Expecting Value – UK Value Investing Blog
1Feb/125

Dairy Crest (DCG)

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!

Comments (5) Trackbacks (2)
  1. I have been trying to work out if I should change the size of my DCG investment. The problem, I think, with DCG is that, although it is cheap, it is probablly going to be quite correlated with economic performance due to supermarkets selling below cost to drive traffic. In addition, the cost at the farmgate is going up due to general commodity price increases (DCG is also affected through fuel and plastic prices) which have been the main factor depressing consumer spending. In other words, it is hard to make DCG fit.

    The RWD takeover may be important too. Before the takeover, RWD said they would never do a DCG and try to build brands rather they would take all their byproducts to market. This will definitely change with the merger and it could mean less supply for DCG of the needed byproducts for their brands and more competition from new RWD products (I say could because I have no idea). It also isn’t clear how Mueller will manage RWD’s relationships with farmers. In my opinion, this relationship was RWD’s competitie advantage. The potential here is made even more interesting considering that the co-operative processors are under a great deal of pressure.

    • Hi Calum, Lewis. When I read comments like this one I feel respect that you’ve developed such industry expertise, and haplessness. How can one possibly weigh up all those variables? And that sends me scurrying back to my default position, which is to check the company is set up for success so to speak, well financed, well managed, and let management take care of the business chalenges.

      • Richard; I have the same thoughts – Calum goes to a great level of detail, and I can exactly identify with what you say. Sometimes reading his posts gives me the distinct feeling that any ‘edge’ I think I have might just be based on the fact that I don’t really understand the intricacies of the competitive dynamics very well!

        For what my uninitiated two pence are worth, everything Calum says above seems to make sense. Logically speaking, both in practice and in theory the real money is moving away from the commoditised milk and towards the processed stuff they make from it. Like Richard, I’d be inclined to simply take it at face value; historically , Dairy Crest seem to have performed pretty well in dealing with challenges – though it’s not perfect. I suspect their brand names are pretty resilient and so we can envisage at least some continuation on the strong margins on that side of the business. Even if milk remains weak, then, returns could still be very good – especially at the current price level.

        Looking at another slant, though, I wonder if the RWD takeover could be spun positively. Mueller obviously saw considerable value in that business (which was also priced rather lowly) so perhaps it’s a vote of confidence for the sector at current price levels.

        • Your comment about not understanding the competitive dynamics made me chuckle (and fwiw I think you do a pretty good job of articulating them).

          I need to understand enough to decide the company is legitimate and management are making sensible choices. Beyond that each investor needs to decide where to stop and I suppose it depends on how diversified you are, how much time you’ve got etc.

          However if we’re not getting an edge from knowing more than the competition (e.g. Calum in this case :-) then where are we getting it? Seems you have to fall back on the value investing favourites. Being prepared to hold companies other people don’t like for longer than they are willing to (i.e. contrarianism and patience).

      • Your default position is probablly right. I naturally tend to situations where there is a lot accessible information, I like finding out how an industry works, and I tend to prefer a few concentrated positions. On the whole, it probablly doesn’t add that much but I think it is the way that works for me. Another factor is that after my catastrophe buying Aeropostale (i think it was down 75% from first purchase to last sale) I have tended to be overcautious of businesses that are just quantitative picks. I totally agree that at the end of the day the real “value” in value investing is created by “Being prepared to hold companies other people don’t like for longer than they are willing to (i.e. contrarianism and patience)”…couldn’t have put it better myself.


Leave a comment

(required)