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Chief Financial Officer's report
Long, long ago
Overview
The year was characterised by high cost inflation, volatile on-farm input costs and resultant erratic milk production.
The first half of the year was marked by lower than expected milk production due to sharp increases in feed and other input costs. Farm-gate milk prices were increased early in the second half of the year to counter this trend. This, together with a subsequent easing of feed and other input costs and favourable climatic conditions in the main milk production areas, resulted in milk production being over-stimulated and consequently increased milk supply steeply during the autumn. This flattened the usual seasonal milk intake trend to some extent. While such a trend would normally be welcomed, the higher than expected national autumn milk production made it difficult to pass on to consumers the high inflationary cost increases during the traditional autumn price increase “season”.
Dairy volumes were somewhat constrained by the short supply of raw milk during the first quarter of the year, as explained in the Interim financial report. Clover’s increased selling prices introduced at the end of the summer, together with the high national milk supply during autumn, eroded dairy fluid volumes during the last quarter – especially on UHT milk.
Additional distribution capacity created to date as part of Project Cielo Blu, enabled Clover to increase Principal distribution volumes and to take on additional Principals. Thus it secured the national sales, distribution and merchandising business of Epic Foods (Pty) Ltd with effect from 1 April 2012 on the following chilled brands:
- Blossom margarine and spreads.
- Canola spreads.
- Ole spreads.
- Cardin margarine.
- Maypole margarine.
- Spread and Bake margarine.
Subsequent to the year-end and with effect from 1 July 2012, Clover was awarded the sales, distribution and merchandising business of the Red Bull brand for the forecourt channel.
Financial highlights
| 2012 | 2011 | % | ||
|---|---|---|---|---|
| Revenue | R7 223,9m | R6 542,3m | 10,4% | |
| EBIT | R371,2m | R319,0m | 16,4% | |
| EBITDA | R477,8m | R419,0m | 14,0% | |
| Headline EBITDA | R481,8m | R415,0m | 16,1% | |
| Headline EBIT | R375,1m | R314,8m | 19,2% | |
| Normalised EBITDA | R486,5m | R428,7m | 13,5% | |
| Normalised EBIT | R379,9m | R328,6m | 15,6% | |
| Net finance cost | R23,9m | R37,4m | (36,1%) | |
| Effective tax rate | 39,6% | 34,7% | 14,1% | |
| Headline earnings | R207,8m | R175,2m | 18,6% | |
| Headline earnings per share | 116,0c | 113,8c | 1,9% | |
| Diluted headline earnings per share | 108,7c | 106,2c | 2,4% | |
| Normalised earnings* | R229,5m | R187,4m | 22,5% | |
| Normalised earnings per share* | 128,1c | 121,8c | 5,2% | |
| Capital expenditure: | ||||
| • | Project Cielo Blu | R83,2m | R79,8m | 4,3% |
| • | Recurring capital expenditure and other projects | R190,5m | R136,5m | 39,6% |
| Return on equity | 11,3% | 12,9% | (10,9%) | |
| Cash generated by operations | R416,4m | R256,9m | 62,1% | |
| Dividends relating to the financial year | 28,4c | 25,0c | 13,6% | |
| * See note 9 to the financial statements for the calculation of normalised earnings | ||||
Comprehensive income
Headline earnings
Headline earnings improved by 18,6% to R207,8 million from R175,2 million in the prior year. A 16,4% increase in operating profit and a 36,3% reduction in net finance costs largely contributed to the increase in headline earnings. However, headline earnings per share only increased by 1,9% to 116,0c (2011: 113,8c) as a result of the greater number of shares in issue during the current year. Although the total number of shares at the end of both years was the same, on a weighted basis the shares issued in the JSE listing during the prior year were only in issue for a little more than six months.
Operating profit
Operating profit for the year under review increased by 16,4% to R371,2 million (2011: R319,0 million). This was achieved on revenue of R7 223,9 million (2011: R6 542,3 million), an increase of 10,4% over the comparative period. The gross margin increased to 27,6% from 26,6%, while the operating margin for the full year was 5,1% compared to 4,9% in the previous year.
Revenue from the sale of products increased by 10,9%, with 2,4% of this relating to volume growth and the rest being attributable to a combination of inflationary price increases and improved product mix. Revenue from rendering services increased by 18,9% or R121,6 million as a result of increased distribution capacity and consequent principal volume growth, together with the additional Epic Foods and Danone merchandising business. Revenue from the sale of raw milk to Danone Southern Africa (Pty) Ltd, which is made at cost, decreased by 10,3% due to greater direct raw milk purchases by Danone in the market.
Raw material costs increased by 10,2%, mostly as a result of the farm-gate milk price increases of more than 20% early in the second half of the year.
