Dean Foods Most Underrated in S&P 500 Pre-IPO: Corporate Finance

No debt issuer in the Standard & Poor’s 500 Index is more deserving of a credit upgrade than dairy processor Dean Foods Co. (DF), according to data compiled by Bloomberg.

The cash flow, debt and market value of the largest U.S. milk processor indicate a 0.23 percent chance it will miss debt payments in the coming year, about 10 times lower than the 2.5 percent implied by credit ratings, Bloomberg data show. The company is rated Ba3 by Moody’s Investors Service and B+, one level lower, at Standard & Poor’s.

The planned initial public stock offering of as much as 20 percent of WhiteWave Foods Co., which makes Silk soy milk, would raise about $300 million that Dean Foods could use to pay down debt, which totaled $3.6 billion on June 30. The company’s bonds have gained 3.7 percent since the IPO announcement last month.

“It’s a very smart move because they’re able to raise cash without increasing risk to the balance sheet,” said Vicki Bryan, an analyst at research firm Gimme Credit LLC in New York, “They’ve got a long way to go to repair the balance sheet, so the best thing they can do right now, instead of borrowing money, is to sell stock and they’re just selling a piece.”

Dean Foods’s $500 million of 7 percent bonds due June 2016 have risen 3.75 cents since the Aug. 7 sale announcement to 107.5 cents on the dollar to yield 4.77 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Risk Declines

Credit default swaps insuring against missed debt payments by Dean Foods have declined 161 basis points since the announcement to 430.5, the lowest level since April 2010, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market.

Jamaison Schuler, a Dean Foods spokesman, said the company couldn’t comment on its finances because securities regulations restrict it from discussing the matter prior to the IPO.

The company’s default risk implies the lowest level of investment grade, equivalent to a Baa3 Moody’s rating and BBB- from S&P, according to data compiled by Bloomberg. Bloomberg’s default-risk analysis uses the ratio of a company’s debt to market capitalization to calculate its odds of failure, similar to the predictive model created by Robert Merton, the Nobel Prize-winning economist at MIT’s Sloan School of Management.

Debt Reduction

Dean Foods will own at least 80 percent of WhiteWave’s common stock after the IPO, distributing its remaining interest in the company to its shareholders, according to an Aug. 7 statement. Proceeds from the offering, as well as $800 million to $925 million that will be borrowed under a new credit facility at WhiteWave, will be used to reduce Dean Foods’s outstanding debt.

The company reported net income of $56 million in the second quarter from a net loss of $51 million a year earlier, the Dallas-based company said Aug. 7. Operating profit increased 30 percent in the first half of 2012 due in part to a 20 percent drop in raw milks costs, according to Kenneth Shea, a food and beverage analyst at Bloomberg Industries in Skillman, New Jersey.

Dean Foods’s leverage ratio, or debt divided by earnings before income, taxes, depreciation and amortization, of 4.36 times in the three months ended June 30 is down from 5.35 a year ago and at the lowest level in three years, data compiled by Bloomberg show. If the IPO closes this year, the company expects that ratio to decline to 3.5.

‘Liquid Asset’

Dean’s total leverage on March 31 was 4.41 times, the company reported in a May 9 regulatory filing. Total leverage under Dean’s current loan agreement must not exceed 5.5 times, according to the company. The threshold steps down next year to 5.25 times at March 31 and to 4.5 times at Sept. 30.

The planned IPO may bring in as much as $500 million, more than the company’s $300 million estimate, Amit Sharma, a New York-based analyst for BMO Capital Markets who has a hold rating on the shares, said in a telephone interview yesterday. Dean may sell more of its stake in WhiteWave to raise more cash, he said.

“If there is a hiccup on the dairy side, they have this highly liquid asset that can be used to repay debt,” he said.

Almond Milk

The company has benefited from the growth in higher-margin products such as coffee creamers and almond milk from WhiteWave, Gimme Credit’s Bryan said. The Fresh Dairy Direct unit that includes the company’s main fluid milk business made up 74 percent of sales in 2011, and 54 percent of operating income. While WhiteWave made up 16 percent of sales, it accounted for 31 percent of operating income, data compiled by Bloomberg show.

“We’ve got the worst drought in 70 years affecting soy, plus affecting the dairy markets with higher feed costs and lower supplies,” Bryan said in a telephone interview, “And they’re actually holding their own.”

Most-active futures of corn, one of the main feed crops for dairy cows, rose to a record $8.49 a bushel in Chicago on Aug. 10 as a drought in the Midwest reduced grain and pasture yields. Most active milk futures declined in the first half of 2012. The U.S. Department of Agriculture forecast on Sept. 12 that milk prices will rise in 2012 after cutting its production forecast from a month earlier.

The immediate gains of paying down debt may not compensate for losing the profit stability that WhiteWave had provided, said Wen Li, an analyst at debt researcher CreditSights Inc. Dean’s earnings will become more volatile as it becomes more tied to commodity prices.

‘Successful Test’

“It’s a very challenging industry once you take away WhiteWave. Their portfolio is going to be much, much weaker going forward after the spinoff,” Li said in a telephone interview from New York.

The earliest the two companies will separate is in the middle of 2013, Li said. The two biggest rating companies have not revised the company gradings since the IPO announcement. Moody’s put the company on review for downgrade on Aug. 8, while S&P changed its outlook to positive on Aug. 10.

“Your strategy is best tested when it’s under stress, and they’ve certainly had a successful test this year,” Bryan said.

To contact the reporters on this story: Matt Robinson in New York mrobinson55@bloomberg.net; Shruti Singh in Chicago at ssingh28@bloomberg.net

To contact the editors responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net; Simon Casey at scasey4@bloomberg.net

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