Dairy Crest (DCG) is set to be transformed. The sale of its struggling dairies business to Muller Wiseman for £80m in cash will, in one fell swoop, turn a complex and unpredictable business into a cleaner, leaner food producing machine, with a well-invested asset base and stronger, more dependable cashflow. That should allow it to continue to pay out generous dividends. And, to top it all off, Dairy Crest's investment in infant formula adds a further layer of value - and diversification - which we think makes the group a tempting acquisition target.
- Solid restructuring play
- Acquisition target
- Better balance sheet
- Freehold property
- Deal needs clearance from competition commission
A few weeks ago, Dairy Crest announced it had agreed to sell its dairies business to Muller Wiseman. The sale will include the liquid milk business, flavoured drink brand FRijj, flavoured milk, cream, bulk butter and milk powders. This is a sensible move given that Dairy Crest has struggled to squeeze profits out of the division, despite pouring money into it. The segment reported £945m of revenue in the year to 31 March 2014, but milked out profits of just £0.6m. At the half-year stage in September, it made a loss. The division has historically consumed a huge amount of capital - with little return - and is vulnerable to fluctuating global dairy prices. That has led to irregular cash flows and exceptional charges.
So, with business off-loaded, the group will be able to focus on its higher-margin branded cheese, spreads and packet butter operations, which have been much better performers of late. Together, they accounted for £442m of revenue last year, but generated £56.1m of profit. And, given that Muller will take responsibility for the Dairies' share of group overheads, ongoing divisional profits for cheese and spreads should not change. Broker Peel Hunt expects the spreads and cheese divisions to deliver some £66m of operating profit in the current financial year, on sales of £443m. That equates to a tasty profit margin of 15 per cent. Furthermore, cash from the sale will help clear debt, leaving the group with a tidy balance sheet. It will even retain £20m of freehold property, earmarked for sale.
| DAIRY CREST (DCG) | ||||
|---|---|---|---|---|
| ORD PRICE: | 505p | MARKET VALUE: | £691m | |
| TOUCH: | 504-507p | 12-MONTH HIGH/LOW: | 560p | 367p |
| FORWARD DIVIDEND YIELD: | 4.7% | FORWARD PE RATIO: | 14 | |
| NET ASSET VALUE: | * | NET DEBT*: | £210m | |
| Year to 31 Mar | Turnover (£bn) | Pre-tax profit (£m)** | Earnings per share (p)** | Dividend per share (p) |
|---|---|---|---|---|
| 2012 | 1.51 | 47.5 | 28.9 | 20.4 |
| 2013 | 1.38 | 49.7 | 29.4 | 20.7 |
| 2014 | 1.39 | 65.3 | 40.8 | 21.3 |
| 2015** | 1.37 | 63.0 | 37.9 | 22.0 |
| 2016** | 0.45 | 64.0 | 37.4 | 23.5 |
| % change | -67 | +2 | -1 | +7 |
Normal market size:3,000 Matched Bargain Trading Beta:0.97 *Negative shareholders' funds **Pro-forma Peel Hunt forecasts, assumes disposal is goes ahead, adjusted PTP and EPS figures | ||||
What's more, previous years of investment and rationalisation in the cheese and spreads division has made Dairy Crest's manufacturing facilities low-cost and best in class. Capital spending requirements in the years ahead will, therefore, be low. Shareholders will also be pleased that management has pledged to continue with its progressive dividend policy, so the stock should continue to yield more than 4 per cent.
The cherry on the cake is Dairy Crest's recent foray into the fast-growing infant formula market through a joint venture with Fonterra. It's investing £65m in its Davidstow creamery in Cornwall where it will begin to produce high-quality de-mineralised whey powder and galacto-oligosaccharide - both bi-products of the cheese-making process. This project is set to contribute to group profits by the 2016 financial year. What all of this adds up to is a stronger, fitter business - and one we think some of the bigger global dairy and ingredients companies might lick their lips at.
Of course, there is the risk that the deal doesn't go through. It needs clearance from the Competition Commission, which will take several months and is not guaranteed. Still, we think there is a good chance of success, and were the deal to fall through, Dairy Crest could sell to a different player. What's more, trading on just 13 times forward earnings, the shares are keenly priced, especially considering the lucrative prospects.
