Monday, June 4, 2012

DF: Momentum on negative equity

Dean Foods Co. (DF) makes a distributes milk- and soy-based foods and drinks. The national brands in the Dallas, Texas company's barn include  Horizon organic milk, Land O'Lakes butter, and Alpro and Silk soy beverages.

It also sells under more than 50 local and regional brands, such as Meadow Gold, Garelick, Pet, Oak Farms and the eponymous Dean's.

The challenge Dean faces in selling its products is that milk, like many agricultural products, is a staple product, a generic. One brand is much like another. And milk spoils easily, meaning that distribution is costly.

No wonder, then, that selling and distribution soak up 41% of Dean's operating costs in 2011.

The question I ask is how a company with Dean's challenges can improve product and so grow value. We all remember what happened with New Coke. Is New Milk even remotely feasible?

Dean Foods was named Today's Momentum Stock on Monday by the investment research company Zacks. Most of the Zacks ratings are for subscribers, but it puts a few up on its website for non-subscribers to view.

I haven't read the Zacks analysis yet -- you can find it here, and then compare it to what I write, for two separate points of view.

[See my note below the Decision for my account section for a discussion of discrepancies between the Zacks financials and those of the brokerages that I relied on.]

DF is a stock given to large upside gaps on earnings days, such as 15.8% on Feb. 15 and 9.7% on May 9.

The May bump differs from the one before in that the price continued to rise, with one correction. The post-correction leg up began May 21 from $14.20 and peaked at $15.70 on May 31.

Since then, amid a sharp market sell-off, the price has dropped two days running to a low today, so far, of $15.19. That's a decline of 3.4%, less than many stocks endured last week.

DF is coming off a troubled time on its chart. After partially recovering from a 2009 recession low, the stock slid 68% from a post-recession peak of $22.09 in July 2009 to a low of $7.13 in December 2010.

From that point the price recovered to nearly $14 in May 2011, again dropped below $8 in September 2011. The present rise is a recovery from that 2011 low, and the price has doubled.

So is DF a momentum play? Definitely. The question is how much more momentum is left after a rise of that magnitude within that short a timespan.

Traders always want to buy low and sell high. Anyone who bought low in 2011 has a lot of profits worth taking now at the 2012 high, and with the general markets faltering, then they'll be motivated to take those profits quickly.

I don't subscribe to the idea that past is prologue in the markets. Each day is forged from a new mix of events and knowledge. However, trader holdings and paper profits and losses are part of the mix, and so in that way past price movements can have an impact today.

Dean Foods has a hugely negative return on equity: -207%. With negative equity, there is no way to calculate a debt/equity ratio. The long-term debt amounts to 101% of the company's total capital.

The company has reported a profit the past six quarters, and profit growth has improved each of the last two quarters. The last six quarters have each produced an upside earnings surprise.

Institutions own 77% of shares. Given Dean's dismal finances, those shares are heavily discounted. It takes only 21 cents in shares to control a dollar in sales.

Dean's financials and chart tell me that it is a company that fell into deep trouble and is seen as recovering from those depths.

DF on average trades 4.9 million shares a day and supports a wide selection of options with high open interest and narrow bid/ask spreads.

Implied volatility stands at 42%, about the midpoint of the six-month range, and has been rising gently since May 29.

Options traders are pricing in a 68.2% chance that the stock will close between $13.34 and $17.04 a month from now, for a maximum gain or loss of 12%.

Option volume is below the five day average, suggesting that near-term speculative interest is lagging.

Dean Foods next publishes earnings on Aug. 3.

Decision for my account: I won't be trading DF at this point. If the markets generally were trending up then I would consider it as a bull play on the strength of its chart as well as its earnings. But the negative mood of a major market correction, if in fact that is what we're seeing, can squash momentum across the board, unless there is a strong countervailing reason for that momentum to continue.

I don't see such a reason in Dean. Its financials are ugly, and its product have little prospect of shining out from the pack. Coke has its secret formula, and Apple has its cool designs. A milk company like Dean has got --- milk.

Note: In reading the Zacks analysis, I see that they put the return on equity at 52%. The brokerages are putting it at the negative level I listed. I'm not sure what they methodology difference is. Zacks is using a trailing 12 month, and it could be that the brokerages are using a calendar year. The Zacks figures would moderate my negative comments on the DF financials, although the debt is still quite high. And my comments on the difficulty of moving a staple product still stand.

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

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