TURNAROUND ASSESSMENT Turnaround of Dean Foods: A Strategy to Milk a Shrinking Industry Turnaround Management Final Project | Professor Kathryn Harrigan December 12, 2018 Arun Nagabhairava | Divyani Kothari | Kavan Reddy | Miles Bloom | Patricia de Carvalho Barros Larcher e Ovidio | Regen Wallis
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TURNAROUND ASSESSMENT
Turnaround of Dean Foods: A Strategy to Milk a Shrinking Industry
Turnaround Management Final Project | Professor Kathryn Harrigan
Patricia de Carvalho Barros Larcher e Ovidio | Regen Wallis
TURNAROUND ASSESSMENT
Table of Contents Executive Summary ....................................................................................................................................................... 3
Company Overview........................................................................................................................................................ 4
Industry Overview ......................................................................................................................................................... 6
Peer and Historical Comparison .................................................................................................................................... 7
Causes of Decline ......................................................................................................................................................... 10
M&A Consolidation and Debt ................................................................................................................................. 10
Declining Demand for Milk ...................................................................................................................................... 11
Slim Margins due to Cost Challenges ...................................................................................................................... 12
Exhibit 2 : Trading and Transactions Comparables ................................................................................................. 27
Exhibit 3 : Liquidation Process Under Chapter 7 ..................................................................................................... 28
Exhibit 4 : Financials and assumptions of investing in the plant-based products business .................................... 29
Exhibit 5 : Financials and assumptions of streamlining the number of plants ........................................................ 29
Exhibit 6 : Financials and assumptions of eliminating unprofitable areas .............................................................. 30
Exhibit 7 : Financials and assumptions of increasing share of ice-cream and fresh cream products ..................... 30
Executive Summary Dean Foods Company, found in 1925, has grown over the better part of a century from a small regional player to a large diversified food company focused primarily on fresh fluid milk, associated dairy products, juices, and water. It operates under many well-known brands such as DairyPure®, LAND O LAKES®, and TruMoo®. The dairy products industry is characterized by razor thin, low single-digit operating margins and has suffered a slow decline over the past half-decade with forward-looking growth expected to be anemic at best. Moreover, it suffers from heavy governmental intervention – through Federally mandated milk prices – and constant competition from large cooperative firms. To compound the industry wide malaise, exportation of excess milk products is challenging – if not impossible – due to the perishable nature of such dairy related products.
In recent periods, the decline in the industry has been pronounced. This coincided with successive years of M&A at Dean Foods, funded primarily through heavy debt issuance. However, the trouble arising from these acquisitions was just beginning and in 2010 lawsuit were filed by US governmental agencies alleging that Dean Foods created a monopolizing provider. In 2012 a rising debt load and increasing pressure from litigation forced Dean Foods to spin off WhiteWave and Morning Star, refocusing on its core dairy business. Post-divestitures, Dean Foods focused on operating improvements and debt reduction. This led to a stable credit rating for several years until an insider trading scandal and missed earnings targets precipitated a Moody’s downgrade in May 2018.
Presently, Dean Foods faces considerable headwinds both internally – from difficult labor unions, high integration costs, and a significant debt load – as well as externally – from a declining demand environment and governmental regulation. Our chief concern is to provide implementable recommendations to provide Dean Foods with a sustainable path to future profitability and growth.
Stock price development
Dean Foods demonstrated strong performance
throughout the half decade after the Great
Recession, but over extension through acquisition,
legal challenges, declining addressable market, and
an unsustainable debt load has pressured the stock
in the past year.
Selection of brands under Dean Foods
The company manages a broad portfolio of brands
(more than 50), driven by regional preferences and
legacy acquisitions.
Turnaround strategy
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Dean Foods (DF) Stock Performance: 2011-2018
TURNAROUND ASSESSMENT
Company Overview Dean Foods Company (NYSE: DF) was founded by Samuel E. Dean, Sr. in Franklin Park, Illinois, in the
1920’s. After purchasing other Illinois dairy plants Dean developed the enterprise "from a small regional
dairy into a diversified food company.” Today, DF operates in the food and beverage industry and is the
largest processor and direct-to-store distributor of fresh fluid milk and other dairy and dairy case products
in the United States.
