Dean Foods Company (DF): Upgraded to Buy at Goldman Sachs

Goldman Sachs is upgrading Dean Foods Company (NYSE:DF) to Buy from Neutral with a $19 price target representing 55% upside.

– They see the stock a potential double in 2-years, with $25 SOTP value.

The crux of Goldman’s call is that DF’s margins have troughed at 3%-4% EBIT margin and they now have increased confidence that margins could recover towards a 5%-6% level over the next few years. Retailer pricing pressure on private label milk is in firm’s view abating – leading to improved margin over milk costs – and cost savings could total more $1 per share of earnings over the next few years. Goldman is raising 2012/2013 estimates to $1.20/$1.50 from $0.78/$0.91.

DF’s margins are nearly 300 bp lower versus historical averages – DF’s EBIT margins have declined to 3.5% from its historical average margin of 6.5% and well off its peak margin of 7.7%. The primary driver of margin decline has been the pricing pressure from retailers on private label milk, which led to lower margin on DF’s private label milk and a wider price gap between branded and private label milk that resulted in consumer downtrading to private label milk.

Two quarters of improved pricing in private label milk – Goldman says they have begun to see signs of a more stable pricing environment as retailers are no longer pressuring private label milk pricing and promotional activity is down from the 2010 level. This is a positive for DF not only as margin over milk costs is improving but the branded milk performance is also improving, helping DF’s mix.

DF expects another $300 mm-plus in cost saves over the next three years – DF’s cost saving opportunity is sizable, with $100mm-plus targeted in each of the next three years. Firm’s channel checks suggest DF’s cost savings opportunity is indeed large as the company improves supply chain, procurement, eliminates headcount, and integrates IT.

Stable pricing plus cost savings should drive margin recovery towards 5%- 6% level over the next few years – Given the improved pricing environment, they now have more confidence that DF should see some portion of its cost savings flow to the bottom line. Goldman is assuming about ½ of the $100 mm cost savings accrues to the bottom line, which should be enough to drive nearly 32% growth in EBIT in 2012 and 10-11% growth in 2013-2014. Their model forecasts 5.5% EBIT margin by 2014.

DF is also a deleveraging story – DF’s balance sheet remains highly levered at north of 5x, though recent asset sales have improved the leverage profile a bit. As their model forecasts sizable EBITDA growth over the next few years, DF should be in position to de-lever its balance sheet more quickly than consensus expects. They see DF’s net debt/EBITDA at 3.2x by the end of 2013. Lower interest expenses should boost EPS significantly, as Goldman estimates EPS growth of 72% in 2012 and 24% in 2013.

Shares could double in the next two years – Goldman’s sum-of-the-parts valuation assumes a 7.5x Fresh Dairy EV/EBITDA multiple, 10x on Whitewave-Alpro, and 8x on Corporate. The two-year implied value of their SOTP points to $25 per share or about double the current DF price. Goldman expects DF’s 2011-2013 EPS CAGR to be about 45% vs. the Staples average of around 11% as DF should see sizable profit growth as margins recover and EPS is boosted by deleveraging.

Notablecalls: Dean Foods (DF) has been one of the the most hated names in the Food group. Huge leverage coupled with declining milk prices created a situation that left the stock for dead.

Two quarters of improved milk prices have caused the stock to double as the smart money buyers moved in.

Now Goldman is out with a ‘all clear’ upgrade, calling for another double. Their estimates & price target are the Street high. The upgrade is somewhat reactionary in nature.

The stock will be up 10%+ today, I suspect.

Hopefully there will be a quick dip in the name after open.

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