Dairy Crest Regulatory News (DCG)

Interim Results Announcement for the six months ended 30 September 2016

Highlights

· Increased profits - adjusted profit before tax up 19% to £19.1m1,2

· Cathedral City launched new branding and packaging with a successful marketing campaign

· Clover, Country Life and Frylight all enjoyed strong volume growth

· Improved underlying cash generation - operating cash inflow3 of £17.5m, up £27.9m on last year

· Good progress made in functional ingredients for the infant formula market

· Proposed interim dividend up 2%

· Full year expectations remain unchanged

1 From continuing operations

2 Before exceptional items, amortisation of acquired intangibles and pension interest (see notes 3 and 7 to the interim financial statements)

3 Cash generated from operations, less capital expenditure, before exceptional cash outflows of £12.0m (2015: £8.1m)

Mark Allen, Chief Executive, said:

"We are pleased to have delivered a strong set of interim results in our first full trading period since the sale of Dairies. Our four key brands are continuing to perform well in a challenging marketplace, with strong volume growth for Clover, Country Life and Frylight and a successful launch of new branding and packaging for Cathedral City.

"We are also seeing the benefits of Dairy Crest's transformation into a leaner and more focused organisation, with strong profit growth and significantly improved cash generation during the first half. Our expectations for the full year remain unchanged.

"Looking further ahead, the significant investment at Davidstow has opened up attractive opportunities in high-margin, global infant formula markets as well as the potential to develop new functional ingredients. Combined with our continued focus on innovation within our key brands, this will underpin future growth and help us to maintain our strong track record of rewarding shareholders with higher dividends." 

For further information:

A video interview with Mark Allen, Chief Executive, and Tom Atherton, Group Finance Director, will be available from 07:00 (UK time) from the investor section of the Group's website investor.dairycrest.co.uk.

There will be an analyst and investor meeting at 9.00 (UK time) today at The Lincoln Centre, 18 Lincoln's Inn Fields, London, WC2A 3ED. An audiocast of the presentation will be available from the investor section of the Group's website investor.dairycrest.co.uk later today.

This announcement contains inside information.

Operating review

A new era of growth

Our success has been built on our links to the countryside, our dairy heritage and the people in our business. Following last year's sale of our Dairies business, we are now a lean, more focused organisation with a simple business strategy to produce high-quality food and added value functional ingredients.

The significant investment at Davidstow gives us further growth opportunities in high-margin, global infant formula markets as well as the potential to develop new functional ingredients. The Innovation Centre at Harper Adams University demonstrates our increased focus on innovation in our branded and ingredients businesses.

Innovation is at the heart of what we do and we have a successful track record of delivering consumer-focused innovation and new product development. Recently we have introduced, amongst other things, a new Clover recipe with 'no artificial ingredients', a much improved Cathedral City Spreadable range and a number of new Frylight variants. We target 10% of revenue from innovation less than three years old and delivered 11% in the year to 31 March 2016. We have improved that to 13% in the first half of this year.

Market background

After two years of very pronounced deflation, most dairy markets, both in the UK and worldwide, have seen a return to inflation in recent months as milk supply has fallen.

We continue to pay our farmers a competitive, sustainable, market-related price to ensure a secure supply of high quality milk. We have announced farmgate milk price increases of 4.3 pence per litre (20%) since the summer.

Key brand performance

* Dairy Crest volume and value sales 6 months to 30 September 2016 v 6 months to 30 September 2015

In aggregate, volumes of our four key brands (Cathedral City, Country Life, Clover and Frylight) grew by 2% in the first half of 2016/17 versus last year. This is a strong performance in a challenging marketplace. Deflationary pressures persisted for much of the first half and this impacted sales, which were down 8%.

Cathedral City maintains category leadership

In the first six months of the year we successfully rolled out a new master brand identity for Cathedral City. The new design simplifies the brand, improves visibility on shelf and strengthens our range, allowing us to build equity across all subsectors of the growing cheese category. It was supported by significant investment including a successful new TV advertisement, "The Rules of Cheese". We have seen a positive consumer reaction both to the new packaging and the marketing campaign.

