Dean Foods Serves Up An IG Rating, While Equity Markets Have High Expectations

Moody’s is materially overstating the credit risk of Dean Foods Company (NYSE:DF) with its B1 rating. Our fundamental analysis highlights a much safer credit profile for DF, whose stable cash flows cover all operating obligations going forward. Moreover, their healthy liquidity profile would allow them to service all obligations including debt maturities through 2022. We, therefore, rate DF five notches higher at an IG4 credit rating, or a Baa2 equivalent using Moody’s ratings scale.

Meanwhile, cash bond markets are overstating the firm’s credit risk with a cash bond YTW of 5.375%, relative to an Intrinsic YTW of 4.055%, while CDS markets are accurately stating credit risk with a CDS of 249bps relative to an Intrinsic CDS of 240bps.

Contrary to credit markets, equity markets are fairly bullish, expecting ROA’ to expand to 8% from 5% in 2015, with 3% Asset’ shrinkage going forward. However, DF is trading at a low 1.1x V/A’ relative to historical valuations. As a result, even if the firm succeeds in pushing ROA’ up to 8% levels, the equity is likely fairly valued, even with more muted analyst expectations. Alternatively, if the firm does have issues making fundamental improvements to expand ROA’, there could be equity downside.

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