Dairy Crest Group PLC is a British company that sells dairy products. Dairy Crest was incorporated in 1981 as a milk processor approved by Milk Marketing Board (“Dairy Crest – Our History” par. 1). The company has various international brands. The company is listed on the London Stock Exchange. The company’s stock symbol is DCG. The head office of the company is in Surrey, UK. The company’s primary business was processing and selling milk till 2015. However, the company sold its milk operations to Muller for $80 million in 2015 (“Annual Report 2015: Dairy Crest Plc. ” 2).
In 2015, the reported sales of the company were $1,329 million and the operating income was $20.5 million. The company employs 4,500 employees. The company’s biggest competitors are Muller, Arla, and First Milk Farmers’ Cooperative (“Dairy Crest – Our History” par. 2).
The table provided below provides the values of liquidity ratios of Dairy Crest.
Table 1. Liquidity Ratios.
The current ratio is used to evaluate the ability of the company to pay its short-term liabilities on a timely basis. Suppliers and investors primarily use it to determine the short-term liquidity of the company and to take a decision whether the company should be given further credit or not (Tracy 20). The current ratio of Dairy Crest was 1.96 in 2015 as compared to 1.59 in 2014. It indicated that the liquidity position of the company enhanced in 2015 (Tracy 20). The value of current ratio was greater than one that showed that the current assets of the company were sufficient to pay its short-term liabilities, and it had a strong solvency position.
The quick ratio is also known as acid test ratio. It determines the ability of the company to pay off its current liabilities by using its quick assets. Quick assets can be easily converted into cash in the short term. Cash, account receivables, and marketable securities are examples of quick assets (Tracy 22). The quick ratio value of Dairy Crest slightly improved and was 0.78 in 2015 as compared to 0.71 in 2014.
The main reason for the improvement in the quick ratio value was that cash generated by operations of the company was $35.3 million as compared to £13.8 million outflows in 2014. In 2015, the working capital of the company also increased by £12.8 million. The improvement in cash and cash equivalents and working capital indicated a reduction in the cost of cheese stocks of the company and its earlier payments to suppliers (Annual Report 2015: Dairy Crest Plc.).
The cash payments for interest expenses also declined and were limited to £10.5 million in 2015 as compared to £14 million in the previous year (“Annual Report 2015: Dairy Crest Plc.” 30). All these factors led to the strong liquidity position and indicated the sound financial health of the company.
The table provided below provides the values of profitability ratios of Dairy Crest.
Table 2. Profitability Ratios.
|Return on capital employed||5.22%||8.33%|
|Profit before interest & tax||32||46|
|Equity plus net borrowings||613||552|
|Profit before interest and tax||32||46|
|Return on Assets||2.63%||5.58%|
|Average Total Assets||797.5||895.5|
The gross profit margin represents the percentage of revenue retained by the company after paying the direct cost of production (Tracy 14). The gross margin of the company declined considerably in 2015 and was 20.8% as compared to 24.% in 2014. The profits of the company declined sharply due to the slowdown in its operations and strong competition in the liquid milk market. The commodity realization also fell that resulted in a low gross margin. Moreover, cheese and whey profits also reduced due to the increase in the cost of sales of milk that also impacted the value of cheese stocks (“Annual Report 2015: Dairy Crest Plc.” 29).
The net profit margin is the percentage of sales retained by the company after paying off all operating and finance expenses, taxes, and preferred dividends (Tracy 12). Investors use this ratio to assess the performance of the company and its ability to generate net income attributable to shareholders. The net profit margin of Dairy Crest reached was 1.6% in 2015 as compared to 3.6% in 2014. The significant decline in the net profit was due to various exceptional costs incurred by the company in 2015.
For instance, the company incurred exceptional costs of £16.7 million related to spread and butter production at Kirby and for establishing the innovation center at Harper Adams University. Moreover, the company announced to shut down its bottling plant at Hanworth and cream potting facility at Chard. The closure of these facilities resulted in exceptional costs of £11.8 million. The company reported that £9.2 millions of these exceptional costs were depreciation expenses related to non-current assets. Moreover, the proposed sale of dairy operations by the company also resulted in exceptional costs related to professional fees and transaction costs. All these costs resulted in higher operational expenses and low profit of the company that declined to £21 million in 2015 from £50 million in 2014 (“Annual Report 2015: Dairy Crest Plc.” 29).
