Can Robert Wiseman regain the initiative after profit warning?
Wiseman, which has warned that operating profits could be down £7m in the second half and £16m in the year to March 2012 in the wake of recent “intense competitive pressures”, is likely to “seize every opportunity to rebuild its margins and profits” over the next 18 months, said Investec analyst Nicola Mallard.
“Although we can only forecast EBIT (earnings before interest and tax) margins of 1.5ppl for full-year 2012, we would be surprised if Wiseman actually reports a number that low in 18 months’ time.”
Morrisons is understood to be reviewing its 400m litre supply contracts (currently with Dairy Crest and Arla) next spring, while Asda is due to review its 550m+ litre arrangement with Arla next summer, she said.
“Winning extra volume might not necessarily increase margins dramatically – although of course it will be accretive to profits - but there should be some benefit to margins from the full utilisation of Wiseman’s Bridgwater dairy and other fixed assets such as the distribution depots.”
Every 100m litre volume gain should add about £2m to profit, she predicted.
Margin-crushing milk discounting
Wiseman did not attribute its profit warning to Tesco, it’s largest customer. However, given that it had recently completed reviews with Sainsbury and the Co-op Group, “we can only assume that the bulk of this downgrade is associated with a Tesco review”, said Mallard.
“The £16m profit impact in a full year would suggest a selling price reduction of 0.8ppl across the group as a whole. When operating margins are only 2.5ppl, this is clearly a painful adjustment.”
Hard discounters steal share from major multiples
The supermarkets have lost market share to the hard discounters in recent years and Asda and Tesco’s recent milk promotions were in part an attempt to regain the initiative from Aldi and Lidl & co, who were able to buy milk more cheaply than the big supermarkets (many of whom now offer farmer contracts with premium prices), she said.
“During the past year, Kantar Worldpanel put the difference in price at 17ppl or 25%. It is no surprise, therefore, that we have seen the discounters’ share more than double from 4.9% in June 2006 to 10.7% in June 2010. Hence, the majors are fighting back.”
Asda was the first to move, reducing 4-pints from £1.53 to £1.25 and running a multi-buy (two for £2), prompting reciprocal action from Tesco, she said.
“Given that the 4- and 6-pint milk bottles are the big volume sellers – we would guess around 70% of a retailer’s volumes together - and applying this across Tesco’s annual liquid milk volume (c1bn litres a year), this price cut, if permanent, would suggest a reduction in revenue and profit of the best part of £80m.”
While the jury was out as to how long such pricing could hold, the “assumption seems to be that it is a permanent cut rather than a promotion”, said Mallard.
What if cream prices go down?
A key factor for Wiseman’s future profitability was the bulk cream price, which had helped to offset input cost rises in other areas such as fuel and packaging in recent months, noted Mallard.
While a fall in cream prices would be unhelpful in the short term, it could however create a trigger for dairy processors including Wiseman to renegotiate prices with retailers, she said.
Moreover, lower cream prices could also put increased pressure on some of the 'marginal middle ground operators' who had been using the windfall gain from higher cream prices to subsidise very competitive pricing in the sector, she claimed.
“If cream revenue were to reduce, it could expose some of these contracts as being unprofitable. Many already operate on very narrow margins, which could lead to casualties in this sector.”
