September 8, 2017 / 5:40 PM / a year ago

Fitch Affirms Dean Foods' IDR at 'BB-'; Withdraws All Ratings

(The following statement was released by the rating agency) CHICAGO, September 08 (Fitch) Fitch Ratings has affirmed and withdrawn all its ratings for Dean Foods Company and its subsidiary, Dean Holding Company: Dean Foods Company (Parent) --Long-term Issuer Default Rating (IDR) 'BB-'; --Secured bank credit facility 'BB+/RR1'; --Senior unsecured notes 'BB-/RR4'. Dean Holding Company (Operating Subsidiary) --Long-term IDR 'BB-'; --Senior Unsecured notes 'BB-/RR4'. The Outlook is Stable. Fitch has withdrawn Dean Foods' ratings for commercial reasons. Fitch reserves the right in its sole discretion to withdraw or maintain any rating at any time for any reason it deems sufficient. KEY RATING DRIVERS Moderate Debt, Rising Leverage: Maintaining moderate debt levels should help Dean withstand the secular decline in U.S. fluid milk consumption and potential volatility in raw milk costs while providing flexibility for the firm to reinvest in its business. Fitch expects total debt for Dean to remain in the $800 million-$900 million range, in line with where it has been since 2013, after the company repays $142 million of 6.9% notes due Oct. 15, 2017. However, leverage is expected to increase materially over the intermediate term due to lower operating earnings and cash flow. Fitch projects total debt/EBITDA and total adjusted debt/EBITDAR will rise from 1.8x and 3.0x in 2016, respectively, to 2.8x and 4.1x, by 2019, which remain acceptable for current ratings. Leading Share, Industry Challenges: Dean is the largest U.S. processor of fluid milk with approximately 34% to 35% market share. However, the category is in secular decline due to competition from alternative beverages and weakness in the cereal category. Milk processors also have limited pricing power due to the commodity orientation of the product and excess capacity. Dean's volumes declined 2.7% in the second quarter of 2017 but were particularly weak for branded white milk where volumes declined 6%. Volume declines are expected to increase to the mid-single-digit range through 2019 due to customer losses caused by loss volume to Wal-mart Stores, Inc., which is building a dairy processing plant to supply certain of its stores in the Midwest, competitive pricing, and retailers promoting private-label milk. Significant Earnings Pressure: Historically Fitch viewed yearly EBITDA of $400 million-$500 million, which is equivalent to operating profit per gallon of about $0.10-$0.13, as normal for Dean. Fitch's view assumed volumes decline 1%-3%, Class I milk prices are within +/- 10% of the roughly $16/hundredweight (cwt) 15-year historical average, and the realization of cost savings. However, we currently expect operating profit per gallon and EBITDA to be sustained below $0.10 and $400 million, respectively, over the intermediate term due mainly to volume declines in the mid-single-digit range and negative mix shift towards private-label milk, and despite accelerated cost reductions. Multifaceted, But Challenged Strategy: Dean's strategy is to balance volume growth and price realization while reducing costs to protect operating profit per gallon. The company initiated a three-year $100 million productivity program in 2017 to eliminate waste, increase supply-chain efficiency, and enhance network optimization, and is also targeting $40 million-$50 million of SG&A cost cuts by year end. Dean is also focused on growing its portfolio of higher-margin brands including DairyPure, TruMoo, and Friendly's, while expanding its go-to-market strategy to include customer warehouses. Fitch does not expect cost reductions to fully offset the negative impact of volume declines and believes Dean's branded strategy is being negatively impacted by retailers aggressively promoting private-label milk to drive store traffic. Positive FCF, Manageable Maturities: Dean's FCF is being negatively impacted by declining operating earnings and a voluntary pension contribution in 2017 but remains positive. Fitch projects Dean annual FCF (cash flow from operations less capex and dividends) will approximate $40 million-$75 million over the intermediate term assuming capex in the $100 million-$130 million range and modest dividend increases. Dean intends to repay $142 million of 6.9% notes due Oct. 15, 2017, after which it does not have any meaningful maturities until 2023 when $700 million of 6.5% notes are due. DERIVATION SUMMARY Dean's IDR is lower than other packaged food companies with similar leverage due to the commodity nature of its business and potential for significant earnings volatility. The company's ratings also incorporate secular challenges in the fluid milk category. Total debt/EBITDA for Dean has generally been in line with that of other commodity-oriented food companies; such as Tyson Foods, Inc. (BBB/Stable) and Smithfield Foods, Inc. (BBB/Stable). However, Fitch's rating is based on lease-adjusted leverage due to the company's significant operating lease obligations. