Equity Analysis of Dairy Crest Group PLC - Case Study Example

Equity report of Dairy Crest Group PLC

Abstract

The report intends to provide a thorough review on Dairy Crest Group PLC to evaluate the investment opportunities from the perspectives of the investors. Both the industry and company analysis has been performed to assess the business environment of the company. Due to the investment of the UK government and high demand of the market, the dairy industry of the country has experienced a positive growth. On the other hand, the financial health of the company has been evaluated by analysing the financial ratios. It has been found that the profitability of the firm has declined due to the increase of competition and the hike of raw material cost. DCF has been used as a valuation technique in the report. The calculation of DCF and P/E ratio has indicated that the firm is undervalued. Thus, it also provides an profitable investment opportunity for the investors.

Table of Contents

Introduction4

Bottom up and top down approach of the company and industry4

Analysis of the financial ratios7

Valuation of the company11

Discounted cash flow (DCF) approach11

P/E value13

Conclusion and recommendations14

Reference List16

Appendix17

• Introduction

The investors conduct a thorough analysis of the company before taking the final investment decisions. Apart from just reviewing the financial health of the company, the investors also evaluate the present condition of the concerned industry and other macroeconomic factors. This report intends to focus on a thorough analysis of the Dairy Crest Group PLC. With the help of bottom up and top down approach, the macroeconomic factors that can affect the financials of the industry and the company has been identified. Apart from analysing the financial ratios, the valuation of the firm has also been derived with the help of discounted cash flow (DCF) and P/E ratio. Based on the analysis, it has been a forecasting for the concerned firm has also been presented in the report.

• Bottom up and top down approach of the company and industry

Before investing in any firms, the investors conduct two types of analysis. Firstly, an overall analysis of the market or specific industry has been conducted to assess the growth of the company. Secondly, the investors perform an individual assessment of the company to evaluate its prospect. This method is often known as the bottom up and top down approach.

Industry analysis

UK is considered as the third largest milk producer in the European Union after Germany and France. However, the country is considered as the tenth-largest milk producer in the world. Based on the figure of 2014, it has been found that milk is accounted for almost 17.48% of the total agricultural output of UK. The value of the total dairy products is estimated as £4.6bn. However, a significant declination of 27% of the number of dairy cows in 2014 since 1996 has affected the production of dairy products. In spite of all the compulsion, UK has produced 14.6 billion litres of milk in 2014 and it is considered as the highest since 1990. A negative trade balance has been observed in the case of butter and cheese. In contrast, for milk and cream UK has recorded a positive trade balance. According to the statistics obtained from the UK dairy industry, it has been found that the doorstep delivery of retail UK market has reduced by almost 42% in 2015 compared to that of 1995.

Table 1: Milk production in UK (by million litres)

Year

Total production of milk

2010

13,453

2011

13,665

2012

13,443

2013

13,534

2014

14,669

UK has been able to export only 3% of the produced milks and the rest of the milks have been used for the domestic purpose. Fresh milk is considered as one of the most common drink for the health conscious British consumers. In response to the ever increasing demand of the UK consumers, the UK government has taken the initiatives to invest in the processing of milk. It has enabled the dairy firms to deliver milk in the market with safety, efficiency and sustainability.

In addition, a high class logistics system of the dairy companies has also ensured smooth distribution of milk. From the complete confidence and trust of the UK consumers reflects the efficiency of its dairy industry. The firms of this industry have been able to exploit the opportunities related to the import substitution and export. Most importantly, the firms have been able to grab the opportunities due to determination, investment and competitiveness. In addition, innovation and efficiency has also contributed to sound performance of the dairy industry and its growth over the years.

Company analysis

Dairy Group PLC is a renowned dairy products company based in UK. The firm is listed in the London Stock exchange and FTESE 250 index (Yahoo! Finance, 2016). Some of the most popular products of the firm are Cathedral City Cheddar cheese, Country Life Butter, Clover etc. The company used to process and sell milk through both wholesales and doorstep delivery process until 2015. In 2015, the firm sold its subsidiaries Friji milkshake to Germany’s Muller for £80 million. However, at present the company owns Express Dairies as its primary subsidiaries. Based on the figure of 2015, Dairy Crest Group PLC has recorded sales of £1329.8 million and net income of £ 20.5 million. The firm has an employee base of 4,500. As discussed in the previous section that in UK the business environment is quite supportive for the dairy business, Dairy Crest PLC has experienced a high growth in the revenues. High demand of the dairy products and support from the UK government to enhance the business performance has helped the company to improve its revenue. The major competitors of the firm include Arla Foods UK PLC, Muller Wiseman Dairies Limited and First Milk Limited.