The first half also saw the relaunch of Cathedral City spreadable in three flavours: Mature, Extra Mature and Garlic & Herb. The second half will see increased listings and the launch of a new flavour, Lighter Mature. Innovation will remain key to our future growth.

IRI data for the 28 weeks ended 8 October 2016 compared to the same period last year shows that the Everyday Cheese market grew 1% in volume but was down 4% in value terms. For much of the first half there were high levels of cheese stocks in the market. In order to maintain the brand's premium positioning within the category we chose not to discount too aggressively. Consequently, Cathedral City volumes were down 5% compared to the six months ended 30 September 2015 and sales fell by 11%. We expect volumes to improve in the second half of the year.

Our butters and spreads brands continue to grow share

IRI data for the 28 weeks ended 8 October 2016 shows that butters volumes grew by 3% but spreads volumes declined by 9%, leaving combined butters and spreads volumes down 4%. Selling prices fell in both markets resulting in retail sales down 2% for butters, 11% for spreads and 6% combined. Country Life and Clover have both outperformed their respective markets by some margin.

Clover, our dairy spread, has grown volumes by 7% in the six months ended 30 September 2016. This, together with the strong momentum seen in the second half of last year, has resulted in a 1.4 percentage points gain in volume market share over the last 12 months.

In September 2015 we re-launched Clover with 'no artificial ingredients', positioning it as a natural dairy spread, made with buttermilk and with a buttery taste. We believe that Clover is well placed should the retail price of butters inflate more than spreads in future. We once again reinforced the 'no artificial ingredients' naturalness positioning through a marketing campaign in September 2016. We will launch new packaging in the second half of the year, further supporting the natural messaging around the brand.

Country Life has continued to perform very well since the launch of the new 'Union Jack' packaging. Volumes have grown by 8% in the six months ended 30 September 2016 and volume share is up 0.5 percentage points over the last 12 months. Our new, improved spreadable recipe will launch in the second half of the year.

Since June 2016 there have been significant increases in prices for dairy products. In particular, the cream price has more than doubled. We expect this sharp increase in input costs to have an impact on the volumes and profitability of our butters business in the second half of the year.

We continue to drive efficiency improvements at our manufacturing site in Kirkby, where all of the butter and spreads brands are produced.

Frylight enjoys excellent growth in sales

Kantar data for the 24 weeks ended 11 September 2016 indicate that the volume and value of the retail oil market increased by 1% and 2% respectively.

Frylight, the UK's leading oil brand, continued to grow well ahead of the market. Sales and volumes grew by 16% compared to the six months ended 30 September 2015. We expect this strong performance to continue in the second half of the year.

The second half will see the launch of new packaging, which will emphasise the new 'no artificial ingredients' credentials. This will be supported by TV advertising across the important fourth quarter period, which encompasses both the start of the New Year and Pancake Day. Innovation has continued, with an avocado oil due to be launched in the second half of the year. The business is also exploring export opportunities in Europe to support its medium-term growth ambitions. We are delighted that Frylight has been singled out by the industry, winning the Institute of Grocery and Distribution (IGD) 'Health and Wellness' product award in October 2016.

Functional Ingredients

The new functional ingredients facility at Davidstow is a significant investment that gives Dairy Crest access to the fast-growing global infant formula market and potential access to the adult functional foods and the animal feed additives markets. This marks a significant new sales channel for Dairy Crest.

We have been producing demineralised whey since May 2016. The focus since then has been on operational efficiency and consistency. Yields are improving and wastage is declining. The required specification for infant formula grade demineralised whey is demanding and there is no room for variability. During the first six months of the year, a high proportion of our demineralised whey was sold as non-infant formula grade, which, although it commands a premium to sweet whey powder, is lower value than infant formula grade. However, the proportion of whey that is meeting the infant formula quality threshold is increasing and we expect to consistently reach our target of over 80% by the end of the financial year.

