Turnaround Stories with Attractive Debt

04/27/2011 2:49 pm EST

Focus: BONDS

Marilyn Cohen

President & CEO, Envision Capital Management, Inc.

Dean Foods and Arch Coal are fixing up their balance sheets and sharing the bounty with bondholders, writes Marilyn Cohen of Bond Smart Investor.

Many of our best high-yield recommendations over the past few years have been turnaround stories: Macy’s (M), Ford (F), and CIT Group (CIT). These were corporate ideas that, when recommended, were already turning their businesses around.

Dean Foods (DF) is an aggressive recommendation that hasn’t begun to turn yet. So the risk of execution is greater than past recommendations.

Dean is one of the largest processors and distributors of dairy products. The company has about a 38% market share. You may be a consumer of their brands: Alta Dena, Swiss Meadow Gold, Oak Farms, Dean’s, Mayfield and Meadow Brook.

As with most food-related companies, cost inflation is a problem. Plus, during the economic downturn volumes for the entire industry were down. Couple that with a drop in the birth rate and changing demographics, and you can understand why Dean Foods has yet to regain its mojo.

Management shot itself in the foot in 2007. It paid a $1.9 billion, $15 per share special dividend. Right afterward, the manure hit the economic fan.

That dividend, financed with bonded debt, levered up its balance sheet and increased debt at the exact time the US economy was getting crushed and Dean’s operating earnings were taking a dive.

What makes Dean Foods a buy now? If customers limit price concessions and begin passing along price increases, as Wal-Mart (WMT) has said it will, then profit margins will turn around for this dairy company.

Dean recently settled a class-action suit. The industry is stabilizing as small milk suppliers go out of business and Dean picks up market share. Dean is selling two yogurt operations. The $125 million in proceeds after tax will be used to reduce debt.

This is not a quick turnaround short story. It is a grind-it-out epic. Nevertheless, it is a story with merit if you are a risk taker.

Dean Foods (DF) 7% notes due June 1, 2016 (CUSIP: 242370AA2) are priced at $96 for a 7.96% yield to maturity. Rated B2 by Moody’s and B- by Standard & Poor’s, the notes are non-callable.

Coalmaker a Play on Nuclear Phobia
Arch Coal (ACI) is another turnaround story, but it’s one already in process. The company mines, processes, and markets coal from the Appalachian region and western United States to electric utilities. With the world turning anti-nuclear, the coal play will certainly revive.

Arch Coal’s balance sheet has improved. Leverage is down to 1.6 and, according to JPMorgan, net leverage after $300 million in free cash flow is down to 1.2.

The outlook for 2011 is bright. Management’s focus is to improve the balance sheet with the free cash flow generated.

Whoopie! This is exactly what we bondholders love to hear. We can’t give enough praise to the way management is improving the company’s finances. The world needs coal exports. Bondholders need a delivering balance sheet in their portfolios.

Arch Coal (ACI) 8.75% notes due August 1, 2016 are priced at $112.375, for a 5.98% yield to maturity. Rated B1 by Moody’s and BB- by Standard & Poor’s, the notes are callable beginning August 1, 2013 at $104.375.

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