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Dean Foods a Potential Buyout Candidate for Canada's Saputo

- By Holmes Osborne, CFA

We are going to look at two large North American dairy operators--Dean Foods Co. (DF) and Canada-based Saputo Inc. (SAP.TO). Dean has fallen on hard times, but Saputo has done quite well. There is talk that Saputo may buy Dean. Prior to the buyout talk, we took a look at some of Dean's real estate and its trucking fleet.

First, we will take a look at Saputo. The stock trades for 46.03 Canadian dollars ($34.38), there are 390.2 million shares and the market cap is $17.96 billion ($13.47 billion). Earnings per share are CA$1.94 and the price-earnings ratio is 23.7. The dividend is 66 cents and the dividend yield is 1.43%.

Sales grew from CA$10.65 billion in 2015 to CA$11.5 billion in 2018. Not great growth, but it is milk, which hasn't done too well. Earnings grew from CA$607.6 million to CA$852.5 million over that time. Now that's nice earnings growth! Profit margins are 5.85% and return on equity is 15.11%. Very profitable. Saputo's stock trades over the counter in the U.S.

The balance sheet is very strong. The assets side shows CA$122 million in cash and CA$1 billion in receivables. The liability side shows CA$1 billion in payables and CA$1.4 billion in debt. Free cash flow was CA$531 million for a free cash flow yield of 3%. This overview started off as a bullish report on Dean, but Saputo is interesting too!

Now we will look at Dean, which is America's largest dairy . The stock trades for $2.30, there are 91.7 million shares and the market cap is $210 million. The stock has fallen to microcap status. Unbelievable. Earnings per share are a loss of $3.58. The earnings loss is greater than the stock price. The dividend has been suspended.

Dean sells its products under the names: DairyPure, TruMoo, Alta Dena, Berkeley Farms, Country Fresh, Dean's, Friendly's, Garelick Farms, Land O'Lakes, Lehigh Valley Dairy Farms, Mayfield, McArthur, Meadow Gold, Oak Farms, PET, T.G. Lee and Tuscan. About half of sales are private label and half company brands. Around 67% of sales is fluid milk and the rest is other dairy products.

Dean lost its Walmart (WMT) contract and the stock has gotten crushed. Sales dropped from $9.5 billion in 2014 to $7.8 billion last year.

In regard to the company's balance sheet, the asset side shows $24 million in cash and $589 million in receivables (which have been financed in a funky transaction). Payables are $700 million and debt is $905 million. Property, plant and equipment shows as $1 billion. We're going to dive a little deeper into this financial. PPE is buildings, land, machinery, desks, computers, etc. Many of these items are bought and then depreciated. The actual market value can be more or less. We will focus on some of the land Dean owns and its trucking fleet.

The first property is located in downtown Houston. Looking at the Harris County appraisal records, it has a value of about $30 million. It does not list the square footage of the property or the building. This $30 million may be low or high. My guess is that it's low as the economy in Houston is pretty hot.

The next property is in downtown Miami. I was able to find a little more information from the Miami-Dade assessor's site. The lot size is 205,967 feet. Another piece of property a few blocks away has 119,186 square feet. Both properties are a few blocks from Biscayne Bay in Little Haiti. There are 43,560 feet in an acre. The first property has a market value of $6.7 million and the second has a value of $2.4 million according to the assessor. Looking at Loop.net, I find that these values seem close to what comparable properties are selling for.

The property in Honolulu covers one-third of an acre and has a market value of $5 million according to the assessor's office. It operates under the Meadow Gold name.

The property in City of Industry, California, is east of downtown Los Angeles. The property shows as worth close to $25 million on the assessor's site. It is located next to a railroad track and not far from the 60 Freeway, one of the major freeways in the Los Angeles area. It operates under the Alta Dena name. Another property a few blocks away has five buildings on it and shows as $8.4 million.

These are some of the "hotter" real estate markets in the country. Now we'll look at a few markets that are closer to average. A property in Lebanon, Pennsylvania is surrounded by farmland, unlike the previous properties. It has 32 acres and an assessed value of $1.6 million. Obviously, it has a replacement cost higher than $1.6 million, but what is an empty dairy worth in a small city? Not a lot. The other properties could be quickly sold and turned into something else.

A property in Decatur, Illinois is not only in farmland but also has gravel driveways. I can't find it on the assessor's site (as their search tool is pretty awful), but it can't be worth much.

According to the Department of Transportation, Dean operates 1,741 trucks and has 2,324 drivers. Another website states that Dean owns 758 tractors and 2,245 trailers. If they are day cabs, they probably keep the trucks up to about 500,000 miles. If so, each tractor is worth about $30,000 to $40,000. A ballpark number on trailers is about $15,000 a piece for reefer trailers. The rough valuation of the fleet is about $60 million. I spoke with a person in the trucking industry who gave me a rough idea of what the fleet is worth.

So what's the value of these assets? Tough to say. The company was not very obliging. They told me to talk to Computershare, which is the same as telling me to get lost. And I am a shareholder. I'd guess these assets are probably worth somewhere between $500 million and $600 million.

We first bought into Dean on March 27 at $2.36. Right off the bat, we began losing. Not until today, April 15, are we close to breaking even. We think it is a no-brainer for Saputo to buy Dean. At this price, there isn't much risk, in our opinion. Dean is asset rich. Saputo can take its brand names and expand. Of course, in any merger and acquisition deal, there are synergies and cost cuts. Saputo specializes more in cheese and other dairy products and Dean on milk. Dean is almost entirely in the U.S. and Saputo gets 53% from the U.S. and the rest from Canada and internationally.

We took a small position in Dean. The question we are asking ourselves is if we should be buying more.

Disclosure: We own stock in Dean Foods.

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This article first appeared on GuruFocus.