Whey, along with other dairy products, has experienced price rises recently. Demineralised whey continues to deliver a price premium compared to the sweet whey powder that we produced previously. The demineralised whey price has not risen as sharply as underlying sweet whey prices, but there is often a lag. We believe we are very well placed to benefit from any price rises in the coming months.

The galacto-oligosaccharide ("GOS") business is proceeding in line with plan. In the first six months of the year we produced initial batches of GOS and we are on track to produce and sell the planned level of infant formula grade GOS in the financial year.

In partnership with Fonterra we are developing the customer base for both products.

Our research into the potential positive impacts of GOS in animal feed continues. Initial academic trials have shown there are several benefits to feeding chickens GOS. Chickens receiving GOS exhibited improvements of over 10% in both weight gain and feed conversion rates, when compared to chickens not fed GOS. We also identified that chickens fed GOS had increased levels of beneficial bacteria and developed a greater surface area in the birds' gut which enables better absorption of nutrients. Furthermore, there are some encouraging signs of the positive benefit that GOS might be able to bring in offsetting the negative impact of pathogens, e.g. campylobacter, on bird development. This includes improved bird performance and potentially reduced infection rates.

We are now moving from highly-controlled academic trials to commercial trials to see whether these benefits can be sustained in the market place and we are increasing our investment by £2 million this year to support this programme. There has already been interest from a number of commercial partners in our progress and we expect to agree a product development partnership in the near future. We have also registered Nutrabiotic® as the brand name for our GOS in animal feed.

Leaner, more focused organisation

Following the sale of the Dairies business, overheads have been significantly reduced. We are driving further efficiencies and cost reductions, including the implementation of new, simplified IT systems. The new platform will be more standardised than that which it replaces and will drastically reduce the number of systems we use. Reducing costs and improving efficiencies are an integral part of doing business at Dairy Crest. The agreement with Fowler Welch, reached in June 2016, is just the latest example of this. This transferred Dairy Crest's transport operations to Fowler Welch and opens up opportunities for both companies to build a larger warehousing and logistics operation at Nuneaton, therefore improving utilisation at this site.

Financial review

Group revenue from continuing operations of £190 million represents a 7% decrease from last year, reflecting the deflationary conditions that remained a feature of our markets for much of the first half.

Total product group profit from continuing operations increased by 16% to £23.1 million (2015: £20.0 million). Cheese and whey product group profits increased by £2.5 million. Butters and spreads product group profits increased by £0.6 million. Efficiencies at our butters and spreads plant in Kirkby and good growth in profits from Frylight helped to offset the effects of lower revenues and rising input costs.

Finance costs of £4.0 million are in line with last year and adjusted profit before tax (from continuing operations, before exceptional items, amortisation of acquired intangibles and pension interest) was £19.1 million, up 19% from £16.0 million in 2015. Product group analysis and a reconciliation to both adjusted and reported profit before tax is included in note 3 to the interim financial statements.

Net exceptional costs on continuing operations of £2.9 million were incurred during the six months ended 30 September 2016 (2015: £2.4 million). Exceptional income of £2.2 million was recognised in relation to the settlement of claims between the Group, Farmright Limited and Quadra Foods Limited at £1 million, which was lower than the creditor balance held of £3.2 million. However this exceptional income was offset by continued exceptional costs of £5.1 million in relation to the ongoing commissioning of the demineralised whey and GOS facilities at Davidstow. Exceptional costs this financial year could be further offset by the profit on disposal of an ex-manufacturing facility in Fenstanton, Cambridgeshire, should this complete before 31 March 2017.

The pension interest charge of £0.4 million is £0.1 million higher than last year. The £0.2 million amortisation charge for acquired intangible assets is unchanged. This results in a reported profit before tax of £15.6 million, an increase of 19% compared to last year (2015: £13.1 million)

The effective rate of tax for continuing operations is 18.9% and is representative of the expected rate for the year ending 31 March 2017.

