Dole’s Cash Harvest From Asset Sale May Not Help Profits Grow

The sale of Dole Food’s most profitable businesses may help the company deal with its hefty debt load and its interest payments, but low margins on the remaining business don’t signal any improvement in earnings quality.

Interest rates may be so low that it’s easy for companies to raise fresh capital, making interest repayments less of a burden than many CFOs have ever experienced. But that hasn’t helped Dole Food Co. (DOLE.N). This marketer and distributor of fresh fruits and vegetables is struggling with nearly $1.5 billion of long-term debt on its books and another $200 million of short-term debt – and only $82 million in cash and cash equivalents on the balance sheet to offset it. Little wonder, then, that the company has low scores on almost the entire array of StarMine models focusing on credit. Dole Foods also scores poorly on the StarMine Earnings Quality (EQ) Model, recording a rank of only 9 out of a possible 100.

The hefty debt load that Dole is carrying means that its interest expenses are significant in absolute terms, and in Dole’s case, these payment obligations look even more difficult in relative terms. While in the last four quarters (ending with the September 2012 quarter) the company reported operating income of $180 million, it paid out $132 million in interest expenses. Whenever a company pays out such a large proportion of its operating income in the form of interest on its debt, it is reasonable to worry that any decline in operating income may trigger further problems, in the form of a struggle to make those payments. Not surprisingly, therefore, Dole’s scores on StarMine’s credit models reflect this state of affairs. The company scores only 5 on the StarMine SmartRatios Credit Risk (SRCR) Model and 8 out of a possible 100 on the Structural Credit Risk (SCR) Model, a metric that reflects the market’s view of the probability of a default event in the future. The SRCR Model score gives Dole an implied credit rating of only B-, while the SCR rank and the score of 7 on the StarMine Text Mining Credit Risk (TMCR) Model translate to an implied credit rating of BB-.

One reason for the company’s troubles, and in particular for its poor earnings quality (as measured by the EQ model) is its poor operating efficiency. As you can see in the chart above, its return on net operating assets for the company has plunged in the last four quarters even as the rest of the industry appears to be doing relatively well. Dole’s return on net operating assets (RNOA) for the trailing four quarters has fallen to 7.3% from 10.9% in the 12-month period ended September 30, while the median RNOA for its peers has edged higher to 14.2% from 13.6% over the same time frame. Dole’s operating profit margins also have taken a hit, falling to 2.6% from 3.5% over the last four quarters and languishing far below the industry median of 8.2%. Some of that margin compression can be traced to the impact of the higher cost of fruit in the wake of a weak planting season in South America, and to the ban imposed by Chinese authorities on imports into that country of Dole bananas grown in the Philippines.

Dole’s cash flows also are flagging. In the chart below, the red section of the bars represents the amount by which the company’s free cash flow trails its net income, and it is immediately obvious that free cash flow has lagged in each of the five most recent quarters. Moreover, in four of those quarters, free cash flow has been negative. That’s bad news for earnings quality, since profits that are backed by strong cash flows tend to be more sustainable.

In an effort to shore up its balance sheet, Dole is looking to sell off some of its assets. Japan’s Itochu Corp. (8001.T) agreed to acquire Dole’s profitable global packaged goods business and its Asian fresh produce business in early December for $1.7 billion. Management changes will follow, as the company’s CEO, CFO and its head of human resources leave Dole to join Itochu as a result of the transaction. That transaction will leave Dole to focus on its fresh fruits and vegetables business and will make it a much smaller company.

This sale means that Dole will reap net proceeds of about $1.39 billion. If the company opts to use all of those funds to pay down debt, that burden could be cut to a more manageable $260 million, by one analyst’s calculations, and leave it with interest expenses of only $16 million, according to the same analyst’s model. This may well change Dole’s score on the StarMine credit models.

One danger of selling the company’s more profitable divisions, however, is that the businesses that management is left to oversee are those that are less profitable, with lower margins. That challenge – of improving margins on the remaining operations – will remain. The odds are that the poor EQ score signals that the company is likely to struggle in vain to improve its profitability.