The credit ratings and Rating Outlook for Dean Foods Co. (Dean; NYSE:DF) and Dean Holding Co. will not immediately be affected by the company's proposed initial public offering (IPO) and tax-free spin-off of its wholly-owned subsidiary - The WhiteWave Foods Co. (WhiteWave).
Fitch's current ratings and Outlook are as follows:
Dean Foods Company (Parent)
--Issuer Default Rating (IDR) 'B';
--Secured Bank credit facility 'BB/RR1';
--Senior unsecured debt 'B-/RR5'.
Dean Holding Company (Operating Subsidiary)
--Senior unsecured debt 'B-/RR5'.
The Rating Outlook is Positive.
At June 30, 2012, Dean had $3.6 billion of total debt, down from $3.8 billion at March 31, 2012.
Proposed IPO/Spin-Off of WhiteWave-Alpro:
On Aug. 7, Dean announced its proposed IPO of up to 20% of WhiteWave and subsequent tax-free spin-off of its remaining ownership to Dean's shareholders. The IPO could occur by the end of 2012 but the tax-free spin-off of its remaining ownership interest will occur no earlier than the expiration or waiver of the 180-day lock-up period following the closing of the IPO. WhiteWave intends to list its Class A common shares on The New York Stock Exchange under the ticker: WWAV.
WhiteWave manufactures, distributes, and sells Dean's branded plant-based foods and beverages, premium dairy products, and coffee creamers and beverages under the Silk, Horizon, International Delight, and Land O Lakes brands in North America and Alpo and Provamel brands in Europe. Per WhiteWave's S-1 filing on Aug.7, 2012, WhiteWave generated $2.0 billion of sales and $236.6 billion of EBITDA during 2011. The sale of up to 20% of Dean's equity in WhiteWave is expected to garner aggregate gross proceeds of around $300 million.
Net proceeds from the IPO combined with between $800 million and $925 million of borrowings under a new credit facility at WhiteWave will be paid to Dean in order to reduce debt. Management expects Dean's leverage ratio, as defined by its credit agreements, to decline to approximately 3.5 times (x) from around 4.0x at the latest twelve month (LTM) period ended June 30, 2012 if these transactions close by the end of 2012. If the IPO and debt raise does not occur by year end, management expects leverage of about 3.75x by Dec. 31, 2012, an improvement versus previous guidance, due to stronger than anticipated first half results.
Positive Rating Outlook and Rating Triggers
On May 15, 2012, Fitch upgraded Dean's issue-level ratings and revised the Outlook on the firm's IDR to Positive from Stable. The rating action was due to margin improvement at Dean's traditional dairy operations Fresh Dairy Direct (FDD), Fitch's expectation that operating fundamentals would remain favorable in the near-term, continued strength at Dean's other operations, and management's commitment to utilizing free cash flow (FCF) to reduce debt. Fitch's base case projection, absent the separation of WhiteWave, was for total debt-to-operating EBITDA to approach 4.0x by the end of 2012 and fall below 4.0x by 2013.
Fitch has long viewed the separation of WhiteWave as a possibility, due to management's belief that Dean's equity valuation did not fully reflect the value of its faster growing higher margin operations and the firm's history of engaging in corporate actions to enhance shareholder value. Furthermore, Fitch has stated that such transformative transactions could result in rating changes.
Fitch believes Dean's business, absent the cash flow of WhiteWave, can support leverage in the mid 3.0x range in most years, and based on management's preliminary leverage estimates, an upgrade is likely to occur in the near term. Should leverage be sustained below this level, multiple upgrades are possible. Recovery prospects for Dean's remaining unsecured debt will also significantly improve due to over $1 billion of secured debt paydown in conjunction with the transactions.
Dean's current ratings reflect its relatively high financial leverage and FDD's mid-single digit operating margin and volatile earnings profile. Financial and operating risk associated with these factors have been partially mitigated by the company's consistent free cash flow, management's focus on debt reduction and the strong growth profile of WhiteWave-Alpro.
During 2011, FDD represented 74% of the firm's $13.1 billion of sales and 54% of its $645 million of operating income excluding corporate expenses. WhiteWave-Alpro represented 16% of sales and 31% of operating income excluding corporate expenses, and Morningstar represented the remaining 10% and 15%.
Fitch also views Dean's leading market share and national distribution capabilities as a competitive advantage and expects continued elimination of fixed costs to better position the firm to withstand industry volatility. Dean believes it can realize roughly $100 million of cost reductions annually, after garnering $300 million under its multi-year productivity initiative implemented in 2009.
Although raw milk prices, as reflected by the Class I mover, declined 9% to $16.48/hundredweight during the first half of 2012, modest increases are expected in the near-term as drought conditions in parts of the U.S. is resulting in higher animal feed costs. Fitch expects Dean's continued focus on price realization, volume performance, and discipline cost management to help the company manage through higher raw milk input costs.