Return on Capital Employed (ROCE) is a profitability ratio that determines how efficiently the company utilized its employed capital to generate profits (Return On Capital Employed (ROCE)). The return on capital employed of Dairy Crest fell from 8.33% in 2014 to 5.22% in 2015. The primary factor behind the decline in ROCE was the increase in long-term debts of the company from £142.2 million of 2014 to £198.7 million in 2015. The company borrowed to finance its capital investments made in three different sites including Kirkby, Davidstow, and Harper Adams. The total investment made by the company in 2015 was £53.3 million that was exceptionally higher than the anticipated amount (“Annual Report 2015: Dairy Crest Plc.” 30).
The return on assets also fell sharply and was 2.63% in 2015 as compared to 5.58% in 2014. It indicated the poor performance of the company in utilizing its assets for generating a net profit. It could also be indicated that the company recorded accelerated depreciation charge in its income statement as a result of write-offs of non-current assets of facilities that were shut down by the company in 2015.
The table provided below provides the values of efficiency ratios of Dairy Crest.
Table 3. Efficiency Ratios.
|Average total assets||797.50||895.50|
|Fixed asset turnover||3.00||3.48|
The asset turnover ascertains the company’s ability to generate sales by utilizing its assets efficiently. The change in the value of asset turnover of Dairy Crest was insignificant, and the ratio value was 1.66 in 2015 as compared to 1.55 in 2014. The slight increase in the asset turnover was due to the decline in the company’s assets. The decrease in the company’s assets resulted from the closure of multiple facilities and plants by the company. Moreover, asset utilization was also affected by the strong competition in the UK dairy industry and unstable economic conditions that slowed sales of the company (“Annual Report 2015: Dairy Crest Plc.” 22).
The company’s trade receivables were £95.3 million and £118.4 million in 2015 and 2014 respectively. Despite the decrease in debtors, the receivable turnover of Dairy Crest remained consistent in both years and had a value of 14.78 times. The ratio value was close to the industry average that reflected the company’s effective management of its debtors. One of the major reasons for the strong debtor turnover was that the company had no history of bad debts related to its sales to large retailers. Furthermore, there were no impairment provisions made by the company in 2015 (“Annual Report 2015: Dairy Crest Plc.” 97).
The company’s inventory turnover improved in 2015 and was 5.01 times as compared to 4.88 times in 2014. However, the increase in inventory turnover did not reflect the efficiency of the company as it was majorly due to the decline in the value of cheese stocks that totaled £149.2 million in 2015 as compared to £167.2 million in 2014. Furthermore, the company wrote off the inventory engendering and packaging materials valued at £0.4 million after the consolidation of the company with Clover (“Annual Report 2015: Dairy Crest Plc.” 94).
The table provided below provides the values of solvency ratios of Dairy Crest.
Table 4. Solvency Ratios.
|Debt To Equity ratio||1.72||1.79|
The debt to equity ratio determines the financial leverage of the company. It determines the proportion of debts to the shareholders’ equity. The debt to equity ratio of the company slightly improved in 2015 and its value was 1.72 as compared to 1.78 in 2014. Although the ratio value declined in 2015, it still indicated that the company was highly leveraged, and it was financed more by external debts more than the shareholders’ equity. It also indicated that the company was subjected to pay high finance costs related to its borrowings. The finance cost of the company was £8.1 million in 2015 that was £2 million less than the previous year. It reflected capitalized interest on the major projects of the company in Davidstow and Kirkby. Furthermore, the finance cost was also lower than the previous year due to the repayment of the loan of £27 million in 2014 (“Annual Report 2015: Dairy Crest Plc.” 30).
The company should consider lowering the value of debt to equity ratio and improve its leverage position. The low value of quick ratio could be a problem for the company as suppliers may be reluctant to do business with the company. It is also indicated that further increase in the value of leverage ratio could create financial problems for the company and it may face difficulties in obtaining credit and loans from suppliers and banks respectively. Moreover, high debt financing ratio value also increases the cost of operations that in turn reduces the net income of the company (Damodaran 51).