Adjusted basic earnings per share on continuing operations amount to 11.1 pence (2015: 9.3 pence) an increase of 19% broadly consistent with higher adjusted profit before tax. Basic earnings per share on continuing operations increased by 22% to 9.3 pence.

The post-tax loss on discontinued operations, being the operations of the Dairy business disposed of in December 2015, totalled £2.8 million. This predominantly reflects the final consideration reduction of £2.5 million paid back to Muller UK & Ireland Group LLP ("Müller") following the final determination of consideration adjustments by the independent expert. Further information is reported in note 8 to the interim financial statements.

Operating cash inflow (before exceptional items and after capital expenditure) in the six months ended 30 September 2016 amounted to £17.5 million (2015: £10.4 million outflow). Working capital inflows of £3.0 million were lower than the £21.4 million seen last year. Milk cost deflation in the first half of 2015 was more pronounced than in the first half of 2016 as UK milk supply has tightened in recent months. Furthermore, the business carried higher than anticipated stocks of demineralised whey powder at 30 September 2016 as the testing, grading and sales process resulted in increased stock levels.

Capital expenditure was £10.1 million. This represents a significant reduction compared to the £35.5 million incurred in the six months ended 30 September 2015, when we were investing in the new demineralised whey and GOS facility at Davidstow.

The Dairies business was sold in December 2015 and initial proceeds received during the year ended 31 March 2016 amounted to £54.5 million. These initial proceeds were subject to further adjustments relating to profit and working capital amounts in the pre-sale Dairies business compared to targeted levels. In April 2016 £25.9 million was repaid to Muller with a further £2.5 million repaid in August 2016 following the independent expert's determination of final adjustments to the consideration. There will be no further adjustments to consideration received.

The impact of the repayment to Muller was partly offset by a sale and lease back agreement to finance the galacto-oligosaccharide investment in Davidstow resulting in proceeds of £18 million. Overall, in line with normal seasonality, net debt increased in the first half of the year to £262.3 million but this is expected to reduce over the second half of the year. Dairy Crest remains committed to reducing levels of net debt with a medium term target of net debt to EBITDA of 1.5 to 2.0 times.

The reported defined benefit pension scheme deficit was £120.5 million at 30 September 2016 compared to £42.5 million at 31 March 2016. The principal driver of this increase is reduced yields on corporate bonds, which are used to determine the discount rate applied to the pension scheme liabilities under IAS19. These fell from 3.5% at March 2016 to 2.3% at September 2016 but have strengthened since then.

We are currently in discussions with the Pension Fund Trustee on the actuarial valuation and revised funding plan based on a March 2016 valuation date. Until such time that this is agreed, we are subject to the March 2013 plan. This plan results in cash contributions by the Company of £13.2 million in 2016/17.

The principal risks and uncertainties affecting the Group are set out below the statement of directors' responsibilities and further details are disclosed on pages 16 and 17 of the 2016 Annual Report and Accounts.

Summary and outlook

We are pleased to have delivered a strong set of interim results in our first full trading period since the sale of Dairies. Our four key brands are continuing to perform well in a challenging marketplace, with strong volume growth for Clover, Country Life and Frylight and a successful launch of new branding and packaging for Cathedral City.

We are also seeing the benefits of Dairy Crest's transformation into a leaner and more focused organisation, with strong profit growth and significantly improved cash generation during the first half. Our expectations for the full year remain unchanged.

Looking further ahead, the significant investment at Davidstow has opened up attractive opportunities in high-margin, global infant formula markets as well as the potential to develop new functional ingredients. Combined with our continued focus on innovation within our key brands, this will underpin future growth and help us to maintain our strong track record of rewarding shareholders with higher dividends.

Mark Allen

Chief Executive

10 November 2016

Consolidated income statement

(Unaudited)

All amounts are attributable to owners of the parent.

*Adjusted earnings per share calculations exclude exceptional items, amortisation of acquired intangibles and pension interest in relation to the Group's defined benefit pension scheme.