As of 2017, consolidated net sales totaled $7.8 Billion. DF operates 65 manufacturing facilities in 31 states
with distribution capabilities across all 50 states. The company manufactures, markets and distributes a
wide variety of branded and private label dairy and dairy case products, including fluid milk, ice cream,
cultured dairy products, creamers, ice cream mix, and other dairy products to retailers, distributors,
foodservice outlets, educational institutions, and governmental entities across the United States. DF
products encompass over 50 national, regional and local dairy brands, as well as private labels including:
• White milk national brand DairyPure®
• Flavored milk brand TruMoo®
• Regional dairy brands such as Alta Dena®, Berkeley Farms®, Country Fresh®, Dean’s®, Friendly's®,
and Garelick Farms®
• Milk and cultured products such as LAND O LAKES®, Lehigh Valley Dairy Farms®, Mayfield®,
McArthur®, Meadow Gold®, Oak Farms®, PET®, T.G. Lee®, and Tuscan®
• Organic milk through the Organic Valley® Fresh joint venture
Dean Foods Company (NYSE:DF) 22.1% 2.7% 0.7% (0.19%) 60.29% 4.2x (13.78%)
TURNAROUND ASSESSMENT
Causes of Decline M&A Consolidation and Debt
Dean Foods is a result of a series of mergers and acquisitions over the past 20 years. The industry as a
whole has significantly consolidated dairy processing since 1970 – as the largest dairy producer in the
United States, Dean Foods played a prominent role in this consolidation.
Figure 6: Milk processors have consolidated significantly and are now concentrated in Great Lakes/CA/FL Regions.
In 2001, Dean Foods was acquired by Suiza Foods. The Dean Foods brand name was kept for the
combined company. Between 2002 and 2005 Dean Foods acquired White Wave, Inc., Horizon Organic
Holding Corporation, and launched TreeHouse Foods. In 2006 Dean Foods acquired Jilbert’s Dairy in
Michigan. The next year, they bought the Wells Dairy milk plant in Iowa. In 2009 Dean Foods purchased
soy beverage maker Alpro for approximately $455 Million along with Foremost Farms USA (Dean Foods).
This wave of M&A activity had consequences. In 2005 and 2008 lawsuits were filed against Dean Foods
for violating organic cow standards in their Horizon brand. In 2010 the US Department of Justice and the
state attorneys general's office of Wisconsin and Michigan, filed a lawsuit alleging that purchases by
Dean Foods were creating a monopolizing provider. Under pressure from litigation and a mounting debt
load, Dean Foods spun off WhiteWave and Morning Star in 2012 to refocus on its core dairy business
(Moody's, n.d.).
Figure 7: Dean Foods stock plummets during litigation, with recovery post-divestiture when refocused on dairy
TURNAROUND ASSESSMENT
After stabilizing in 2016, Dean Foods acquired Friendly’s, formed a joint venture with Organic Valley, and
invested in Good Karma, Steve’s Ice Cream, and Uncle Matt’s Organic.
Post 2012 divestitures, Dean Foods has focused on improving its operating costs and paying down its
debts. Dean Foods credit rating had been stable for a number of recent years until a combination of an
insider trading scandal in 2017 and missing earning targets in 2018 led to a Moody’s downgrade in May
2018 (Jagdale & Kutua, 2015).
Figure 8: Moodys credit rating for Dean Foods
Dean foods renegotiated its debt covenants to allow for meaningfully higher leverage, which can
increase to 5.5x in 2019 compared to 2.8x today, and implies soft 1H19 results. In order to meet these
new levels, earnings will need to be flat year over year according to Jeffries covenant analysis below
(Goldman & James, 2018).
Figure 9: Covenant analysis based on reduced Dean Foods earnings
The earnings miss and low confidence by investors is due largely to industry shifts and cost reduction
challenges that are putting a strain on a historically strongly performing company.
Declining Demand for Milk
The U.S. milk industry is cyclical facing periods of oversupply and overdemand. Right now, there is an
oversupply of raw milk which was brought about by three years of 1-2% yoy increases in milk
production. Demand from consumers has declined an average of 2% yoy since 2009. Lower raw milk
costs in 2015 and 2016 intensified competition between dairy processors, enabling them to offer lower
prices in order to win contracts for key customers.
TURNAROUND ASSESSMENT
Structurally, US milk volumes are facing headwinds due to lower cereal consumption and higher plant-
based beverage consumption that is growing at a tremendous velocity. Although Dean Foods has made
investments in soy, flax, and almond milk production they often divest non-dairy production or their
investments are too small to make a substantial impact in their changing business.
Soy, almond, oat, flax, and other milk substitutes are becoming more preferred by consumers across the
United States. This can be observed in any casual trip to the supermarket through the dairy section.
Premium placement is now being given to non-dairy items as milk demand erosion continues. Figure 10
below from J.P. Morgan shows the dairy aisle at a Ralph’s grocery store where a majority of space is now
being taken up by dairy substitutes (Dickerson & Fishbein).
