Dairy Crest has insisted it will not consider reversing cuts to the price it pays farmers for milk as it struggles to return its dairies division to an “acceptable” level of profitability. While challenges in the liquid milk market and the collapse of bulk cream prices mean the company has its work cut out, careful margin management looks set to result in improved results as the year progresses. Katy Askew reports.

Following last year’s losses in its dairies business, Dairy Crest has given itself the clear mandate to return the unit to an “acceptable” level of profitability. However, the company must overcome a number of hurdles before it hits its target of a 3% return on sales.

In a trading update released yesterday (17 July), Dairy Crest said the unit had seen a “challenging” first-quarter as profits were hit by the collapse in the price of bulk cream on the global commodities market.

Cream is a significant product for UK dairy companies because the majority of liquid milk sold in the country is semi-skimmed and cream is therefore a by-product of milk production.

“Cream revenues have fallen really steeply since about October last year. That is not particularly to do with a UK situation. That is to do with a world position. Skimmed milk prices have been very high but as a result there has been more skimmed milk powder produced, which means there is more cream in the world, more butter in the world, and that’s driven prices down,” Arthur Reeves, Dairy Crest external affairs director, tells just-food.  

According to information collected by industry body DairyCo, the average price of cream fell to 5.95 pence per litre in June, down from 10.03ppl last year. However, it is also worth noting that June’s price is 21% higher than the low that bulk cream hit in April of this year. Although it is too early to suggest that the price of bulk cream is rallying, any improvement must surely come as welcome relief for beleaguered dairy processors.   

In addition to poor cream prices, Dairy Crest is facing strong pressure from UK retailers to keep liquid milk prices down as it vies with the other dairy processors for retail contracts.

“Retailers are under pressure because their consumers are under pressure. Consumers are looking to keep the cost of their shopping down. So we are seeing some pressure on liquid milk prices. Both our revenue streams are under pressure,” Reeves says.

According to the latest data from research firm Kantar Worldpanel, fluid milk sales totalled GBP3.91bn in the 52 weeks to 15 May. This represents a decline of 0.3% on the prior year.

Relatively flat liquid milk value sales were the consequence of a 1.4% increase in volumes over the year, with an additional 70.7m litres of milk sold, the Kantar figures reveal. Average selling prices are in fact down by 1.7% on the year. This means that dairy companies are selling more milk at a lower price, with obvious implications for margins.

In the face of these pressures, Dairy Crest insisted yesterday it is “making progress” towards its medium-term goal of generating a 3% return on sales.

As part of its drive to improve efficiency, the company expects to achieve efficiency savings in the region of GBP20m across the whole business.

Margin progress at the dairies division is being achieved on two fronts. Firstly, Dairy Crest has indicated it is taking the first steps to rationalise production levels by shedding unprofitable volumes, with the majority of sacrificed business likely to come from the middle ground.

As Dairy Crest looks to right-size its business, it is making cuts at the manufacturing level. In recent months the company has announced a swathe of job cuts at its creameries, including the closure of two dairies. The company has also reduced its field sales team by merging the functions of its dairies sales teams – originally divided by customer base – into one division.  

While Dairy Crest has identified ways to lower its cost base internally, the firm has also taken controversial steps to reduce the price it pays farmers for milk.

In a move that farmers say pulls the farmgate milk price below the cost of production, alongside the UK’s other major dairy processors, Dairy Crest recently announced a series of cuts in the price it pays for milk.

In total, Dairy Crest is cutting the price it pays farmers for milk by 3.65ppl.

In the face of widespread outcry from the farming community, the group has insisted it will not reverse these cuts – as farming organisations are demanding – because the price Dairy Crest is being paid for liquid milk and cream cannot justify a higher farmgate milk price.

Farmers have warned they could go out of business in droves if they do not receive a price for their milk that covers the cost of production. While Reeves insists he “hopes that doesn’t happen” he also suggested Dairy Crest’s milk supply was relatively secure. “The milk supply will probably fall back this year. However, we are paying market-leading prices…. The milk supply may fall back but we don’t expect Dairy Crest to be affected by that.”

According to Investec analyst Nicola Mallard, these actions are expected to result in improved profitability as cost cuts feed through to the bottom line in the back half of the year.

“The dairy division has seen a challenging start to the year, so profits will be second-half weighted as the benefits of recently announced raw milk price cuts take effect, alongside the plan to close two dairies which will be undertaken in the coming months,” she says.

As Dairy Crest works on enhancing the performance of its dairies division, the group’s overall profitability levels are underpinned by strong sales growth at its consumer foods unit.

The firm revealed that sales of its four top-selling brands – Country Life, Frijj, Cathedral City and Clover – were up 15% in the period.

According to Shore Capital analysts Clive Black and Darren Shirley, this represents an “outstanding” performance.

“Whilst the comparatives are weak and the brands have benefited from strong promotional activity and a step up in marketing support, this is an excellent achievement in any market in our view,” the analysts write in a note to investors.

While ShoreCap predicts the growth rate for Dairy Crest’s branded business will slow as the year progresses – and the company laps tougher comps – the analysts continue to predict “robust” growth from the unit.

“We believe the strong performance of the UK Food Division, with its higher margin credentials, is improving the quality of Dairy Crest’s business mix, so supporting its equity rating.”

Dairy Crest has once again demonstrated the benefits of being a broad-based dairy business. A strong performance from its branded foods unit has served to shore-up a shaky showing from its liquid milk business. And, with a light at the end of the tunnel seemingly appearing for dairies, Dairy Crest’s full-year results look set to benefit from an improved performance from the unit that is currently its weakest link.