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Investors hoping to fatten their portfolios may want to consider a low-milk diet.

Dean Foods Co. saw its share price sink after the largest dairy processor in the United States cut its earnings outlook, blaming higher costs and intense competition in the grocery aisles.

The stock price fell 8 per cent on Tuesday as investors focused on its falling market share and shrugged off the company's introduction of a dividend and bigger share buyback program.

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While the stock appears cheap compared with its rivals, there is concern about the outlook for Dean and other dairy processors as raw milk prices remain high and consumers turn to a growing number of alternatives, from juices to yogurt.

"We don't think Dean will garner any sustainable competitive advantages over the near term … and it seems the market agrees with us," Morningstar Inc. analyst Erin Lash said in a note, calling the milk industry "a highly volatile space."

Ms. Lash added that consumers tend to buy perishable products such as meat and dairy based on price rather than brand. "As such, we don't believe that dairy processors like Dean and Saputo [Inc.] possess sustainable competitive advantages."

The challenges ahead of Dean Foods are typical of those facing food companies, given sluggish economic growth across North America, said Barry Schwartz, vice-president at Baskin Financial Services Inc.

"There is little to no growth. Revenue is D.O.A.," he said.

Dean Foods, which offers brands such as Meadow Gold and TruMoo, has been cutting costs and closing plants in response to lost customers, higher raw milk prices and lower margins from retailers.

Earlier this year it lost what it calls a "significant" amount of business to a large customer, which analysts have identified as Wal-Mart Stores Inc. That led to a 10-per-cent drop in milk volumes versus a year earlier, which compares with a 1.7-per-cent dip across the industry.

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The company's share of the U.S. milk market fell to 34.9 per cent in the quarter, down from 36.4 per cent three months earlier and 38.2 per cent a year ago.

Meantime, raw milk costs increased 5 per cent over the three-month period and 15 per cent from the same time last year. Analysts said last year's drought has raised the cost of feed, which encourages dairy farmers to reduce the size of their herds, at the same time as Asia's rising middle class is demanding more of the beverage.

"What's causing Dean's higher milk costs this year is lower global milk production and stronger global dairy product demand, particularly from China," said dairy economist Mary Ledman with the Daily Dairy Report.

The company cut its full-year earnings guidance to 85 cents (U.S.) to 91 cents a share, down from 94 cents to $1.06 (adjusted for a 2-for-1 reverse stock split in August).

"The dairy commodity environment looks more challenging than previously expected as prices remain stubbornly high," Dean Foods chief executive Gregg Tanner told investors on a conference call Tuesday.

To lessen the blow to investors, the company said it would pay a 28-cent-per-share annual dividend, which works out to a yield of about 1.5 per cent. It also said it was boosting its share repurchase program and refinancing debt.

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Some analysts were surprised at the company's decision to spend cash on a dividend given its current struggles, which include closing up to 15 per cent of its manufacturing facilities, or eight to 12 plants, to save $120-million this year.

"We remain skeptical that committing to returning cash to shareholders is a wise move. From our view, keeping some dry powder to ensure financial flexibility might be a more desirable decision," Ms. Lash said.

Dean Foods' stock is cheap compared with some of its peers, trading at 15 times earnings, compared with 20 times for Synutra International Inc. and about 17 times for Saputo and General Mills Inc., according to data from S&P Capital IQ.

However, there are few signs of growth. The company said Tuesday its third-quarter sales were flat from a year earlier, at $2.2-billion. It sold its Morningstar division, which sells ice cream mixes and other dairy products, to Saputo earlier this year. It also divested the last of its stake in its organic and soy business, WhiteWave Foods Co., as part its plan to focus on milk products.

Earnings adjusted for the transaction were 12 cents per share, compared with 14 cents last year, which was also below analyst expectations for the quarter.

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About the Author
Contributor

Brenda Bouw is a freelance writer and editor based in Vancouver. She has more than 20 years of experience as a business reporter, including at The Globe and Mail, The Canadian Press, the Financial Post and was executive producer at BNN (formerly ROBTv). Brenda was also part of the Globe and Mail reporting team that won the 2010 National Newspaper Award for business journalism. More

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