May 15, 2012 at 18:35 PM EDT
Fitch Upgrades Dean's Credit Facility and Unsecured Debt Ratings; Revises Outlook to Positive

Fitch Ratings has upgraded the secured bank credit facility and senior unsecured debt ratings of Dean Foods Company (Dean; NYSE: DF) and the senior unsecured debt rating of Dean Holding Company. Fitch has also affirmed each entity's Issuer Default Rating (IDR). The ratings are as follows:

Dean Foods Company (Parent)

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

--Secured Bank credit facility to 'BB/RR1' from 'BB-/RR2';

--Senior unsecured debt to 'B-/RR5' from 'CCC/RR6'.

Dean Holding Company (Operating Subsidiary)

--IDR at 'B';

--Senior unsecured debt to 'B-/RR5' from 'CCC/RR6'.

The Rating Outlook has been revised to Positive from Stable.

At March 31, 2012, Dean had $3.8 billion of total debt.

Rating Rationale:

The upgrades are due to improved recovery prospects on Dean's debt obligations following two quarters of significant operating income growth and management's commitment to conservative financial policies. Furthermore, Fitch views recent EBITDA margin improvement for Dean's Fresh Dairy Direct (FDD) segment as sustainable in the near term. Moderately lower raw milk prices, higher retailer margins on milk that alleviates the need to discount in order to drive foot traffic, and an improving U.S. economy have provided Dean increased operating visibility for 2012.

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 'B-/RR5' unsecured rating is due to Fitch's opinion that bondholder recovery would be below average at 11% - 30% in a distressed situation. This is due mainly to the high mix of secured priority debt in Dean's capital structure and Fitch's assumptions regarding the going-concern enterprise value of the firm in a distressed situation.

Fitch continues to view excess milk processing capacity and the slow gradual decline in industry volumes as a longer term challenge for processors such as Dean. In the near term, however, risks pertaining to wholesale price concessions and retail discounting of private label milk appear to have subsided. Moreover, growth of non-traditional higher margin dairy products produced at the firm's WhiteWave-Alpro (WhiteWave) and Morningstar segments remains strong. WhiteWave and Morningstar represented 16% and 10% of Dean's consolidated sales and 31% and 15% of operating income excluding corporate expenses, respectively, in 2011. The remaining 74% of sales and 54% of operating income was from FDD, which as mentioned above, is experiencing more favorable operating conditions.

Dean's ratings reflect its high level of financial leverage given the low margin volatile nature of the traditional dairy industry. This is partially mitigated by management's focus on debt reduction and the strong growth profile of WhiteWave and Morningstar. Fitch 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 for future industry downturns. 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.

Positive Outlook and Rating Triggers:

The Positive Rating Outlook is due to faster than anticipated improvement in Dean's credit statistics and the company's strategy of utilizing free cash flow (FCF), which is currently being enhanced by a meaningful pullback in capital expenditures (CAPEX), for debt reduction. Dean plans to reduce 2012 CAPEX to the $260 million - $275 million range from $325 million in 2011. Fitch expects Dean to generate roughly $150 million of FCF in 2012 and reduce total debt-to-operating EBITDA to near 4.0 times (x) by year end.

An upgrade of Dean's IDR could occur if total debt-to-operating EBITDA is sustained at the low 4.0x due to continued debt reduction and stable to improving operating performance. Conversely, a downgrade could occur if reduced profitability or a change in financial strategy result in leverage rising above 5.0x.

For the latest 12 months (LTM) period ended March 31, 2012, total debt-to-operating EBITDA was 4.75x, operating EBITDA-to-gross interest expense was 3.2x, funds from operations (FFO) fixed charge coverage was 2.2x, and FCF was $85.7 million. LTM FCF, which includes approximately $90 million of cash litigation payments, should increase as the year progresses and these large extra-ordinary cash costs are cycled.

At March 31, 2012, Dean's balance sheet included $73 million of long-term liabilities related to litigation settlements to be paid over the next four years. Fitch views the preliminary approval of the settlement for the Tennessee Dairy Farmers case and dismissal of the Tennessee Retailer Action earlier this year positively.

Scheduled maturities of long-term debt at March 31, 2012 were $196 million in 2012, $511 million in 2013, and $1.1 billion in 2014. Fitch believes Dean could refinance a portion of these obligations as early as late 2012 because good operating results and a disciplined financial strategy are improving the firm's financial flexibility.

Liquidity and Financial Covenants:

Fitch views Dean's liquidity as adequate. At March 31, 2012, Dean had $1.35 billion available under its secured revolver, $75 million under its receivables-backed facility, and $130.3 million of cash. The firm's revolver has two tranches for which $225 million expired on April 2, 2012. The remaining $1.3 billion expires April 2, 2014. Dean's $600 million on-balance sheet receivables-backed facility matures on Sept. 25, 2013.

Financial maintenance covenants 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 has improved over the past year due to debt reduction and operating income growth. At Dec. 30, 2010, Dean had less than 10% headroom under its leverage covenants. However, at March 31, 2012, Dean had approximately 20% cushion under its total leverage covenant, 15% under its senior secured leverage requirement, and 24% under its interest coverage requirement.

Operating Performance and 2012 Outlook:

Dean revised its 2012 consolidated operating income growth guidance to a range of the high-teens to 20% due to better than expected first quarter results. Previously, the company had forecast high single-digit to low double-digit growth due to moderately lower raw milk costs, new business at FDD, cost reductions, and continued growth at WhiteWave and Morningstar. On a segment level, Dean expects full year operating income growth to be in the low-teens for FDD, high-teens for WhiteWave, and mid-teens at Morningstar. Fitch's outlook reflects growth at the low-end of management's guidance.

FDD experienced 11% operating income growth in the fourth quarter of 2011 and 18% growth in the first quarter ended March 31, 2012, breaking a string of double-digit declines experienced for eight straight quarters beginning in the fourth quarter of 2009. Given recent performance and historical growth rates, the outlook for WhiteWave and Morningstar are also viewed as achievable. WhiteWave, which includes the Horizon Organic, Silk, Alpro, and International Delight brands, is benefiting from increased brand marketing and innovation while Morningstar is growing with expanded specialty beverage offerings in the quick-service restaurant industry.

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);

--'U.S. Leverage Finance Spotlight - Dean Foods Company' (April 20, 2012).

Applicable Criteria and Related Research:

Corporate Rating Methodology

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=647229

Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=677740

U.S. Leverage Finance Spotlight -- Dean Foods Company

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=675206

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Fitch Ratings
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