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MILKING THE SUPPLIER FOR MARGIN

Corporate action pending with diversification from dairy likely

DAIRY PRODUCTS GROUP Clover Industries – which delivered on its promise of a strong turnaround in the year to end-June – seems set to pursue acquisitions in the months ahead that will lessen its dependence on milk-based products.

Unlisted Clover, which boasts empowerment investor Hosken Consolidated Investments (HCI) as a major shareholder, more than tripled attributable profits to R65m on the back of a slender increase in turnover to R4,2bn.

Key to Clover’s bottom line success has been the effective management of milk prices.

Chairman John Bredin notes: “As a consequence of our efforts to reduce price premiums (to suppliers) there’s been a significant increase in market demand. That demand has resulted in a shortage of raw milk, exacerbated by the seasonal effect on production during the latter part of the year.”

CE Johann Vorster adds that Clover has enjoyed “tremendous” support from all its procurement partners over the past 18 months. “That strategy will continue in order to meet growth targets.”

Vorster says that the milk flow position – which caused temporary shortages of raw milk – has been addressed by moving away from a national milk price to pricing by region or area. He says the depreciation of the rand should also bring long awaited relief to SA’s dairy industry. “Imports should slow down and improved prices to the local producer fraternity will become a reality.”

What’s clearly of more importance is Clover, which has a tendency to swing from major profits into a loss, achieving of a 6% net operating margin. In the year to end-June, Clover managed an improved gross trading margin of 5,7%, with operting profit coming at R242m. That performance should be contextualised, as Clover is operating in a tough market. Vorster says: “Competition for market share is fierce, with many small players fighting vehemently for shelf space.” He says selling prices are declining even further in the long life milk market, and cheese prices are lower than two years ago. What’s more, imports have reached their second highest level ever.

With that in mind. Clover’s 5,7% margin could be regarded as rather thick.

However, deputy CE Manie Roode says the group isn’t yet satisfied with that margin. When Clover was still a co-operative, big profits in one year could quickly be turned into losses, as the group was expected to give profits back to suppliers in the form of higher prices.

Roode says: “A 6% margin on turnover is the minimum ratio we need to create a sustainable model going forward. We’ve shown an improvement, but there’s still a challenge to get past 6% – and having a more profitable mix of products will help.”

While the 5,7% trading margin achieved for its 2006 financial year sounds reasonable, it’s important to remember that traditionally weaker second half trading saw the margin fall closer to 4%.

The key Christmas trading period and the dynamics of raw milk flow mean a large portion of Clover’s revenue and profits is clustered in its first half. In 2006 two-thirds of operating profit was earned in the first half. Roode says Clover is working hard at taking the seasonably out of the business.

With the core dairy business sweating assets, it’s no surprise that corporate activity is on the cards at Clover. Diversification won’t only help smooth annual profit flows but hopefully also offer scope to fatten the trading margin further.

Roode says Clover’s board has given the official thumbs up to “move forward” with merger and acquisition activity. He says a couple of deals are being contemplated and an announcement possibly made at its upcoming AGM. Clover’s acquisition strategy will be interesting to gauge.

With more than R4bn of sales generated from milk-based products. Clover will need to make a few sizeable purchases to build a meaningful non-dairy component. A piece-by-piece assemblage of non-dairy businesses could be an arduous task, remembering the considerable efforts expended by fellow food giant Pioneer Foods in bedding down acquisitions made to lessen reliance on its staple foods core.

Whether it’s conducive for Clover to pull off a mega-merger (for example, with another meaningful unlisted food business) remains to be seen. But with the opportunistic and inventive HCI ranking as a major shareholder at Clover, you can’t dismiss the possibility of a corporate coup. Would Pioneer Foods – currently sans a dairy angle – be completely out of the question?

Source: Finweek – Marc Hasenfuss