Dairy processor Dean Foods (NYSE:DF) said on Friday that it will sell approximately 18.7 million shares of common stock in a registered public offering underwritten by Lehman Brothers. The sale, which closes March 5, is expected to dilute the existing share count by about 13%.
Generally, when secondary offerings are made in the market, Wall Street sees the event as a negative occurrence in the short-term for two reasons:
1. When an established company needs to raise funds, it means there could be trouble brewing.
2. Having additional shares outstanding waters down a stock, thereby requiring extra volume to move the stock up. It's a bit of a catch 22 for the company and shareholders.
However, there may be something else shaping up at Dean Foods, and the offering may prove to have actually been a very wise decision in the present business environment. (To learn more, see What is dilutive stock? and Why do share prices fall after a company has a secondary offering.)
Never Own Anything That Eats While You Sleep
First and foremost, investors probably aren't too happy with Dean Foods' 2008 stock performance, as the shares have fallen almost 20% since the start of the calendar year. The problem is simply one of higher commodity input prices, such as oil and feed corn. With oil trading at more than $100 a barrel, it simply costs more to transport goods. What's more, with corn prices up almost 38% since last November alone, it simply costs more to feed all those cows.
The fact is, cows like to eat, and even though many cattle-based companies attempt to feed their stock alternative products like soy-meal and alfalfa, there's just no getting around higher commodity prices on the whole. At the end of the day, even with demand for milk soaring, higher input prices are limiting profit at Dean Foods.
Paying Down Dairy Debts
At present, shareholders are likely wondering what Dean Foods needs the extra cash for. And it is here that we see that the recent offering may have proved to be a very good move, at a strategic time.
In the offering press release, Chairman and CEO Gregg Engles said, "As we've noted previously, the operating environment in 2007 was extremely difficult and operating results were below the expectations we had when we recapitalized the balance sheet last March. As a result, we entered 2008 approximately a year behind our original debt reduction expectations." In other words, the company realizes that the interest expense on additional outstanding debt will only hurt earnings in the years to come. (For more on analyzing corporate debt, see Debt Reckoning.)
Consequently, proceeds from the offering will go toward paying off debt, and thus take a substantial bite out of interest expenses in the future. What's more, with shares already trading near the 52-week low, the stock probably would have fallen more anyway - the offering news simply accelerated the downside. However, even though Wall Street has sold off the stock on the news, the simple fact is this is a strategic move to increase income and strengthen its balance sheet in the future. Those benefits need to be acknowledged in the price at some point.
Milking the Future
Beyond paying down debt, Dean Foods' management said some of the cash will stay on the sidelines to be used in acquisitions in the future. And even with difficult times, the company reiterated guidance of 15-20 cents per share for the first quarter and at least $1.20 per share for the full year 2008.
What everything really comes down to is the company made a very wise decision raising additional cash, even if it hurts the stock in the short-term. And while investors may be a little sour with the share count dilution, future quarters could prove to benefit more than the cost of the decision to sell more stock now.