Dairy Crest still delivering

Earlier this year, the dairy industry appeared to have reached a balance. The so-called 'milk merry-go-round' that had seen big supermarkets operators ruthlessly squeezing extra profit on a pint of milk seemed to be over.

That rose-tinted view was tested by a profit warning from Robert Wiseman Dairies, which blamed "an accumulation of market pressures" for an anticipated £7m profit shortfall in the second half and a £16m hit next year. Wiseman insisted that it wasn't the result of its major customer, Tesco, demanding lower prices so that it could match Asda in a milk-price war.

However, City analysts feared the liquid milk industry was once again in the grip of price squeeze and Robert Wiseman's shares took a pounding. Despite assurances that it hadn't suffered a similar fate, Dairy Crest's shares followed Wiseman's down.

But Dairy Crest said that, while the liquid milk business remained highly competitive, it had seen minimal impact from milk promotion, and that it was confident of meeting the City's profit expectations for 2010-11. The group added that trading was in line with expectations, and announced a five-year, 210m litre liquid milk contract with Wm Morrison without, it seems, a material impact on future profitability.

It's worth noting, as we did when we previously at 340p in February, that its profit margins were lower than Wiseman's - that could have saved it from further downward pressure, although our suggestion that it could raise margins towards Wiseman's now looks less likely. That's why many analysts have tempered their expectations of a re-rating, and worry that Dairy Crest won't generate the planned returns from its £75m dairies investment fast enough. However, its branded milk, Jugit, is performing strongly; and Dairy Crest has pushed through price increases in doorstep-delivered milk and is making progress with its grocery delivery service, milk&more.

Dairy Crest has other strings to its bow - in particular, its branded dairy products, which include Clover and Country Life spreads and Cathedral City cheese. Sales of its five key brands climbed by an estimated 3 per cent in the first half of 2010-11, against strong comparatives a year earlier and despite price cuts.

One analyst, Clive Black at broker Shore Capital, suggests that the strength of Dairy Crest's food division might allow it to be more aggressive in its milk business without affecting overall profits. He is not entirely convinced, but still reckons the group's brands are undervalued. European dairy giant Müller might share that view - last month it increased its stake in Dairy Crest to 3.04 per cent. Although analysts rule out an imminent bid, at least Müller's move seem to put a floor under the share price.