Potentially negative effects from structural industry challenges related to excess milk processing capacity and gradual declines in volumes also remain risks for Dean's FDD business. However, as long as retailers continue to price milk rationally the risks are lessened.
The current '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 current 'B-/RR5' unsecured rating is due to Fitch's opinion that bondholder recovery would be below average at 11% - 30% in a distressed situation.
As previously mentioned, recovery prospects for Dean's unsecured debt will improve post the IPO transaction due to the company's new capital structure. Fitch's assumptions regarding the going-concern enterprise value of Dean without WhiteWave will also affect recovery ratings.
For the LTM period ended June 30, 2012, total debt-to-operating EBITDA was 4.1x, down from 5.3x at Dec. 31, 2010, and operating EBITDA-to-gross interest expense was 3.6x, up from 3.1x. LTM FCF was $206.1 million, modestly lower than the company's $260 million annual average since 2001, excluding the debt-financed $15/share special dividend in 2007. Dean's FCF is benefiting from improved operating cash flow, lower inventory related working capital, and a reduction in capital expenditures. Management now expects capital expenditures of $250 million - $265 million in 2012, down from $325 million in 2011.
Liquidity, Maturities, and Financial Covenants:
Fitch views Dean's liquidity as adequate. At June 30, 2012, the firm had $60.4 million of cash, $1.2 billion available under its secured revolver, and $185 million under its receivables-backed facility. Dean's $1.3 billion revolver expires April 2, 2014 and its $600 million on-balance sheet receivables-backed facility matures on Sept. 25, 2013.
Scheduled maturities of long-term debt at June 30, 2012 were $103.5 million in 2012, $376.2 million in 2013, and $1 billion in 2014 and consisted mainly of term loans and balances outstanding under the revolver and receivables-backed facility. Proceeds from the IPO and debt incurrence at WhiteWave along with internally generated cash flow will help Dean repay this debt.
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.
As Fitch anticipated, EBITDA headroom under Dean's financial maintenance covenants continues to improve due to debt reduction and operating income growth. Dean reported total leverage and senior secured leverage, as calculated by its credit agreement, of 3.96x and 2.79x, respectively at June 30, 2012, which indicates EBITDA cushion in excess of 20%.
Recent Operating Performance and 2012 Outlook:
Dean revised up its 2012 consolidated operating income growth guidance for the second time this year. The company now expects mid to high-teens full year operating income growth at FDD versus low-teens growth previously and continues to expect high-teens growth for WhiteWave and mid-teens growth at Morningstar.
During the most recent second quarter, consolidated sales declined 5.3% to $3.1 billion and operating income, adjusted non-recurring litigation settlement expenses during the prior year period, increased 37% to $157 million. The reduction in revenue was due mainly to the 11.5% and 0.5% increase in sales at WhiteWave and Morningstar, respectively, being offset by a 9.6% decline in sales at FDD. FDD's sales declined due to lower raw milk prices, given the pass-thru nature of the business, and modestly lower volumes. WhiteWave and Morningstar both generated double-digit volume growth.
Higher gross profit at each of Dean's operating segments and lower selling and distribution costs at FDD drove the increase in operating income. Cash flow from operations increased 33% to $238.7 million during the first half of 2012 and FCF increased to $143.2 million from $60.9 million due to lower capital spending.
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 and the expectation that the company can maintain leverage at this level in most years could result in a one-notch upgrade in Dean's ratings;
--If Fitch ascertains that leverage can be sustainably maintained below mid-3.0x, following further review of Dean's business post the IPO/Spin-off transaction, multiple upgrades would be possible;
--On-going FCF generation, continued structural improvement in Dean's FDD business, and a rational wholesale pricing environment are also critical factors surrounding future upgrades in ratings.
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 above 5.0x, 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.
Additional information is available at www.fitchratings.com. The ratings above were unsolicited and have been provided by Fitch as a service to investors.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 12, 2011);
--'Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers' (May 12, 2011);
--'Fitch Updates Recovery Analyses for U.S. Food and Restaurant Companies' (June 31, 2012);
--'Fitch Upgrades Dean's Credit Facility and Unsecured Debt Ratings; Revises Outlook to Positive (May 15, 2012);
--'U.S. Leverage Finance Spotlight - Dean Foods Company' (April 20, 2012).
Applicable Criteria and Related Research:
Corporate Rating Methodology
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
U.S. Food and Restaurant Recovery Models
U.S. Leverage Finance Spotlight -- Dean Foods Company
Carla Norfleet Taylor, CFA, +1-312-368-3195
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Wesley E. Moultrie, II CPA, +1-312-368-3186
David E. Peterson, +1-312-368-3177
Brian Bertsch, +1-212-908-0549