Fitch Rates Dean Foods' $700 million Sr. Unsecured Notes 'BB-'

CHICAGO--()--Fitch Ratings has assigned a 'BB-' rating to Dean Foods Co.'s (Dean; NYSE: DF) $700 million 6.50% senior unsecured notes due 2023.

Dean plans to utilize the net proceeds to repay its $475.8 million 7.0% notes due in 2016 plus the estimated make-whole and interest for a total of $520.8 million. The proceeds will also go toward the repayment of its $70.3 million senior secured revolver balance and a portion of $235.0 million outstanding on its receivables-backed facility. Fitch believes there will be a minor uptick in leverage of 0.1x - 0.2x due to associated fees and expenses related to this transaction. The indenture and covenants will be substantially similar to the existing 2016 notes. The new notes will be guaranteed by Dean's material, wholly owned U.S. subsidiaries except receivables securitization subsidiaries. The notes will have a change of control provision at 101 and will not have financial covenants.

See the end of this press release for a complete list of the ratings for Dean and its subsidiary, Dean Holding Company (Dean Holdings). The Rating Outlook remains Negative.

KEY RATING DRIVERS

Limited Diversification, Earnings Volatility, Low Margins: Dean's operations largely consist of processing and marketing fresh fluid milk, which represented 73% of Dean's product mix during 2014. Dean also produces ice cream, cultured dairy products, juices, and teas. Ratings consider the fundamental challenges faced by the fluid milk industry, which has significant excess capacity, volume declines, and high levels of competition. The dairy industry also remains highly sensitive to volatile raw milk prices. Fitch factors Dean's historical success at reducing costs into the ratings, and views the continued rationalization of processing operations as necessary given excess capacity and declining demand. Dean's current ratings incorporate Fitch's view that the company's normalized EBITDA margin is in the low to mid-single-digit range, and earnings and cash flow exhibit volatility.

Class I Milk Prices Finally Declining: Dean's challenges include category volume declines that have accelerated recently to approximately the 4% level from 2% historically, record high milk prices and elevated per unit costs due to capacity reductions lagging lower volumes. Prices for Base Class I milk rose to record levels during 2014, up 24% year over year to an average of $23.29/cwt. Strong global demand for whole milk powder, particularly in the Chinese market, along with production shortfalls in key regions, were drivers of the elevated global milk prices. Class I prices have fallen substantially in 2015, down 34% year over year to $15.56/cwt for March. After a significant lag, prices are finally reflecting that global milk production has improved and international dairy prices have fallen.

EBITDA Declines, FCF Reflects Lower Earnings: Fitch has brought down its EBITDA expectations for Dean but still anticipates Dean can generate more than $300 million EBITDA during most years. In 2014 EBITDA was well below this level at approximately $200 million, due to the record high input costs mentioned above that were passed through on a lagged basis and not fully passed on due to volume declines and Dean's concerns about not exceeding certain retail price points. There is still a lack of earnings visibility beyond the very near term. Given substantially lower earnings, Dean's reported cash flow from operations less capital expenditures was $4 million in 2014. Adjusting for non-recurring items, cash flow from operations less capital expenditures was $25 million. However, Fitch's definition of FCF (cash flow from operations less capital expenditures and dividends) factors in Dean's recently initiated $26.2 million annual dividend. Fitch believes Dean can generate FCF of at least $50 million to $100 million in a normal environment.

Negative Outlook Driven by High Current Leverage: The Negative Outlook reflects Dean's currently high leverage for the rating level. In addition FCF was impacted by weak earnings, as mentioned above. The timing and magnitude of earnings and FCF improvement will be keys to determining if Dean can return to sustainable leverage appropriate for the current ratings. Fitch's view is that Dean can reduce leverage and generate FCF improvement after 2014, driven by recent moderation in milk input costs. Per Fitch, total debt to EBITDA was 4.6x for the latest 12 months ended Dec. 31, 2014, funds from operations (FFO) adjusted leverage was 5.2x, and operating EBITDA to gross interest expense was 3.3x. 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 5.8x for the latest 12 months. Leases are primarily for machinery, equipment and vehicles, including Dean's distribution fleet.

In Compliance with Covenants: Dean's total net leverage ratio for its secured credit facility and accounts receivable securitization facility were 5.25x for the third and fourth quarter of 2014, and will be 5.00x for the first quarter of 2015, 4.50x for the second quarter of 2015, and 4.00x in the third quarter of 2015 and thereafter. Dean was in compliance with the net leverage covenant at December 31, 2014 at 4.48x. Dean also has a maximum senior secured net leverage ratio of 2.50x, which Fitch believes will have ample cushion.

Good Liquidity for Volatile Industry: At Dec. 31, 2014, Dean's liquidity is supported by $16.4 million cash and $830.9 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 June 12, 2017. Included in the availability above, there was $679.7 million available under the revolver and $151.2 million remaining available borrowing capacity under the receivables facility. After the anticipated refinancing of the 2016 notes mentioned above, the company's next long term maturity is $142 million 6.90% subsidiary notes due in October 2017.

KEY ASSUMPTIONS

--Improving operating performance resulting from lagging pass-through of lower milk input costs, and continuing realization of cost savings from recent plant closures.

--Base case factors in leverage improvement so that covenant leverage stays below maximums outlined above.

--Positive FCF, as defined by Fitch, reflecting improving earnings.

--25% decline in base Class I milk prices for the first quarter of 2015 compared to the first quarter of 2014, and anticipated year over year input cost declines throughout the year.

--Cautious outlook on the pace of dairy category volume declines and Dean's ability to effectively manage its branded price gap to private label milk in a declining input cost environment.

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 a prolonged period of EBITDA declines.

--Expectations for multiple years of minimal or negative FCF, per the Fitch definition, due to weak operating earnings and sustained acceleration of volume declines driven by a contraction in milk consumption and/or loss a major customer would also support negative rating actions.

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

--A positive rating action is not anticipated in the near-to intermediate term, and any positive rating action is likely to be limited to within the 'BB' category;

--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, per Fitch, 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;

Fitch's ratings for Dean and Dean Holdings are as follows:

Dean Foods Company (Parent)

--Long-term Issuer Default Rating (IDR) 'BB-';

--Secured bank credit facility 'BB+';

--Senior unsecured notes 'BB-'.

Dean Holding Company (Operating Subsidiary)

--Long-term IDR 'BB-';

--Senior unsecured notes 'BB-'.

As stated above, the Rating Outlook remains Negative.

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

Applicable Criteria and Related Research:

--'Corporate Rating Methodology' (May 2014).

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=749393

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=980172

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Contacts

Fitch Ratings
Primary Analyst
Judi M. Rossetti, CFA/CPA, +1-312-368-2077
Senior Director
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Carla Norfleet Taylor, CFA, +1-312-368-3195
Director
or
Committee Chairperson
Michael Simonton, +1-312-368-3138
Managing Director
or
Media Relations
Alyssa Castelli, +1-212-908-0540 (New York)
alyssa.castelli@fitchratings.com
Elizabeth Fogerty, +1-212-908-0526 (New York)
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Judi M. Rossetti, CFA/CPA, +1-312-368-2077
Senior Director
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Carla Norfleet Taylor, CFA, +1-312-368-3195
Director
or
Committee Chairperson
Michael Simonton, +1-312-368-3138
Managing Director
or
Media Relations
Alyssa Castelli, +1-212-908-0540 (New York)
alyssa.castelli@fitchratings.com
Elizabeth Fogerty, +1-212-908-0526 (New York)
elizabeth.fogerty@fitchratings.com