoppers into the store. Fortunately, this cannot last forever. As the retailer's margins begin to get squeezed, they will have to raise prices to reflect he input costs of milk and pass those costs onto consumers. Historically, the input costs of milk and the retail price of milk have moved in tandem, and their is no reason things shouldn't revert back to normal in the future.

One thing that is worrisome is that DF does have a significant debt load. However, they do not have any significant maturities until 2012 and will not have to refinance anything until 2014. They also have 1.4 billion in undrawn credit available. Also, they launched a $300 million, 3 yr cost cutting initiative during 2010 and have announced savings of $100 million already. Recently, a prominent hedge fund announced that they have taken a 7% ownership stake valued at $132 million. Another large shareholder is Blackrock. Many analysts believe most of the bad news is already priced into the stock.

I suggest setting up a synthetic long position by selling the Jan 13 $10 puts and using the proceeds to buy the Jan 13 $10 calls for a net costs of .50 or $50 per spread. This allows you to participate in any upside in DF until 2013.

A number of analysts have calculated the fair value of the stock at $15/share. If DF is $15/share before Jan 2013, your $50 investment will be worth $500-$700.

As always, selling naked puts obligated you to buy the stock anytime before expiration. However, the net costs will be < $8/share. But you can always roll your options out or close them out at anytime. Also, they report earnings on Feb 16, which might allow you to get in at a lower price.


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