The high value of equity ratio indicated that shareholders of the company were willing to invest in the company as the business position of the company improved. It also reflected the willingness of shareholders to invest in the company’s stocks of the company as they considered it to be a sustainable business. Furthermore, the increase in equity ratio value of Dairy Crest had a positive impact on the relationship between the company and its suppliers and creditors as they perceived the company to be less risky (Damodaran 51).
Top down and bottom up Analysis
The gross margin of the company declined by 20% as the company’s gross profit in 2015 was $69 million less than the previous year. The unstable economic conditions of the UK and low spending on food items can further decrease the company’s sales and profit margins in the next year. The size of milk market in the UK has reduced in the last 15 years. However, cheddar cheese sales contribute significantly to the total revenue of the dairy industry. A slight change in the cost of sales was also observed due to the increase in the cost of cheese and spread materials. Dairy Crest reported a fall of 90% in its profit in 2015 as compared to the previous year due to tough economic conditions and trends in the UK dairy industry. The company made an agreement with the Muller to sell its dairy operations for £80 million (“Annual Report 2015: Dairy Crest Plc.” 30).
The deal is expected to increase the company’s profit. Moreover, it could be stated that this deal is not only expected to benefit the company but the overall UK dairy industry as well. Another significant reason for the fall in the company’s profit was that it lost its contract with Morrison’s supermarket. The contract went to Aria that is the main competitor of the company (“Annual Report 2015: Dairy Crest Plc.” 29). Although ‘Cathedral City’ brand had a significant growth in its sales in 2015, the total revenue of the company was down by 4% to £1.33 billion in 2015 due to the increase in the cost of cheese and spread (“Annual Report 2015: Dairy Crest Plc.” 8). Such poor management of business decisions can decrease the company’s sales in the next year.
Discounted Cash Flows
The table provided below presents the calculation of discounted cash flows of the company.
Table 5. Discounted Cash Flows.
|Particulars||2014||2015||2016||2017||Growth after 2017|
|Shares outstanding (Av.m)||138||137||138||138|
|Free cash flow (in millions)||-85||-55||-15||-14|
|DCF||2014||2015||2016||2017||Growth after 2017|
|Terminal value (TV)||5.565|
|PV (= Vf)||4.641|
Discounted Cash Flow (DCF) analysis uses the present value of future cash flows to determine the fair value of investment. DCF method used in this calculation discounts free cash flows (“The Discounted Cash Flow Method” par. 1).
The DCF calculation is made in an attempt to determine the value of the company’s stock based on the future projections of the company’s free cash flows. The analysis reveals that the current share price of the company should be $2.98 per share. However, the share price of the company was $6.97 at the end of 2015. It indicates that the company’ shares were trading at higher prices as compared to their forecasted present value. Therefore, the current share price of the company is not suitable for investment, and the price of the company’s stock is expected to decline in the near future as per the DCF analysis.
The analysis reveals that the liquidity position of the company was strong, and its cash inflows increased in 2015 as compared to the previous year. Profitability ratios indicated that the company’s net income declined due to strong competition and unstable economic conditions. However, the company is confident that its profitability will increase after the completion of the sale of its dairy milk operations to Muller. Solvency ratios also showed the company performed satisfactorily, and the slight improvement in the company’s performance was observed in 2015. The DCF analysis shows that the stocks of the company are overpriced. Therefore, investors are not recommended to purchase the company’s shares at the current market price.
Annual Report 2014: Dairy Crest Plc. 2014. Web.
Annual Report 2015: Dairy Crest Plc. 2015. Web.
Dalry Crest – Our History 2016. Web.
Damodaran, Aswath. Investment Valuation: Tools and Techniques for Determining the Value of Any Asset, Hoboken, NJ: John Wiley & Sons, 2002. Print.
Return On Capital Employed (ROCE). 2016. Web.
The Discounted Cash Flow Method. 2013. Web.
Tracy, Axel. Ratio Analysis Fundamentals: How 17 Financial Ratios Can Allow You to Analyse Any Business on the Planet, Sydney, NSW: Bidi Capital Pty Ltd., 2012. Print.