TEXT-Fitch: Dean Foods' Ratings Not Immediately Affected by Agreement to Sell Morningstar

Mon Dec 3, 2012 6:16pm EST

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CHICAGO, December 03 (Fitch) Dean Foods Company's (Dean's; NYSE: DF) credit ratings and Positive Rating Watch will not be immediately impacted by the firm's announcement to sell its Morningstar Foods division (Morningstar). A full list of ratings follows at end of this release.

Pending Divestiture of Morningstar:

Dean Foods today announced that it has entered into a definitive agreement to sell its Morningstar Foods division to Saputo Inc. for $1.45 billion. Morningstar produces and sells dairy and extended shelf-life products including coffee creamers, aerosol whipped toppings, and blended iced beverages to retailers and foodservice providers in the United States.

For the latest-twelve-month (LTM) period ended Sept. 30, 2012, Morningstar generated approximately $1.6 billion of sales and $154 million of EBITDA. The purchase price is approximately 9.4x Morningstar's LTM EBITDA or about 8x EBITDA after giving effect the tax structure of the transaction. The divestiture, which has been approved by Dean's Board of Directors and is subject to customary closing and regulatory conditions, is projected to close by the end of 2012 or early in the first quarter of 2013.

Proceeds net of taxes and expense are expected to approximate $887 million. Dean plans to use substantially all of the cash to help retire term loans outstanding under its senior secured facility. Dean is forecasting net debt-to-EBITDA, as defined by its credit agreements, of below 3.0x at the end of 2012 if the transaction closes in the fourth quarter.

At Sept. 30, 2012, Dean had $3.5 billion of total debt of which $2.2 billion was term loans. On Oct. 31, 2012, subsequent to the end of the third quarter ended Sept. 30, 2012, Dean used a $1.2 billion distribution from The WhiteWave Food Co. (NYSE: WWAV) to fund the repayment of term loans due April 2, 2014. The distribution consisted of $282 million of net proceeds from the IPO of a 13% ownership stake in WWAV, which remains consolidated, and approximately $885 million of borrowings under WWAV's secured credit facilities.

Recent Rating Actions and Rating Rationale:

Fitch upgraded Dean's ratings on Nov. 5, 2012 due to the firm's reduced financial leverage, improved credit profile, and increased profitability at its Fresh Dairy Direct (FDD) operations. For the LTM period ended Sept. 30, 2012, total debt-to-operating EBITDA was 3.8x, down from 5.0x at Dec. 31, 2011, and operating EBITDA-to-gross interest expense was 4.0x, up from 3.0x. LTM FCF was $284 million, up from $124 million during calendar 2011.

Fitch also placed Dean's ratings on Watch Positive due to Fitch's view that further deleveraging was possible following the spin-off and potential divestiture of Morningstar. Fitch anticipates that Dean will generate approximately $10 billion of annualized sales, $500 million of EBITDA and have approximately $1.3 billion of debt following the spin-off of WWAV and divestiture of Morningstar. Pro form total debt-to-operating EBITDA is approximately 2.5x, which is modestly better than what Fitch had anticipated.

Dean's issuer default rating (IDR) could be upgraded to the 'BB' range following the closing of the Morningstar transaction, due to the firm's significantly reduced leverage. Future rating actions will reflect Fitch's assessment of Dean's on-going capital structure, free cash flow, and business risk as a less diversified traditional dairy business given volatile raw milk costs and the continued decline in fluid milk volumes. Fitch currently believes Dean can generate an excess of $100 million of FCF as interest expense declines and capital expenditures are reduced to reflect the needs of Dean's standalone FDD business.

Recovery Ratings:

The 'BB+/RR1' rating on Dean's secured debt reflects Fitch's view that recovery prospects for these obligations would be outstanding at 91% - 100% if the firm filed for bankruptcy. The debt is secured by a perfected interest in substantially all of Dean's assets. The 'BB-/RR3' unsecured rating is due to Fitch's opinion that bondholder recovery would be good at 51% - 70% in a distressed situation.

Liquidity, Maturities, and Financial Covenants: At Sept. 30, 2012, Dean had over $1.4 billion of liquidity consisting of $69.8 million of cash, $1.0 billion of secured revolver availability, and $337 million available under its receivables-backed facility. Dean's $1.275 billion revolver expires April 2, 2014 and its $600 million on-balance sheet receivables-backed facility matures on Sept. 25, 2013. Dean voluntarily reduced the size of its revolver to $1 billion on Oct. 31, 2012.

Scheduled maturities of long-term debt at Sept. 30, 2012 were $51.7 million in 2012, $206.6 million in 2013, and $1.2 billion of mainly term loan debt in 2014. As previously mentioned, Dean repaid all of its 2014 term loans on Oct. 31. 2012 and its resulting 2013 maturities have also declined to $10.5 million.

Financial maintenance covenants in Dean's credit facility currently include maximum total and senior secured leverage ratios. The calculation excludes up to $100 million of unrestricted cash and adjusts for charges and non-recurring items therefore bank leverage ratios are modestly lower than those calculated by Fitch.

The total leverage covenant is currently 5.5x, stepping down to 5.25x on March 31, 2013 and 4.5x on Sept. 30, 2013. The senior secured leverage restriction of 3.75x, steps down to 3.5x on March 31, 2013. Dean is also bound by a minimum interest coverage requirement of 2.75x which steps up to 3.0x on March 31, 2013. Dean reported total leverage and senior secured leverage, as calculated by its credit agreement, of 3.71x and 2.58x, respectively at Sept. 30, 2012, which indicates EBITDA cushion in excess of 25%.

What Could Trigger A Rating Action

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

--Total debt-to-operating EBITDA in the mid-3.0x range or lower in most years and continued good FCF generation;

--Continued structural improvement in Dean's FDD business and a rational wholesale pricing environment are also critical factors surrounding future rating upgrades.

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

--A sustained period of materially higher than expected leverage; such that total debt-to-operating EBITDA consistently exceeds 4.5x, could trigger a downgrade in Dean's existing ratings;

--Negative FCF generation, additional step downs in FDD's profitability due to lower gross profit and/or wholesale pricing concessions could influence future downgrades in ratings.

Fitch's rates Dean Foods as follows: Dean Foods Company (Parent)

--Issuer Default Rating (IDR) 'B+';

--Secured bank credit facility 'BB+/RR1';

--Senior unsecured debt 'BB-/RR3'. Dean Holding Company (Operating Subsidiary)

--IDR 'B+';

--Senior unsecured debt 'BB-/RR3'.

The above ratings have been placed on Rating Watch Positive.

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