Figure 10: Milk substitutes are taking up prime real estate in the dairy aisle
Additionally, Dean Foods has historically had sales exposure concentrated with large customers. The
company’s top five customers accounted for 29% of FY15 sales. Loss of major customers has had
material impact on company performance. In 2018, Dean Foods lost 90 Million gallons of Walmart
business. Walmart, one of their biggest customers, decided to invest in their own milk production and
have built a factory with an estimated capacity of 100-110 Million gallons.
Slim Margins due to Cost Challenges
Cost competition on milk has continued to get increasingly more competitive. Milk production
consistently peaks each year at record highs as farmers become more efficient at producing more milk
from less cattle. In May of 2016, more than 18,500 pounds of milk was produced (Andress & Charrow,
2016).
Figure 11: Herd sizes shrink as yield per cow more than doubles
TURNAROUND ASSESSMENT
Dean Foods 3Q2018 earnings were lower than expected due to what management is indicating are
“transitory costs”. Although there have been significant dairy processing plant consolidations that have
happened in the past few years, there is a lot of room for further consolidation. Aggressive factory
consolidation in Q3 closed 7 plants in 6 weeks, stretching resources and leading to unintended cost
increases above modeled synergies from rationalized operations.
Relying heavily on a company owned fleet of diesel-powered delivery trucks to move milk across the
country, Dean Foods has significant energy exposure. This has hurt margins in years and seasons where
energy prices have spiked and continues to be a major operational risk for the company.
Further, Dean Food’s has limited ability to influence their gross margins since fluid milk prices are set by
the USDA, which maintains tight control over supply and demand. In reality, gross margins are
negatively correlated with the price of milk. As milk prices and margins rise the government consistently
correct by reducing prices. In short, the $106 Billion milk industry sees only $4 Billion in profits each year
(Goldman & James, 2018).
Figure 12: Correlation of Dean Food’s Gross Margin with Class I Mover
Recent Insider Trading Scandal
In April 2017, famed sports gambler William T. Walters was convicted of fraud and conspiracy in one of
the biggest insider trading scandals in recent years. Walters was convinced of 10 charges of securities
fraud, wire fraud and conspiracy (potential sentence of up to 20 years in prison).
Walters had been getting information from Thomas C. Davis, a board member of Dean Foods. Through
realized profits and avoided losses, Walters made more than $40 Million on the scheme.
It was established that Davis and Walters would speak in code, using “Dallas Cowboys” to refer to Dean
foods and asking “How’s the milkman doing?”. They used a prepaid burner phone, codenamed the “Bat
Phone,” to communicate.
The government’s main witness, Thomas C. Davis, came out while trying to avoid punishments on
several offenses related to the trading scheme that he had pled guilty to. Under cross examination,
TURNAROUND ASSESSMENT
Davis acknowledged being squeezed for money after taking $100,000 of a charity he was running and
mislabeling expenses on his taxes. He had lied to many including SEC investigators.
The investigation brought to the spotlight prominent figures including hedge fund billionaire Carl Icahn
and professional golfer Phil Mickelson. Icahn and Walters were friends that frequently spoke. Many
historical trades that Walters had made were stocks that Icahn had made public announcements he was
interested in. Because of this relationship it was difficult to charge Icahn with any wrongdoing.
Mickelson on the other hand owed nearly $2 Million in gambling debts to Mr. Walker. Michelson made
nearly $1 Million in trading Dean Foods shares which were seized by the SEC in a civil suit. Michelson
was not criminally charged (Moynihan & Moyer, 2017).
TURNAROUND ASSESSMENT
Liquidation Analysis Overview Dean Food’s causes of decline and current position make it critical for the company to change the operating strategy over the next 6-8 months, to avoid the breach of debt covenants. In the event, the above does not pan out, the company would be forced to liquidate under chapter 7, assuming the qualification under 11 U.S.C. §§ 101(41) and 109(b). Below is a liquidation analysis for Dean Food’s based on the latest available balance sheet dated
September 2018. Data is not projected, given a fire sale provides limited opportunity for a full valuation
of assets. Debt holdings are based on data obtained from Dean food’s latest available 10K, December
2017. There will most likely be discrepancies between present day and December liability figures, but
these differences are not assumed to alter the conclusions of the below liquidation analysis materially.
The liquidation analysis indicates a recovery value of $1.058B or 44.9% of the full value of Dean Food’s
assets. Figure 13 below details the recovery analysis of the firm’s assets.
Figure 13: Assets as of September 2018 with realizable value under Liquidation (Note: all numbers are $m)
Asset Assumptions The assumptions and observations based on Dean Food’s 2018 balance sheet and 10-K informed the
recovery values deemed realizable in a Chapter 7 liquidation:
• Dean Food’s 5Y average days of sales outstanding (DSO) is ~30 days
• Dean Food’s credit terms to customers generally range up to 30 days, as an internal process they perform ongoing credit evaluations of the customers and maintain allowances for potential credit losses based on historical experience. The reserve for product returns has not historically been material.
