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

Fitch Ratings has affirmed the Long-term Issuer Default Ratings (IDRs) for Dean Foods Company (Dean) and its subsidiary, Dean Holding Company, at 'BB-'. The Rating Outlook has been revised to Stable from Negative driven by Fitch's expectations for substantial improvement in operating earnings in 2015 on lower milk input prices and the removal of structural costs. As a result, Fitch anticipates that gross leverage (total adjusted debt-to-EBITDAR) is likely to improve to the 4x range in 2015 from 5.8x at the end of 2014.

Fitch has also assigned Recovery Ratings (RRs) in accordance with criteria, which allows for the assignment of RRs for issuers with IDRs in the 'BB' category. Given the distance to default, RRs in the 'BB' category are not computed by bespoke analysis. Instead, they serve as a label to reflect an estimate of the risk of these instruments relative to other instruments in the entity's capital structure. Fitch has assigned an 'RR1' to Dean's secured bank credit facility, notching it up two from the IDR and indicating outstanding recovery prospects (91% to 100%) under a distressed scenario. Unsecured debt will typically achieve average recovery, and thus the senior unsecured notes were assigned an 'RR4'.

A full list of ratings follows at the end of this release.

KEY RATING DRIVERS

Challenged Industry with Low Margins: Dean's operations largely consist of processing and marketing fresh fluid milk, which represented 73% of the company's product mix in 2014. Dean also produces ice cream, cultured dairy products, juices and teas. Ratings consider the fundamental challenges faced by the 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 in Dean's historical success at reducing costs into the ratings, and views the continued rationalization of processing operations as necessary given declining demand.

Input Price Pressure Abating: Dean's challenges include category volume declines that accelerated recently to approximately 4% from 2% historically, record high milk prices in 2014, and elevated per unit costs due to capacity reductions lagging lower volumes. The Class I milk price was up 24% in 2014 to a record high average of $23.29/cwt. on strong global demand and production shortfalls. Prices are finally reflecting improved global milk production and have fallen substantially year to date, down 34% year over year in April 2015 to $15.50/cwt.

Earnings and FCF Improvement Ahead: Fitch anticipates Dean can generate EBITDA in the range of $300 million to $350 million annually - below the 2013 level near $400 million - with Fitch assuming a more normalized pricing environment, mid-single-digit operating margin per gallon and total volume declines of approximately 1% to 2%. In 2014 EBITDA was well below this level at $203 million due to the record high cost that was passed through on a lagged basis and not fully passed on due to Dean's concerns about exacerbating volume declines when exceeding certain price points.

Fitch expects Dean can generate at least $50 million annual free cash flow (FCF; cash flow from operations less capital expenditures and dividends) in a normalized pricing environment, substantially better than the negative $23 million in 2014.

Lower Leverage Anticipated in 2015: Dean's leverage rose substantially in 2014 driven by the unprecedented high-cost environment's impact on earnings and slightly higher debt. Total debt-to-EBITDA rose to 4.6x from 2.3x in the prior year. Fitch also considers EBITDAR leverage due to Dean's significant leases for machinery, equipment and vehicles. Total adjusted debt-to-EBITDAR rose to 5.8x from 3.7x.

Fitch anticipates significant improvement in EBITDA in 2015 as milk input prices have abated, which should result in leverage moderating to the 4x range; however, the pace and magnitude of volume recovery is uncertain coming out of the unprecedented cost environment. Fitch assumes that Dean's volume will decline 1% to 2% annually relative to projected industry volume decline of 2% to 4%.

Good Liquidity for Volatile Industry: At Dec. 31, 2014, Dean's total debt was $924 million, including the $142 million aggregate principal of 2017 notes (rather than the GAAP amount). Dean's liquidity was supported by $16.4 million cash and $831 million available on the company's credit facilities, which included 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 were $680 million of available commitments under the revolver and $151 million of unused borrowing commitments under the receivables facility.

Refinancing Extends Maturities: In February 2015, Dean repaid its $476 million 7% notes due in June 2016 and a portion of the outstanding borrowings under the senior secured credit facility and receivables-backed facility with proceeds from a new issuance of $700 million 6.50% notes due in March 2023, with no net debt reduction. The company's next long-term debt maturity is $142 million 6.90% subsidiary notes due in October 2017.

On March 26, 2015, Dean entered into a new $450 million revolving credit facility (RCF) credit facility through March 2020, essentially reducing the revolver commitment by $300 million. The previous $750 million facility, dated July 2, 2013, was terminated. In conjunction with the new credit facility, Dean also amended its $550 million receivables facility to extend the maturity through March 26, 2018 and to match certain modifications under the new RCF.

The company has total revolving commitments of $1 billion and expects to have more than $750 million accessible liquidity after letters of credit. Dean is currently in compliance with all of its covenants. The facilities above require the company to maintain maximum senior secured net leverage of 2.50x, which allows Dean to subtract up to $50 million unrestricted cash and outstanding principal on receivables financing. Fitch expects Dean to have ample cushion within this covenant. The total leverage covenant was eliminated.

KEY ASSUMPTIONS

--Continued dairy category volume declines of 2% to 4% with Dean expected to perform better than the industry with average volume declines not exceeding 2% annually.

--Operating income per gallon returns to mid-single digits ($0.05-$0.06), from one-cent per gallon in 2014.

--25% decline in base Class I milk prices for the first quarter of 2015 (1Q'15) compared to 1Q'14, and input costs remain moderate throughout the year.

--Improving EBITDA to approximately $300 million in 2015, resulting from lagging pass-through of lower milk input costs, and continuing realization of cost savings from recent plant closures. EBITDA could range from $300 million to $350 million in moderate pricing environments.

--Base case factors in improvement in leverage to roughly the 3x range for total debt-to-EBITDA in 2015, which equates to total adjusted debt-to-operating EBITDAR in the low 4x range, with modest additional improvement beyond this year in the absence of material input price spikes.

--Positive FCF of more than $50 million annually, as defined by Fitch, reflecting improving earnings and excluding NOL benefits.

--Capex declines modestly from $150 million in 2015 due to continued plant closures.

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 near 5x, due to a material increase in debt and/or a prolonged period of EBITDA declines.

--Sustained acceleration of Dean's volume declines beyond 2% annually, driven by a contraction in milk consumption and/or loss of a major customer.

--Expectations for multiple years of minimal or negative FCF, per the Fitch definition, due to weak operating earnings.

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, given long-term pressure on dairy volumes.

--Total debt-to-operating EBITDA consistently in the low 2x range, which equates to total adjusted debt-to-operating EBITDAR consistently in the low 3x range, due to materially higher EBITDA and/or stable-to-declining debt levels;

--Sustainable annual FCF, per Fitch, of approximately $100 million or greater and elimination of additional fixed costs.

--Stable-to-modest volume declines and growth in market share would also be required for further upgrades.

Fitch has affirmed the following ratings and assigned RRs as follows:

Dean Foods Company (Parent)

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

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

--Senior unsecured notes at 'BB-/RR4'.

Dean Holding Company (Operating Subsidiary)

--Long-term IDR at 'BB-';

--Senior unsecured notes at 'BB-/RR4'.

The Rating Outlook is revised to Stable from Negative.

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

Applicable Criteria and Related Research:

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

--'Recovery Ratings and Notching Criteria for Non-Financial Corporates issuers' (November 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

Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=813588

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=983602

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