A final dividend of £22.4 million (16.0 pence per share) was paid in the period to 30 September 2016 (2015: £21.6 million; 15.7 pence per share). A dividend of £8.7 million (6.2 pence per share) was approved by the Board on 9 November 2016 for payment on 26 January 2017 (2015: £8.4 million; 6.1 pence per share). See Note 6.

Consolidated statement of comprehensive income

(Unaudited)

Consolidated balance sheet

(Unaudited)

The interim results were approved by the directors on 9 November 2016.

Consolidated statement of changes in equity

(Unaudited)

All amounts are attributable to owners of the parent.

Consolidated cash flow statement

(Unaudited)

Notes to the interim financial statements

(Unaudited)

1 General information

Dairy Crest Group plc (the "Company") is a public limited company incorporated in the United Kingdom under the Companies Act 2006. The address of the registered office and principal place of business is Claygate House, Littleworth Road, Esher, Surrey, KT10 9PN. The principal activity of the Company and its subsidiaries (the "Group") in the period was the processing, manufacture and sale of branded dairy products in the UK and Europe as described in the Group's annual financial statements for the year ended 31 March 2016.

2 Basis of preparation, accounting policies and approval of interim statement

Basis of preparation and approval of interim statement

These condensed interim financial statements comprise the consolidated balance sheet as at 30 September 2016 and related income statement, statement of comprehensive income, statement of cash flows, statement of changes in equity and supporting notes (hereinafter referred to as "financial information").

The financial information is not audited and does not constitute statutory financial statements as defined in section 435 of the Companies Act 2006. Comparative figures for the year ended 31 March 2016 have been extracted from the Group's 2016 statutory accounts, on which the auditors gave an unqualified opinion, did not include an emphasis of matter reference and did not include a statement under section 498(2) or (3) of the Companies Act 2006. The comparative figures for the year ended 31 March 2016 and the half year ended 30 September 2015 reflect the impact of the Dairies operation as a discontinued operation. These sections address whether adequate accounting records have been kept, whether the Company's financial statements are in agreement with those records and whether the auditors have obtained all the information and explanations necessary for the purposes of the audit. The Group financial statements for the year ended 31 March 2016 have been filed with the Registrar of Companies and can be found on our corporate website, www.dairycrest.co.uk.

The financial information for the period ended 30 September 2016 has been prepared in accordance with the Disclosure and Transparency Rules of the Financial Services Authority and with IAS 34, "Interim Financial Reporting" as adopted by the European Union. The financial information should be read in conjunction with the Group's financial statements for the year ended 31 March 2016, which have been prepared in accordance with International Financial Reporting Standards ("IFRS") as adopted by the European Union.

The results for operations for the half year are not necessarily indicative of the results expected for the full year.

This financial information was approved for issue on 9 November 2016.

Going concern

The Directors have reviewed current performance and forecasts, combined with expenditure commitments, including capital expenditure. After making appropriate enquiries, the Directors have a reasonable expectation that the Group has adequate financial resources to continue its current operations, including contractual and commercial commitments, for the foreseeable future. For this reason, they have continued to adopt the going concern basis in preparing the interim financial statements.

Accounting policies and areas of estimation and judgement

The financial information has been prepared in accordance with accounting policies used for the Group's financial statements for the year ended 31 March 2016, with the exception of the adoption of the new standards and interpretations that came into effect in the half year.

2 Basis of preparation, accounting policies and approval of interim statement (continued)

New standards, interpretations and amendments

The following accounting standards and interpretations became effective for the current reporting period:

- Amendment to IFRS 5: Non-current Assets Held for Sale and Discontinued Operations

- Amendment to IFRS 7: Financial Instruments: Disclosures

- Amendment to IFRS 10: Consolidated Financial Statements

- Amendment to IFRS 11: Joint Arrangements

- Amendment to IFRS 12: Disclosure of Interests in Other Entities

- Amendment to IAS 1: Presentation of Financial Statements

- Amendment to IAS 16: Property, Plant & Equipment

- Amendment to IAS 28: Investments in Associates and Joint Ventures

- Amendment to IAS 34: Interim Financial Reporting

- Amendment to IAS 38: Intangible Assets

The adoption of these standards and interpretations do not have a material impact on the Group's interim financial statements in the period.

