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Dean Foods Chapter 11 Bankruptcy Analysis

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Dean Foods low profit and cash flow margins left little room for financial maneuvering. Above the Dean Foods office in Franklin Park, IL..

Dean Foods bankrupcty shows the importance of market valuation and operating cash flow in determining credit and investor risk.

On November 12, 2019, Dean Foods Company, the nation's largest milk producer, and its subsidiaries filed chapter 11 bankruptcy in the Southern District of Texas as the massive size of its operations, steady decline in milk consumption, rising costs and limited financial options finally convinced management to pull the plug.  Now, the company is looking at a sale to its largest supplier, Dairy Farmers of America

In recent years, Dean Foods, based in Dallas, Texas, has been a company living on the edge insolvency even as annual sales remained relatively stable--hovering around $7.8 billion, after a decline of 19 percent in 2014 when sales peaked at $9.5 billion--while at the same time a changing industry landscape was putting a massive squeeze on profit margins, cash flow and financing options as lenders and investors rapidly lost interest in the company.  

For the nine months ended September 30, 2019, overall sales at Dean Foods, based in Dallas, Texas, dropped only 5.8 percent from the previous year but the company was rapidly running out of cash and had limited credit as a receivables securitization facility, a secondary form of financing, was the company's main source of short-term liquidity.  The possibility of losing customers was also a key factor in the timing of the bankruptcy, the company said in its filing.

In order to keep operating, Dean Foods has secured $850 million in debtor-in-possession (DIP) financing with existing lenders led by Rabobank, a bank based in The Netherlands, until the company can secure a possible sale with its largest supplier and unsecured creditor, Dairy Farmers of America (DFA), a privately-run cooperative based in Kansas.  Dean Foods owes DFA $172.9 million, one of the largest unsecured creditor amounts of any bankruptcy. 

"The actions we are announcing today are designed to enable us to continue serving our customers and operating as normal as we work toward the sale of our business," said Eric Beringause, the President and Chief Executive Officer of Dean Foods.

The Dean Foods bankruptcy is a little unusual in the fact that the company's total assets still exceed total liabilities something that does not happen in most bankrupticies as most troubled companies typically amass a large amount of debt in an effort to stave off bankruptcy.  In 2018, Dean Foods' long-term debt was $905 million or 11.7 percent of revenue well below the food processing industry benchmark of 30.1 percent, according to data from the Credit Standards Index (CSI).

The company's debts-to-assets ratio, a key solvency ratio used in detecting bankruptcies that measures total liabilities divided by total assets, was only 0.85, well below the 1.20 benchmark for most chapter 11 bankruptcies in recent years.

But in the case of Dean Foods, the lack of debt was largely due to limited borrowing capacity and short term lending restrictions placed on the company by its lending consortium.  The last sizable loan obtained by the company was a $700 million unsecured senior note issued in 2015 by The Bank of New York Mellon Trust Company.

Investors had soured on the company as far back as 2013 when the company's market value plunged from $3.1 billion in June 2012 to $1.65 billion in 2014 (see accompanying chart).  In 2014, an analysis of the food processing industry by CreditPulse found that Dean Foods had the second lowest market capitalization-to-revenue ratio out of 86 global publicly-traded companies included in the CSI.  Chiquita Brands International, which was acquired by two Brazilian firms in 2015, had the lowest at 0.16 and Bunge Limited was third at 0.19. 

The company's market value leveled off in 2015 and 2016 as many food industry stocks began to rise, but then began its final nose dive reaching a market capitalizaton of $981 million in 2018.  By February 2019, only 1,893 people held the company's common stock, according to an SEC filing.  By June 2019, the company's market capitalization had reached an unsustainable depth of $89 million, an incredible amount for a company with sales of $7.8 billion.  The last proceeds the company received from a common stock offering was $7.8 million in 2014. 

That same year net operating cash flow, the amount of cash generated beyond supplier and labor costs, was only 1.6 percent of revenue, well below the industry benchmark of 8.2 percent.  By 2016, operating cash flow had improved slightly to 3.3 percent but then fell again to 2.0 percent in 2018 as the company reported a loss of 4.2 percent.  Dean Foods was slowly running out of cash. 

In 2016, Dean Foods had a CSI score of 3.20 on a scale of 1 to 5 with one the best and five the worst.  The CSI is a scoring system that ranks companies based on five scoring factors: bad debt allowance, days sales outstanding (DSO), operating cash flow as a percent of revenue, current ratio and debts-to-assets ratio.  Interestingly, Kellogg Company, a $13 billion cereal maker, had the same score but a market cap-to-revenue ratio of 2.05 to 1.00.  By 2018, Dean Foods' CSI score had dropped only slightly to 3.40, not very good but still not in insolvency territory.