• Analysis of the financial ratios

Financial ratios enable the investors to assess the financial health of the company. Liquidity, profitability, leverages and efficiency of Dairy Crest Group PLC has been assessed with the help of corresponding ratios.

Liquidity ratios

Current ratio of Dairy Crest Group PLC

2014

2015

1.60

1.97

The above table represents that the current ratio of the firm has experienced a positive growth in the last financial year. Most importantly, it can also be inferred that the liquidity position of the company is sound enough. Thus, the firm can pay its short-term obligations with the help of its current assets.

Quick ratio of Dairy Crest Group PLC

2014

2015

0.71

0.79

Although, the current ratio of the company is quite high, there is a significant deviation between the current ratio and quick ratio of the company. It is due to the fact that the firm posses huge inventories in the concerning years.

Profitability ratios

Net profit margin of Dairy Crest Group PLC

2014

2015

3.61%

1.54%

A sharp fall in the net profit margin can be considered as an alarming factor for the firm. Due to the fall of sales by 67.79%, the net profit margin of the company has experienced such declination. In addition, it can also be predicted that the adverse market condition and hike of prices of the raw materials has contributed to fall of net profit margin.

Return on equity (ROI) of Dairy Crest Group PLC

2014

2015

16.82%

7.08%

A sharp fall of ROI indicates that due to the reduction of sales, the firm has not been able to generate sales from the invested capital of the shareholders.

Leverage ratios

Debt-equity ratios of Dairy Crest Group PLC

2014

2015

0.62

0.91

From the debt-equity ratio of Dairy Crest Group PLC, it can be shown that the firm is not heavily leveraged. It also indicates the lower amount risk associated with the company from the perspectives of the investors. Dairy Crest Group PLC has mainly focus on the equity financing rather than external borrowings top expand the operation. However, the debt-equity ratio for the company has increased in 2015. It is due to the reason that in the last financial year, the amount of long-term borrowings has also enhanced by 48.76%. As the debt-equity ratio is still lower than 1, it can be considered as a positive point for the investors.

Efficiency ratios

Inventory turnover ratio of Dairy Crest Group PLC

2014

2015

4.89

5.03

A slight increase in the inventory turnover ratio has been observed in 2015 compared to the 2014. However, the inventory turnover ratio indicates that the firm requires almost 2 months time to convert the inventories into sales. It can reduce the efficiency for the company. However, it can be observed that the amount of inventory has reduced slightly in 2015 compared to that of 2014. It has helped to firm to reduce the time to convert the stocks into sales.

Receivables turnover ratio of Dairy Crest Group PLC

2014

2015

14.79

14.81

From the analysis of the receivables turnover ratio, it can be inferred that the firm requires less than 1 month of time to receive cash from the debtors. It clearly depicts the effectiveness of the firms’ credit management policy.

Payables turnover ratio of Dairy Crest Group PLC

2014

2015

42.06 days

40.06 days

The payables turnover ratio of Dairy Crest Group PLC indicates that the company maintains a fixed time to repay its debts. In addition, it can also be inferred that the company has negotiated with its suppliers to delay the payment for the raw materials by more than 1 month. It can impact on the retained earnings of the company.

Assets turnover ratio of Dairy Crest Group PLC

2014

2015

1.55

1.67

Assets turnover ratio reveals the ability of the company to convert the assets into sales. Low asset turnover ratio indicates that the firm needs to improve the efficiency to convert its assets into sales. In addition, the managers are also required to identify the idle assets to improve its efficiency. However, the asset turnover ratio for the company has experience slight improvement in the last financial year.

• Valuation of the company

From the perspective of the investors deriving the value of the firm is important. However, the investors use various methods to derive the values of the company. However, in this report, discounted cash flows (DFC) methods, P/E ratio of the company and economic value added (EVA) has been calculated to analyse the investment opportunities for the investors.

• • Discounted cash flow (DCF) approach

DCF is considered as a popular method for the valuation of the firms. It is often used by the investors and the financial analysts to evaluate the attractiveness of the investment opportunities available to the investors. In the case of discounted cash flow method, future cash flow projections and discounts are calculated to determine the investment opportunity.

In the present case the discounted cash flows for Dairy Crest Group PLC has been forecasted for 3 years. In order to calculate the DCF, free cash flows of the company has been derived with the formula:

FCFE= Net Income-Net Capital expenditure-change in net working capital + new debt.

Based on the free cash flows, discounted cash flows have also been calculated by the formula:

DCF= Free cash flows/ (1+Weighted average cost of capital)^number of years.