Taxation

Taxes on income in the interim periods are accrued using the tax rate that is expected to be applicable to total annual earnings for the full year in each tax jurisdiction based on substantively enacted or enacted tax rates at the interim date.

Key areas of judgement and estimation

The areas of particular significance to the Group's financial information which include the application of judgement and estimation, which is fundamental in the completion of a set of condensed consolidated interim statement, are detailed below.

The key areas where judgement has been applied are:

(i) Nature of exceptional items

Items of a material, one-off nature, which result from a restructuring of the business or some other event of circumstance, are disclosed separately in the consolidated income statement as exceptional. Management considers this to be an area of judgement due to the assumptions made around the nature of exceptional cost. See Note 4 and Note 8.

(ii) Deferred Tax Asset

The Group has recognised a deferred tax asset in relation to the trading losses of the Dairies operation. Management considers this to be an area of judgement due to the assumption made that this deferred tax asset can be set off against future trading profits despite the disposal of the Dairies operation.

The key sources of estimation uncertainty that have a significant risk of causing material adjustments to the carrying amounts of assets and liabilities within the next year are:

(i) Calculation of promotional discount accruals

The Group accrues for agreed promotional funding. Accruals for promotional funding are calculated based on an estimated redemption rate of the promotion. The redemption rate used is dependent on the promotional mechanic and considers known historical data on the performance of that mechanic. Management considers this to be an area of judgement which is dependent on the customer mix and promotion mechanic.

(ii) Measurement of defined benefit pension scheme assets and obligations

The Group recognises and discloses its retirement benefit obligation in accordance with the measurement and presentational requirement of IAS 19 'Retirement Benefit Obligations'. The calculations include a number of judgements and estimations in respect of the expected rate of return on assets, the discount rate, inflation assumptions, the rate of increase in salaries and life expectancy, amongst others. Changes in these assumptions can have a significant effect on the value of the retirement benefit obligation. There has been a change in the discount rate assumption for the valuation as at 30 September 2016 that has had a significant effect on the valuation. See Note 10.

2 Basis of preparation, accounting policies and approval of interim statement (continued)

(iii) Estimation of tax costs in France in relation to the sale of St Hubert

The sale of St Hubert resulted in the tax payable in France both on the chargeable gain on disposal and on dividend payments made to the UK parent between 31 March 2012 and the date of disposal in August 2012. An estimate has been made of the likely tax a cost resulting from these transactions, however, the final assessment has yet to be agreed with the French tax authorities which may result in a change to the level of tax provisioning.

3 Segmental analysis

IFRS 8 requires operating segments to be determined based on the Group's internal reporting to the Chief Operating Decision Maker ("CODM"). The CODM has been determined to be the Company's Board members as they are primarily responsible for the allocation of resources to segments and the assessment of performance of the segments.

The business is managed centrally by functional teams (Demand, Supply, Procurement and Finance) that have responsibility for the whole of the Group's product portfolio. Although some discrete financial information is available to provide insight to the management team of the key performance drivers, the product group profit is not part of the CODM's review. Management has judged that the Group comprises one operating segment under IFRS 8. As such, disclosures required under IFRS 8 for the financial statements are shown on the face of the consolidated income statement and balance sheet.

To assist the readers of the financial statements, management considers it appropriate to provide voluntary disclosure on a basis consistent with historical reporting of the cheese and spreads product groups results included within the consolidated income statement. In disclosing the product group profit for the period, certain assumptions have been made when allocating resources which are centralised at a group level for the continuing business and property income.

The 'Other' product group comprises revenue earned from distributing products for third parties and certain central costs net of recharges to the other product groups. Generally, central costs less external 'Other' revenue is recharged back into the product groups such that their result reflects the total cost base of the Group. 'Other' operating profit therefore is nil.

The results under the historical segmentation basis for the continuing business included in the financial information are as follows: