Fitch Affirms Dean Foods' IDR at 'BB-'; Outlook Stable

CHICAGO--()--Fitch Ratings has affirmed the following ratings of Dean Foods Co. (Dean; NYSE: DF) and Dean Holding Co.:

Dean Foods Company (Parent)

--Issuer Default Rating (IDR) at 'BB-';

--Secured bank credit facility at 'BB+';

--Senior unsecured notes at 'BB-'.

Dean Holding Company (Operating Subsidiary)

--IDR at 'BB-';

--Senior unsecured notes at 'BB-'.

The Rating Outlook is Stable.

Key Rating Drivers:

Leverage Appropriate for Ratings: During 2013 Dean repaid more than $2 billion of debt and is currently focused on maintaining a strong balance sheet. Dean had $907 million of debt at year-end 2013 (including the aggregate principal amount of the 2017 notes) and, per Fitch, total debt-to-operating EBITDA was 2.3x. Dean's commitment to maintaining average net leverage below 2.5x supports the current ratings. Operating EBITDA to gross interest expense, excluding interest on swaps related to recent transactions, was 3.6x for the latest 12 months. Due to Dean's high level of operating leases as a stand-alone company, total adjusted debt to operating EBITDAR is also an important leverage metric, which was 3.7x for the latest 12 months. EBITDAR includes eight times the company's $124.7 million rent expense in 2013. Leases are primarily for machinery, equipment and vehicles, including Dean's distribution fleet.

Earnings Volatility, Low Margins: Dean's ratings continue to incorporate the company's mid-single-digit EBITDA margin, earnings and cash flow, which can be volatile at times. Also factored in is the company's limited diversification following the divestment of its higher margin and faster growing WhiteWave (WWAV) and Morningstar operations discussed below. However, these negatives are balanced against the firm's lower leverage, positive free cash flow (FCF) excluding one-time transaction related cash payments in 2013, and historical success reducing costs. Ratings also consider the fundamental challenges faced by the fluid milk industry, which continues to have excess capacity, experience low-single-digit volume declines, and exhibit high levels of competition. The dairy industry also remains highly sensitive to volatile raw milk prices. Fitch views the continued rationalization of processing operations as necessary given the excess capacity.

Record High Milk Prices: Dean's leverage commitment is balanced with the company's near-term challenges including record high milk prices and high per unit costs due to capacity reductions lagging lower volumes. Prices for conventional raw milk increased during the back half of 2013 and, on average, were approximately 8% higher during 2013 compared to 2012. Prices have continued to rise to record levels during the early part of 2014, reaching $24.47 per hundredweight for base Class I milk for May 2014. Strong global demand for whole milk powder, particularly in the Chinese market, remains a key driver of the elevated global milk prices. The company expects this trend to continue through at least the first half of 2014, with prices that could exceed the highest six-month period average ever previously achieved. Assuming normal weather patterns, Dean believes solid global supply growth will ultimately lead to declining raw milk prices in the second half of 2014.

Long-Term Challenges in Milk: Dean's operations consist of its fresh-dairy operation, which processes and markets fluid milk, ice cream, cultured dairy products, juices, and teas. Declining U.S. milk consumption, volatility in the price of raw milk, and excess industry capacity are fundamental challenges for the industry, increasing the risk of wholesale pricing pressure. Mitigating factors include gradual improvement in the U.S. economy, a fairly rational retail pricing environment, and continued reductions in industry capacity. Fluid milk represented 73% of Dean's product mix during 2013.

WhiteWave-Alpro (WhiteWave) and Morningstar Transactions: Dean completed the IPO of 13.3% of WWAV on Oct. 31, 2012 and spun off the majority of its 86.7% ownership interest on May 23, 2013. Dean maintained 19.9%, or 34.4 million shares, of WWAV, which it monetized in July 2013 in a tax free debt for equity exchange. Dean recorded a $415.8 million tax-free gain on the disposition. On Jan. 3, 2013, Dean completed the sale of Morningstar for $1.45 billion of pretax proceeds, or an estimated $887 million, net taxes and expenses. The selling price was 9.4x LTM EBITDA, or about 8x EBITDA, after reflecting the tax structure of the transaction. Due to the timing of tax payments, Dean used the majority of pretax proceeds to fully retire $1,027 million of secured term loans and to repay a $265 million of revolver balance.

FCF Expectations: Dean's FCF was negative $491.8 million in 2013 primarily due to cash taxes related to the divestiture of Morningstar and other one-time items. Given lower cash interest expense and reduced capital expenditures, Fitch believes Dean can generate annual FCF of approximately $50 million to $100 million after the approximately $27 million annual dividend initiated this year. Fitch views $350 million to $400 million as an achievable EBITDA range for Dean during most years, although 2014 is likely to be below this level due to high input costs that are passed through on a lagged basis and may not be fully passed on. The company's current guidance is for EBITDA of $335 million to $355 million in 2014. This guidance includes a portion of Dean's $400 million to $600 million year over year increase in cost of goods sold due to milk inflation that will be a drag on operating income.

Good Liquidity, Covenant Cushion: Dean's liquidity is supported by $16.8 million cash and $799.8 million available on the company's credit facilities, which include a $750 million secured revolver expiring July 2, 2018 and a $550 million accounts-receivable securitization facility through March 6, 2015. Included in the availability above, at Dec. 31, 2013 there was $699 million available under the revolver and $100.8 million remaining available borrowing capacity under the receivables backed facility. The revolver and receivables facilities require maximum consolidated net leverage of 3.50x and minimum consolidated interest coverage of 3.00x. Per these agreements, Dean's leverage was 2.24x and interest coverage was 4.41x for the prior four consecutive quarters ending Dec. 31, 2013. These metrics allow for ample covenant cushion. Dean's next significant debt maturity is $476 million of 7% notes due June 1, 2016.

Rating Sensitivities:

Future developments that may, individually or collectively, lead to a negative rating action include:

--Total debt-to-operating EBITDA sustained above the 3.5x range, which equates to total adjusted debt to operating EBITDAR above the 4.5x range, due to a material increase in debt and/or EBITDA decline for a prolonged period, potentially related to the inability to pass through raw milk prices in a timely manner, could trigger a downgrade in ratings;

--Multiple years of minimal or negative FCF generation and an acceleration of volume declines due to a contraction in milk consumption or loss a major customer could also support negative rating actions.

Future developments that may, individually or collectively, lead to a positive rating action include:

--Total debt-to-operating EBITDA consistently in the low 2.0x range, which equates to total adjusted debt to operating EBITDAR consistently in the low 3.0x range, due to materially higher EBITDA and/or stable-to-declining debt levels could lead to a positive rating action;

--Sustainable annual FCF of approximately $100 million or greater, elimination of additional fixed costs, absence of significant volume declines and the maintenance of market share would also be required for further upgrades;

--Further diversification could also be positive for the ratings;

--Any positive rating action is likely to be limited to within the 'BB' category.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (August 2013).

Applicable Criteria and Related Research:

Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139

Additional Disclosure

Solicitation Status

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Contacts

Fitch Ratings
Primary Analyst
Judi M. Rossetti, CFA/CPA
Senior Director
+1-312-368-2077
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Carla Norfleet Taylor, CFA
Director
+1-312-368-3195
or
Committee Chairperson
Wesley E. Moultrie, II CPA
Managing Director
+1-312-368-3186
or
Media Relations:
Sandro Scenga, +1-212-908-0278 (New York)
sandro.scenga@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst
Judi M. Rossetti, CFA/CPA
Senior Director
+1-312-368-2077
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Carla Norfleet Taylor, CFA
Director
+1-312-368-3195
or
Committee Chairperson
Wesley E. Moultrie, II CPA
Managing Director
+1-312-368-3186
or
Media Relations:
Sandro Scenga, +1-212-908-0278 (New York)
sandro.scenga@fitchratings.com