OREANDA-NEWS. Fitch Affirms Dean Foods' IDR at 'BB-'; Outlook 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 is Stable.

KEY RATING DRIVERS

Leading Share but Modest Declines

Dean is the largest processor and direct-to-store distributor of fluid milk in the U. S. with about 35% dollar share. However, the fluid milk industry is highly sensitive to volatile raw milk prices due to its low margins and is facing secular volume declines due to maturity and competition from alternative beverages. Volume declines of t 2% - 3% for Dean are tracking modestly higher than the industry as the company balances volume, margin, and price realization.

Branded Focus, Operating Efficiency

Branded products represented 48% of Dean's $8.1 billion of sales in 2015, up from 47% in 2014. Dean strategy is to build its higher margin branded business, to leverage its national distribution network by acquiring strong brands, and to continue to improve its operating efficiency via cost savings. DairyPure and TruMoo are examples of internally created national brands while the acquisition of Friendly's Ice Cream, a leading regional ice cream brand in the Northeast, for $155 million in June 2016 underscores the company's push into branded products while diversifying its product mix.

Normalized EBITDA, Good FCF

Fitch Ratings anticipates Dean can generate EBITDA in the range of $350 million - $400 million annually, assuming a normalized commodity cost environment, low single-digit volume declines, tight cost control and $0.07 - $0.09 operating margin per gallon. EBITDA margin is expected to be in the 5% range in most years. Fitch expects EBITDA to approximate $400 million - $450 million in 2016 and 2017 as gross margin benefits from benign dairy costs and gradual mix shift towards branded products continues.

Favourable Milk Cost Environment

Conventional milk prices, as measured by Class I Mover, declined 30% to $16.34 per hundredweight (CWT) in 2015, after reaching record levels in 2014, and fell another 14% to $14.49/cwt in the first quarter of 2016. Current USDA forecasts are for milk prices to decline roughly 10% - 15% in 2016 and to rise about 5% in 2017. Dean's gross profit rose 18% to approximately $2 billion in 2015 due to lower cost of sales, pricing actions, and an increased mix of branded products. Fitch expects Dean's gross profit to be relatively stable or slightly higher in 2016 and 2017.

Conservative Balance Sheet

Dean's conservative balance sheet enables it to better withstand potentially volatile raw milk costs while providing flexibility to make accretive bolt-on acquisitions. The firm had $847 million of total debt at March 31, 2016. For the LTM ended March 31, 2016, total debt/EBITDA and total adjusted debt/EBITDAR (adjusted leverage) were 1.8x and 3.0x, respectively.

Fitch projects total debt/EBITDA will be sustained in the 2x - 3x range and adjusted leverage in the low-3.0x to low-4.0x range in most years. Fitch also believes total debt/EBITDA and adjusted leverage could rise to 4x and 5x, respectively in periods of high commodity prices.

Fitch anticipates that Dean can generate FCF of about $100 million in most years assuming capex in the $150 million - $160 million range and a modestly growing dividend. Discretionary cash is expected to be deployed towards acquisitions and share repurchases.

Recovery Rating Notching

Dean's secured credit facility is secured by a first priority perfected security interest in substantially of its assets. The 'BB+/RR1' rating on the senior secured credit facility reflects Fitch's expectation that recovery prospects would be outstanding (91%-100%) in the event of default.

The 'BB-/RR4' rating on the unsecured notes reflect Fitch's view that recovery on this debt would be average (31% - 50%) in the event of default. Dean's $700 million 6.5% guaranteed senior unsecured notes due 2023 issued by the parent company and $142 million 6.9% senior unsecured notes at the operating subsidiary level are pari passu, as such, Fitch rates these issuances the same.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for Dean include:

--Total annualized revenue approximates $7.5 billion - $8 billion over the intermediate term as volume declines in the 3% range persist and the contribution from price/mix varies with conventional milk prices.

--Conventional milk prices, as measured by the class I mover, decline approximately 10% to below $15/cwt in 2016 and increase slightly in 2017 as supply/demand conditions get closer to equilibrium.

--Operating profit per gallon approximates 10 cents - 11 cents in 2016 and 2017, above Fitch's view of a 7 cent - 9 cent normalized range.

--EBITDA approximates $400 million - $450 million in 2016 and 2017, versus Fitch's expectation of $350 million - $400 million on a normalized basis, as gross margin benefits from benign dairy costs and gradual mix shift towards branded products continues.

--FCF after dividends approximates $100 million in 2016 and 2017.

--Total debt/EBITDA is sustained in the 2x - 3x range and total adjusted debt/EBITDAR in the low-3.0x to low-4.0x range in most years.

RATING SENSITIVITIES

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

--Better than expected volume trends that are in line or better than the industry;

--Further improvements in operating efficiency, as measured by cost reductions;

--Total debt/EBITDA sustained near 2.0x; equating to total adjusted debt/EBITDAR in the low 3x range;

--FCF approximating at least $100 million or more annually.

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

--Sustained acceleration of Dean's volume declines beyond 3% annually, driven by higher than expected declines in U. S. milk consumption, market share declines, and/or loss of a major customer.

--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 large debt-financed acquisition and an inability to delever within a reasonable time period due to a prolonged downturn in the business.

LIQUIDITY

At March 31, 2016, Dean had $882 million of liquidity consisting of $84.6 million of cash and availability under a $450 million secured cash flow revolver maturing 2020 and a $550 million account receivables securitization facility expiring 2018. The company's liquidity is also supported by its FCF generation, which Fitch anticipates will remain positive in most years. Fitch projects annual FCF of about $100 million in 2016 and 2017, assuming $160 million of capex and $30 million to $35 million of dividends annually.

FULL LIST OF RATING ACTIONS

Fitch affirms the following:

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'.