The restructuring/repositioning of Dean Foods (NYSE:DF) has taken another significant step forward. On Monday before the open, the country's largest dairy processor announced that it had reached a long-awaited agreement to sell its Morningstar business. While Dean Foods got a reasonable price for this asset, it's still an open question as to whether Dean Foods' overall operating strategy can reward shareholders.

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Farewell to Morningstar
Before the open on Monday, Dean Foods announced that it had reached an agreement with Canada's Saputo to sell them its Morningstar business for $1.45 billion in cash. While Dean Foods would probably have preferred to keep this producer of extended shelf life products like creamers, sour cream and ice cream, selling the business was an invaluable part of the company's overall debt reduction program.

At $1.45 billion (about $887 million in net proceeds to the firm), Morningstar got a solid bid that was slightly better than most of the estimates I had seen. This deal values Morningstar at about 0.9 times sales and 9.5 times EBITDA; not as robust as the premium that Ralcorp (NYSE:RAH) got for selling itself to ConAgra (NYSE:CAG), but then the businesses have different margin and competitive structures.

SEE: Analyzing An Acquisition Announcement

The Two Major Items Are Done ... But Much Is Left
With the sale of Morningstar and the initial public offering of WhiteWave (Nasdaq:WWAV), management at Dean Foods has checked off two of the major items on the corporate to-do list. All together, these moves should help cut the net-debt position by more than a third, though the company will still have upwards of $10 per share in net debt weighing down the balance sheet.

For better or worse, these were the easier steps to take and now it remains to be seen how much progress the company can make on its margin structure. Certainly the third quarter showed some progress. Although milk demand continues to fall faster than supply, and revenue declined 8% on a reported basis, adjusted EBITDA rose about 11% for the quarter.

SEE: A Clear Look At EBITDA

Can Dean Foods Win When the Competitors Play by Different Rules?
I think it's still worth asking whether Dean Foods' basic model still makes sense. For better or worse, the fresh dairy business is largely a pass-through business. Although it's possible to create premium-priced brands (and Dean Foods has done so), the company still does not have all that much pricing power - price is determined in large part by difficult (if not impossible) to control costs and the willingness of retailers to use private label milk as a loss leader.

Dean Foods' original plan was to use the efficiencies of a national system (one that has about 25% share) to better control costs and eventually squeeze out smaller regional players. Unfortunately, there's still excess capacity in the industry and those smaller private regional players are often willing to accept lower returns on capital than Dean Foods. So that means not as many players leaving the field and less ability for Dean Foods to flex its leverage.

What's more, retailers like Kroger (NYSE:KR) and Harris Teeter (NYSE:HTSI) still have a vested interest in keeping those regional players alive - if for nothing else than giving them options on the private label milk side.

The Bottom Line
Unlike larger packaged food companies like Kraft Foods (Nasdaq:KRFT) and ConAgra, Dean Foods has had only modest success in building a branded business with defensible margins and above-average returns. Overall, I see this as a business that hasn't ever earned its cost of capital and likely will always struggle to do so given the pass-through nature of the business. As a result, I think investors interested in the dairy space would probably be better served with admittedly more speculative plays like China's Mengniu Dairy.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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