While Uniq announced a move into profit this week, little else the UK-based food group had to say will have enchanted investors, and most certainly not its decision to scrap its dividend. The company is suffering from the cost inflation hitting all food processors but, writes Ben Cooper, Uniq’s problems do not end there.

Uniq, the UK dairy group turned convenience food supplier, may have been able to announce a return to profit this week, but the scrapping of its dividend and the revision of its turnaround schedule caused consternation among some already battle-weary investors.

The company attributed cancelling the dividend to rising raw material costs and, in the current climate, to find a food company troubled by cost inflation is no surprise. But analysts remain concerned at other structural challenges the company faces, while the ongoing supplier review at Uniq’s biggest customer, Marks & Spencer (M&S), is a further worry.

“The outlook for Uniq has always been uncertain,” says Andrew Saunders, analyst at Panmure Gordon. “There have been fundamental problems with the company pretty much from the time it restructured itself from the Unigate dairy and transport business to a chilled-foods company.”

Uniq acquired its chilled food business from a company spun out of the Hillsdown group called Terranova Foods, and while these included both European and UK businesses, analysts have questioned whether the company has the scale to be a pan-European operator. “[Terranova] had some attractive UK businesses but it also had a whole range of European businesses too and Unigate was traditionally not a player in Europe,” Saunders explains.

“The market in continental Europe is very different [from the UK], particularly with chilled food, which is not at the same level of development as in the UK. There is also not the same prevalence of retail own-label in continental Europe. Uniq needs to have the management depth and scale to make a success in Europe – and it has never had enough of those.”

Having already sold off its St Hubert European spreads business to Dairy Crest last year, one possible solution might be to sell off the entire operation in order to focus on the UK. However, it is hardly a seller’s market for such a move, while CEO Geoff Eaton publicly stated the company had no plans to do so.

Saunders believes selling off the European businesses would help, but as St Hubert was the most attractive part of the business finding a buyer for what remains will not be easy. “There aren’t really any buyers beating a path to the door. Uniq has to stick with it, try to improve them and wait until market conditions improve. For the moment, the big problem is trying to convince the market that it can deliver. There has been too much talking a good story rather than delivering.”
The scrapping of the dividend was a bitter pill for investors to swallow but arguably the results themselves could have been worse. Indeed, some analysts had been expecting another pre-tax loss. However, Uniq turned in a pre-tax profit of GBP1.9m (US$3.8m), against a loss of GPP21.9m in the last nine months of 2006, on revenues up 3% at GBP736.1m. But, Uniq still made an operating loss of GBP3.6m, albeit representing a GBP7.3m improvement from the GBP10.9m operating loss last year.

The City’s disappointment manifested itself in a 27.5p fall in Uniq’s share price to 107.25p. Not surprisingly, Eaton put a brave face on it. While he said the company’s planned turnaround would take two years longer than expected – meaning 2010 rather than the end of 2008 – he maintained that the results represented a significant improvement, particularly in the current cost environment.

“Our businesses are now better prepared for the tougher economic environment we face in 2008,” Eaton said. “While the short-term outcome carries uncertainties, there remains considerable potential for improvement on profit margins and return on capital employed across the group.”

However, on the issue of cost inflation, Eaton added: “From the second half of last year we’ve hit unprecedented raw material price increases. It’s as bad as anyone can remember. We’ve got cover for six months. Beyond that it’s difficult to know where prices are going to go. It’s all about margin management.”

Uniq plans to put most of the GBP5.1m raised from foregoing the dividend into its underperforming desserts operation. But while retaining cash for investment at a difficult time could be seen as a wise move, Saunders remains unconvinced by the decision. “It doesn’t help because if you are a long-term, value-based investor waiting for the business to turn around and to get upside from your investment, then the dividend yield sweetens things.”

Given that all food companies are struggling with cost inflation, Uniq’s focus on this problem may seem logical, but in addition to question-marks over the viability of its European operation, the company also faces a further challenge in its supposedly more robust home market – uncertainty over its relationship with M&S, its most important customer.

The fact that one customer accounts for some 27% of Uniq’s sales may already be seen as a sign of over-exposure. However, add to that the fact that M&S is currently conducting a major supplier review, specifically in order to gain better terms from its suppliers, and the situation seems that much more worrying.

The review of course could bring good news. Indeed, Uniq has already gained a contract to supply M&S with fish, deli and premium desserts “food to go” products. But it could also result in reversals. “For Uniq, the review could be an opportunity in sandwiches and ready meals but the company hasn’t got the cashflow to meet that growth,” says Saunders. “Uniq is vulnerable when you look at its desserts business with M&S so the review is not a win-win. Uniq could win in some categories and lose in others.”

Eaton says he expects Uniq to gain more business than it loses, but the situation at M&S reminds observers – and investors – of a challenge facing the likes of Uniq not directly linked to the hopefully temporary problem of cost inflation – the ever-increasing buying power of the major multiple retailers it supplies.

As the commentary in The Times put it, the company “does not have any problem devising, manufacturing and selling sandwiches and desserts to the likes of Tesco and Marks & Spencer. Its problem is making any profit whatsoever in the process”.