In this WACC of the company has been considered 6.6%. In addition, a positive growth of 2.05% for the free cash flows of the firm has also been assumed. Based on the figure obtained in the discounted cash flows for the company, the enterprise value of the firm has also been obtained by the formula:

Enterprise value= (DCF/ Number of outstanding shares).

The enterprise value of the company has been calculated as £610.83 (refer to the appendix). However, the share price for the firm has been obtained as £3.92. Hence, it can be stated that the share value of Dairy Crest Group PLC is highly undervalued. The investors can invest in the firm to obtain a good return.

On the other hand, Economic value added (EVA) of the company has also been estimated. EVA enables the investors to estimate the firm’s financial health on the basis of residual wealth after the deduction of cost of capital. EVA is often considered as the economic profit and ensures the investors to evaluate the economic profit for the company. The EVA of the company has been calculated on the basis of the following formula:

EVA= Net Operating profit after taxes (NOPAT) - Invested capital* weighted average cost of capital. However, on the basis of the calculation, it has been found that EVA of Dairy Crest Group PLC is positive (refer to the appendix). Therefore, it can be assumed that Dairy Crest Group PLC has been able to generate values from the investment. Positive EVA is also treated as a positive factor to attract the investors.

• • P/E value

Price/Earnings (P/E) are also treated as widely used techniques to evaluate the value of a firm. P/E ratio of the company is calculated by the following formula:

P/E= Stock price per share/ Earnings per share

P/E ratio of the company has been derived as 12.67. Therefore, from the analysis of the P/E ratio it can also be assumed that the company has been proven to be extremely profitable with such a high value of price to earnings ratio. The investors may not have trusted the firm to generate significant amount of profits in the upcoming years. A high P/E ratio of Dairy Crest PLC also reveals the investment opportunities available to the firms. It also indicates that the firm has relatively low amount of risk.

In order to determine the market risk or systematic risk for the company, the beta of the company has also been considered. It has been found that the beta of the firm is 0.78 (Yahoo! Finance, 2016). It depicts that the security will be less volatile compare to that of the market.

The terminal value of Daily Crest Plc has been found to be £3.8 billion. This indicates the value of the company at a future time period. The company’s stable cash flows over the past few years combined with a consistent growth in the forecasted cash flows to be generated in the upcoming years have led the researcher to obtain such a high terminal value indicating the profitable nature of the business.

• Conclusion and recommendations

The report has been initiated with the purpose to conduct a detailed analysis of the leading dairy firm of UK, Dairy Crest Group PLC. The report has served the objective to analyse the financials of the company from the point of view of the investors. However, a bottom up and top down approach has also been conducted to determine the external business environment that can influence the business performance of the company. Both the analysis of the dairy industry and the concerned firm has been conducted to evaluate the external factors. Based on the research, it has been found that the UK government has taken the necessary investments to improve the infrastructure of the dairy industry. Due to the excellent logistics and supply chain system, the perishable dairy products have been distributed in an effective manner to the end users. In addition, high demand of dairy products has also helped the industry to grow at a rapid rate. Along with the growth of the industry, Dairy Crest Group PLC has also experienced significant growth in the revenues.

In order to evaluate the financials of the firm, the primary focus has been given on the financial ratio. It has been found that the liquidity position of Dairy Group PLC is sound enough to repay its short-term obligations. However, the low amount of cash and cash equivalent can be considered as a concerning fact from the point of view of the company. The firm needs to boost up its current assets in the upcoming years. However, from the analysis of the profitability, a declining trend has been observed. The firm needs to manage its operational cost for improving the profit margin. Moreover, improvement of the profit margins may also help the company to attract the investors. The analysis of leverage ratio indicates that the firm primarily depends on equity financing rather than the debt financing. Dairy Crest Group PLC needs to improve its efficiency in terms of converting the assets into sales.

DCF has been used in the report to determine the value of the company. On the basis of valuation, it can be concluded that the firm is undervalued. Therefore, the investors can invest into the firm to derive high profits. On the other hand, low P/E ratio has also supported the investment opportunity available to the investors. The beta value of the company has indicated that the stock of the firm will move lesser compare to the market. Positive value of EVA has also revealed that the firm has been able to generate profits from the invested capital. Therefore, on the basis of detailed analysis of industry, company financials and valuation, it can be inferred that the investors can expect a high return by investing in Dairy Crest Group PLC.

• Reference List

Yahoo! Finance, 2016. Dairy Crest Group PLC (DCG.L) Available at <https://uk.finance.yahoo.com/q?s=DCG.L>, Accessed on 28th May, 2016

• Appendix

Calculation of DCF, EVA and P/E ratio