• One largest customer accounts for ~20% of net sales
Inventory • Given >90% of these items are perishable in nature and thus have a small shelf life, recoverable amount is assumed to be half of historical recovery averages i.e. 50-60%
• Dean Food’s inventory comprises of dairy, diary case products such as fluid milk, ice creams, cultured dairy products, creamers, ice cream mixes and other products such as juices, teas, bottled water.
• 5Y average inventory days is ~11 days
Prepaid expense and other current assets
• The nature of the description from the 10-K does not indicate it is recoverable
• Derivative assets that have settlement dates equal to or less than 12 months from the respective balance sheet date were included under this category
Net Property, Plant & Equipment
• 25% of the assets are land and building used for commercial purposes and finding active buyers for these offices seems reasonable. ~65% of the fixed asset class is machinery with estimated average useful life ranging from 3 to 20 years, given the overall decline in the industry seems a more difficult proposition to sell. Furthermore, this includes the distribution fleet which are leased assets with terms ranging from have 1-20 years.
• Largest component of the total assets on the book, ~40% of total assets
• On an average Dean Food’s makes addition through capital expenditure of ~2% of sales per anum
• It comprises Land and building, leasehold improvements, machinery and equipment
• Annual Asset impairment: In 2017 the impairment analysis indicated an impairment of $27.8 million (~2.5%-3% of fixed asset base). 5Y average is <2%.
Goodwill and other intangible assets
• Given goodwill has resulted from acquisitions recovery is assumed to be 0%. On the other hand the private labels and brand value is likely to result in a retrieval rate of ~15% on liquidation, with potential interest from competitors.
• According to company’s accounting policies, goodwill and other intangible assets with indefinite lives are not amortized
• Other intangible assets are assumed to be the trademark of Dean Foods and the private labels used for the products
Other long-term assets
• No clear information is available for the characteristics of these assets - on conservative-basis only 5% realizable due to lack of further information
TURNAROUND ASSESSMENT
Figure 14: : Assets as of September 2018 with realizable value under Liquidation ($ million USD)
Waterfall Analysis At time of liquidation, according to section 292 there is an order of payment and thus the purpose of a waterfall analysis is to sort creditors according to their seniority.
Figure 15: Order of payment chart according to S 292
Further, it provides an overview of what each creditor could expect to receive in the event of a liquidation, assuming the pecking order of the absolute priority (AP) rule holds. Creditors in the same group must be treated equally, according to the pari passu principle, and no one lender can be unfairly discriminated against relative to its peers. The analysis commences at the top of the seniority ladder. Dean Food’s has first lien creditors with claim of $11.2 Million, which would be satisfied completely in a liquidation. The claim of second lien debt holders is $907.7 Million, including Senior notes that are unsecured but have a rank above all other unsecured creditors. All second lien creditors will also recover 100% of their face value. All other unsecured creditors (Accounts payable, accrued expenses, def tax liability and other non-current liabilities) would be paid proportionally i.e. 15% of their face value.
1. The cost & expenses of the winding up - S292 (1) (a)
Note: If the funds that remain for the general unsecured creditors are not sufficient to settle all the claims,
the available money must be divided proportionately
Order of Payment
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Figure 16: Creditor repayment schedule under Liquidation ($ million USD)
Details on the Liabilities of Dean Food’s
Senior Secured Revolving Credit Facility: As per the credit agreement, the facility is for up to $450 Million with the right to request an increase of the aggregate commitments under the Credit Facility by up to $200 Million, which can be either term loans or revolving loans, without the consent of any lenders not participating in such increase. Security: The Credit Facility is guaranteed by existing and future domestic material restricted subsidiaries substantially all of our wholly- owned U.S. subsidiaries. It is secured by a priority perfected security interest in substantially all of the assets and the assets of the Guarantors. Receivables Securitization Facility —Up to $450 Million receivables securitization facility pursuant to which certain of the subsidiaries sell their accounts receivable to two wholly- owned entities intended to be bankruptcy- remote. The entities then transfer the receivables to third- party asset- backed commercial paper conduits sponsored by major financial institutions. Dean Foods Company Senior Notes due 2023 — Dean Food’s issued $700 Million at 6.50% senior notes due 2023. The 2023 Notes are our senior unsecured obligations. They rank equally in right of payment with all of our existing and future senior obligations and are effectively subordinated in right of payment to all of our existing and future secured obligations, including obligations under our Credit Facility and receivables securitization facility. Capital Lease Obligations and Other — primarily comprised of leases for information technology equipment
Creditors Amount Interest % Recovery % Recovery Amount Assets Left