Buying up the food chain
What with Tesco, Cranswick and to a lesser extent, Marston’s, I already feel a significant tug towards the broad ‘food’ sector. Dairy Crest continues that theme, but first I should probably address why I’m looking at that common sector. The answer is, simply, that I’m not, really. Tesco, Cranswick, Marston’s and Dairy Crest could all be considered ‘value’ for different reasons. It’d be disingenuous for me to say there is no broad market feeling about that group that is probably hampering their share prices, but they are all fundamentally different businesses - the drop in margins that is coming right down the chain may well be hampering the share price, but is hardly the sole reason I chose to look at these businesses. There is a good degree of visibility in food spending and many of the businesses involved have long track records. That always interests me.
I’ll cover Dairy Crest in two posts, and in this one I’ll aim to both give an overview of the business and look backwards at historical trends in the hope of uncovering whether the current share price is undervalued. The holy grail of investing, right there! Moving straight on to the graph, we see that operationally the business is fairly solid; revenues and operating profits are both stable on a slight upward trend. Net profit has dipped in the last couple of years, but this is brought about – sadly – by a pension plan’s fluctuations. I hate these things. More specifically, 2008 & 2009 saw a surplus in that plan bringing in an extra £7m and £10m of revenue respectively, which was a feat not repeated either this year or last.
Consistenency is the name of the game in operating terms, then, and that’s confirmed by an even longer timescale graph I’ve included below left. There may be a small mountain range in operating profits between ’02 and ’07, but note that unlike many companies they haven’t had a year of losses – or anywhere near! The other thing that struck me as I flicked through 10 years of reports was the enduring nature of their big three brands. Page 1 of their 2001 report features a scene with Dairy Crest’s three big winners – Clover (spread), Cathedral City (cheese) and Frijj (milkshake). All three were market leaders then, and all three are market leaders now. Anecdotally, Cathedral City has always entertained me as a brand. I know several people who refuse to eat any other type of cheddar. I can’t taste any difference; but it probably explains why they enjoy such strong margins on it. They’ve obviously marketed it rather shrewdly!
Alongside the longterm performance chart, though, I’ve included two other rather telling charts; the breakdown of revenue by segment and the breakdown of profit by segment. The story there is quite a neat one economically; the group enjoys far greater margins on products they can brand than the homogeneous white stuff. Interesting to note is that the ‘spreads’ segment also includes the market leader in France as well as Clover and Country Life, the no. 1 and 3 brands in the UK. Notably, it’s their branded products which are also growing strongly. This is a positive for the business given the respective margins of the sectors.
If we anticipate any sort of resilience in margins and don’t see a significant drop off in revenues, then, the current P/E – 7.6 – seems rather low. I also like the dividend yield, at 6.5%, which I consider to be moving into the territory of (to reignite an old debate!) a catalyst – simply put, if the business does perform better than expected, share price reaction should be swifter than otherwise, as it indicates that the very meaty dividend may well continue to be paid. Indeed, management signalled confidence when they chose to increase the dividend – if only slightly – at the interims in November, particularly given their own caution with regard to their outlook and a higher net debt level.
In that vein then, and given a long operating history, it makes sense to consider at what level DCG have traded historically. The graph below, then, shows (very roughly!) how the P/E ratio of Dairy Crest has evolved through time. While its use as a mean-reverting indicator is probably limited, what it does show is that they have never really traded at a particularly high P/E; barring some spikes from timing differences in the way I’ve collected the data and general market bullishness.
Why is this? I’m not entirely sure. It’s always easy to look for one reason but a lot more difficult to find it. The pension scheme is hardly a great positive, though aside from that the balance sheet doesn’t look too bad. That said, there is a significant amount of debt on their books; the redeeming feature being that it is counterbalanced by significant amounts of property and current assets. The sector isn’t particularly loved, and the ongoing milk wars and concerns about the sustainability of the prices we pay hardly seem to be helping; though I do like that Dairy Crest focus on their 5 main brands as the real money spinners. These less commoditised products should be far more resilient.
Business looks good and price does too, then. Consider my interest piqued!