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: --Raw milk prices, as measured by the class I mover, increase nearly 10% to approximately $16.30/cwt in 2017 and remain near that level in 2018. --Total annualized revenue approximates $7.8 billion in 2017, declining to under $7 billion by 2019 due to mid-single-digit volume declines and pricing correlated to with raw milk prices. --Operating profit per gallon approximates 7 cents-8 cents per gallon through 2019. --EBITDA approximates $325 million-$375 million annually through 2019. --FCF after dividends around $40 million-$75 million annually through 2019. --Total debt/EBITDA increases towards 3.0x and total adjusted debt/EBITDAR to the low 4.0x range by 2019. RATING SENSITIVITIES Rating sensitivities are no longer relevant given today's rating withdrawals. LIQUIDITY At June 30, 2017, Dean had approximately $910 million of total debt, the vast majority of which is unsecured. Total debt consisted mainly of $142 million aggregate principal amount of notes due Oct. 15, 2017 which the company intends to repay, $700 million of 6.5% notes due March 15, 2023, and $65 million outstanding under the company's $450 million receivables-backed facility due Jan. 4, 2020. On Jan. 4, 2017, Dean amended its $450 million revolving credit facility (RCF) to extend the maturity through Jan. 4, 2022, eliminate a maximum senior secured net leverage ratio requirement, and reduce the interest rate. The amendment also modified the definition of Consolidated EBITDA to permit certain pro forma cost-savings add-backs in connection with permitted acquisitions and dispositions. The credit facility has an accordion feature that allows the company, subject to certain conditions, to increase the commitment by up to $200 million through the issuance of incremental term loans or increased revolver commitments. In conjunction with the amended credit facility, Dean also amended its receivables facility to extend the maturity through Jan. 4, 2020. As a part of the amendment, the size was reduced from $550 million to $450 million. Covenants were also made consistent with the amended RCF and pricing was modified. Dean is currently in compliance with all of its covenants. The facilities mentioned above require the company to maintain maximum total leverage of 4.25x, which allows Dean to subtract up to $50 million unrestricted cash. A/R borrowings are included in the total leverage covenant. At June 30, 2017, Dean's total leverage ratio as defined in the credit agreement was 2.25x. The company's liquidity is also supported by FCF generation (excluding one-time items), which Fitch believes will approximate $40 million-$75 million annually through the forecast period. Capital spending declined modestly to $145 million in 2016 from $163 million in 2015 and is expected to approximate $120 million-$130 million in 2017. We estimate that maintenance capex is about $75 million. FULL LIST OF RATING ACTIONS Fitch Ratings has affirmed and withdrawn the following ratings for Dean Foods as follows: Dean Foods Company (Parent) --Long-term Issuer Default Rating (IDR) 'BB-'; --Secured bank credit facility 'BB+/RR1'; --Senior unsecured notes 'BB-/RR4'. Dean Holding Company (Operating Subsidiary) --Long-term IDR 'BB-'; --Senior Unsecured notes 'BB-/RR4'. The Outlook is Stable. Contact: Primary Analyst Carla Norfleet Taylor, CFA Senior Director +1-312-368-3195 Fitch Ratings, Inc. 70 W. Madison St. Chicago, IL 60602 Secondary Analyst Bill Densmore Senior Director +1-312-368-3125 Committee Chairperson Joan Okogun Senior Director +1-212-908-0384 Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below: --Historical and projected EBITDA is adjusted to add back non-cash stock-based compensation and one-time costs. --Total adjusted debt/EBITDAR is defined as total debt plus 8x rent-to-EBITDA plus rent. Media Relations: Alyssa Castelli, New York, Tel: +1 (212) 908 0540, Email: For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. 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