Bear Stearns recommends Dean Foods/Suiza Foods convertible preferred

By Ronda Fears

Nashville, Tenn., July 23 - In the current market turmoil, Bear Stearns & Co. convertible analysts are recommending the Dean Foods Co./Suiza Foods convertible preferred, noting it is about 5% cheap, for strong upside exposure to a stable story.

Dean Foods' stock has traded off 26% over the last month and the convertible preferred issue has traded off 12% over the same time period, noted Bear Stearns convertible analyst Matt Hempel.

"In light of the current market meltdown, we like the stable nature of Dean Foods business. We also feel that when Dean Foods reports earnings [on Aug. 8], there is a strong likelihood to meet or exceed our earnings estimates for the quarter, as well as raising guidance going forward," said Hempel and Bear Stearns head of convertible research, Rao Aisola, in a report Tuesday.

"The trough level of the stock valuation, combined with the perceived cheapness of the preferred offer, strong upside potential for hedge and outright investors."

The analysts put a buy recommendation on the Dean Foods (issued by Suiza Foods) 5.5% convertible preferred due 2028 on an outright basis, or on swap.

The convertible last traded at 42.75, and assuming a volatility of 30%, that translates to an implied spread of 1,425 basis points over Treasuries, which is substantially wider than other convertible issues in the food processing and distribution sector.

It modeled 5% cheap using a 30% volatility in the stock and a 1,000 basis points spread, the analysts said.

"Dean Foods convertible preferred offers excellent cost of carry, solid equity sensitivity profile on a buy rated stock and cheap volatility in a defensive old economy name," the analysts said.

Bear Stearns food processing analyst Terry Bivens recently upgraded the stock to a buy based on potential for better deal synergies between Dean Food and Suiza, the likelihood of a successful thrust into higher margin branded products and the idea that the base dairy business likely to prove increasingly attractive to larger grocery retailers.

The company has an entrenched position with Wal-Mart, which is having great success expanding grocery offerings, the analysts noted.

Bivens has a price target of $45 on Dean Foods.

The convertible analysts feel the company's credit spreads are out of proportion, comparatively to other convertibles in the food business.

The Dean/Suiza convertible (B+/B2) at 43.125 is trading with a spread of 1,425 basis points, compared to Fleming's 5.25% convertible note due 2009 (B+/B2) trading at 85.75 for a spread of 632 basis points. And, the analysts noted that the Performance Food Group 5.5% convertible note due 2008, which is not rated, is trading at 120.75 for a spread of 365 basis points, while Supervalu's 0% convertible note due 2031 (BBB/Ba3) is trading at 28.5 for a spread of 200 basis points.

"There seems to be an overhang on the company, shown by the negative outlook by S&P related to doubts about merger synergies being realized," the analysts said.

"We feel this is overblown and the company will actually continue to raise estimates as synergies kick in. The 1425 bps implied spread factors in these leverage worries and overhang from the merger, which we feel presents opportunity as the company continues to execute their game plan."

Dean Foods raised estimates for synergies for 2002 by $20 million to $80 million as it continues to solidify the combined entity, the analysts noted.

The company also repaid $170 million in debt in first quarter, the analysts said said, adding that they expect the company to pay down $500 million more over the next two years, funded by free cash flow.

Once the common shares reach $39.13, the convertible preferred shares can be converted to common, something the company has said it intends to do to reduce its debt load if or when the stock reaches that level.

That poses a potential 39% upside for the convertible from current levels, the analysts pointed out.

"We realize the company is relatively highly levered due to the acquisition of the old Dean Foods, with a current debt to capitalization ratio of 1.8 times," the analysts said.

"We feel this is manageable as the new company is showing traction in their debt reduction efforts and their focus in corporate strategy to shift from acquisitions to brand building."

Suiza Foods (Ex-Dean Foods) 5.5% convertible preferred due 2028

Price: 43.125

Conversion Premium: 19.45%

Stock Price: $28.25

Conversion Price: $39.124

Current Yield: 6.38%

Market Delta: 75%

Yield to Maturity 6.62%

100-Day Volatility: 28%

Call Price 51.375

Implied Spread: 1,425 bps over Treasuries

Call: Current

Credit Ratings: B2/B+

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