Questor share tip: Dairy Crest 5pc dividend worth a look

Dairy Crest
432½p-5.8
Questor says HOLD

DAIRY Crest [LON:DCG] delivered a solid start to its new financial year, with sales up 4pc in the first quarter. The shares offer a chunky 5pc dividend yield that Questor thinks is well worth a closer look.

The dairy giant said total sales of its four key brands – Cathedral City, Country Life, FRijj and Clover – rose 4pc when compared with the same period last year. Three of those brands increased sales by more than 5pc and this offset falling sales of Clover which faces fierce competition from supermarket own brand spreads.

Mark Allen, chief executive, has plans to fightback in the spreads market, adding: “We expect Clover’s future performance to benefit from the forthcoming television advertising campaign.”

It is well known that the profit margins are wafer thin in the milk market. The business model at Dairy Crest is based around driving much higher profits through its core brands. For example, a pint of milk will retail for about 50p, while FRijj milkshakes sell for £1 per 471ml drink, or the equivalent of £1.20 per pint.

The group plans to increase profits through better sales of its FRijj products, with new coffee flavours already contributing to growth, and reduce costs by £20m across the entire business during the next nine months.

Dairy Crest is also investing heavily in China. Last week the company signed a five-year deal with the world’s biggest dairy exporter to sell baby food in the lucrative Far East market.

The company has agreed to sell powdered whey from its cheese plant in Cornwall to global markets through New Zealand group Fonterra, which will receive a commission. Dairy Crest is spending £45m on a new facility to remove minerals from the whey, which will be sold to Fonterra to make into baby milk formula.

Dairy Crest also plans to maximise profits from the sale of surplus properties. In the first quarter, the group completed the sale of a redundant depot, resulting in a profit on disposal of £4.9m, and anticipates that full-year profits from disposals will be as much as £15m.

Combining all these factors Dairy Crest said full-year expectations remain unchanged, with markets forecasting a 21pc increase in pre-tax profits to £65.4m, giving 38.2p in earnings per share.

Questor thinks those forecasts should be manageable, in which case the shares - trading on 11.5 times forecast earnings, falling to 10 times next year - are fairly valued.

There is clearly a risk from a more intense supermarket price war in the second half of the year, which could target butter, spreads and milk drinks as a key battleground. However, Dairy Crest’s brands have a strong market position, which would give it pricing power.

The dividend is a key attraction of these shares. The forecast 21.9p full-year dividend offers a prospective yield of 5pc and is covered 1.7 times by forecast earnings.

Questor had concerns around the cash outflow in last years results that resulted in net debt more than doubling from £60m to £142m at the end of March. Therefore, the detailed numbers at the half year stage will need closer examination to ensure these fears have subsided.

Dairy Crest said in the statement yesterday that its financial position was in line with expectations.

The shares have slumped 18pc so far this year, easily underperforming the wider FTSE 100, which is flat. Questor thinks this sell-off looks unfair, but we wouldn’t expect a rapid recovery any time soon. However, with a nice 5pc dividend yield, you don’t need one. Hold.