Buy market leader Dairy Crest

Cathedral City cheddar is the company’s most popular product. It has strong brand recognition and was recently voted one of the top 10 brands by UK consumers in YouGov's annual brand health rankings. Cathedral City is the largest cheddar brand in the country, accounting for a fifth of total cheddar sales and more than half of the branded market. It outsells all the other cheddar brands combined, with retail sales of around £280m, and is three times larger than the number two brand. Meanwhile, in the UK butters and spreads market, which is worth £1.3bn in retail sales, Dairy Crest has five brands, including Country Life butter and Clover spread, which account for nearly a fifth of that market by volume.

However, while strong brands are a way to generate higher returns and protect margins when times are tough, there is only so much they can do, as shareholders have learned over the past two years as milk and cream prices have soared. High prices for butter have limited the use of promotions to boost volumes and manage the margin. Oil brand Frylight also saw volumes decline as hot weather put consumers off cooking with the vegetable oil spray. Meanwhile, the value of stock on the balance sheet has squeezed cash flows.

Nevertheless, the group remains focused on long-term growth. Product innovation is a major objective as the company seeks to capitalise on significant investment in its production facilities to tap into the high-growth infant milk market. It is developing galacto-oligosaccharide (GOS) products that help the body better digest food and absorb nutrients, which has applications for infant formula, animal feed and the adult health-food market. During the second half it will be launching a GOS 'shot' for consumers marketed under the Promovita brand name, for example. 

During the most recent financial year, 14 per cent of Dairy Crest’s sales came from recent innovations, and the launch of new GOS products is expected to increase this proportion further. The group is also planning other product introductions, such as new snacking products for adults and kids, and is set to relaunch Clover City with no artificial ingredients.

The company completed a £70m share placing at 495p in May, which has helped bring the net debt to cash profits ratio closer to its target of one to two times – the ratio has fallen from 2.9 times cash profits to 2.1 times. The proceeds will help with a four- to five-year £85m investment programme designed to boost Dairy Crest's annual cheese-making capacity from 54,000 tonnes to 77,000 tonnes. Management expects the UK cheese market to grow by around 2 per cent a year, and also believes brands can take more share from the 65 per cent of the market that is still private label (such as own-brand supermarket products).