Packaging costs increased by 6,7%, slightly above inflation, because of the influence of higher oil prices on plastic packaging and to a lesser extent the effect of the weaker exchange rate on UHT packaging.
Despite the direct impact of higher fuel prices and staff costs on milk collection costs, the overall increase of only 5,3% was brought about by the increased UHT production capacity created in Port Elizabeth as part of Project Cielo Blu. Less raw milk was therefore transported to Gauteng, though the primary transport cost of finished product to Gauteng increased, albeit not to the same extent.
Higher staff costs and inflation in energy costs caused production costs to rise by 9,3%. Increased volumes put further upward pressure on overall production costs.
Primary distribution costs are heavily influenced by volume growth and fuel costs. The high volume growth in Principal distribution volumes and Clover’s own volume growth and fuel cost increases, pushed the increase to 11,7% for the year. The move of UHT manufacturing capacity from Gauteng to the coastal areas also increased primary distribution volumes but this was more than offset by reduced raw milk transport volumes and milk collection costs.
High staff inflation, increased distribution volumes and higher fuel prices all contributed to the 14,4% increase in selling and distribution expenses. Clover’s investment in the production of its Clover “Way Better™” advertising campaign, which was accounted for during this year also contributed to the increase in selling expenses. The benefits of this campaign will be experienced over the medium term.
Administrative expenses increased by 10,4% or R18,1 million. A departmental restructuring of a business unit from marketing to administration accounted for R4,9 million of this increase, with the remainder being attributable to inflation adjustments on annual staff costs.
The 2010/2011 restructuring expenses included a sum of R8,5 million associated with the listing on the JSE. This mainly accounted for the 43,4% decrease in restructuring expenses in the year under review.
Profit for the year
As is the case with headline earnings, the increase in operating profit and the reduced net interest charge increased profit for the year by 14,0% to R209,7 million (2011: R184,0 million). However, the effective tax rate of 39,6%, largely resulting from tax adjustments, eroded the earlier gains to some extent.
The effective tax rate is far higher than the official tax rate mainly for the following reasons:
Permanent differences:
- The preference dividends are not tax deductible, which increased the effective tax rate by 1,8%.
- The costs associated with the equity accounted share – based payments are not tax deductible, increasing the effective tax rate by 0,7%.
- A historical loan to Clover Zambia has been written off, increasing the effective tax rate by 0,4%.
- Depreciation on administrative buildings, non-deductible for tax purposes, which increased the effective tax rate by 0,5%.
- Deferred tax assets on losses in foreign subsidiaries not recognised, which increased the effective tax rate by 0,81%.
Other tax adjustments:
- 2009 tax deductions not allowed by SARS, which increased the effective tax rate by 0,3%.
- The reversal of a deferred tax asset raised in the prior year on the basis of a judgement handed down by the Supreme Court of Appeal (not related to Clover) during the current year, which increased the effective tax rate by 1,0%.
- The reversal of deferred tax assets on property plant and equipment raised in prior years, which increased the effective tax rate by 3,8%.
Return on equity weakened from 12,9% to 11,3% following from the equity raised halfway through the previous financial year with the listing on the JSE. This capital is earmarked for Project Cielo Blu that will only yield its full benefits during the next financial years. The increased equity without the immediate increase in returns caused the return on equity to weaken before it increases again.
Dividends
The Company declared and paid an interim dividend of 15 cents per share during April 2012. A final dividend of 13,4 cents was declared by the Board, which will bring the total annual dividend relating to the 2011/2012 financial year to 28,4 cents. This is 3,4 cents or 13,6% more than the dividend for the 2010/2011 financial year. Dividends are calculated in terms of the Company’s dividend policy of 25% of total comprehensive income attributable to shareholders of the Company but excluding capital profits. In terms of the rules pertaining to the preference shares, this dividend policy may not be exceeded until after the redemption of the preference shares in June 2013. The Board will reconsider the dividend policy at the 2012/2013 year-end based on the Company’s capital requirements.
Financial position
Significant movements from 30 June 2011 to 30 June 2012 on individual line items of the statement of financial position are explained below.
Non-current assets
The increase in property, plant and equipment stems mostly from the capital expenditure associated with Project Cielo Blu and other capital projects.
Intangible assets increased with R10,7 million, mainly as result of a new warehouse management system and a new call centre consumer line management system that were rolled out.
Current assets
Inventory levels increased sharply by 30,8%. This was the cumulative result of the farm-gate milk price increase of more than 20%, volume growth, imported UHT milk to facilitate the move of production facilities in terms of Project Cielo Blu and lower UHT sales volumes in the last quarter of the year after Clover’s selling price increases.
Clover’s volume growth and increased Principal volumes, together with the higher selling prices accounted for the 15,1% increase in trade and other receivables from 30 June 2011. Trade receivable days outstanding remained at very low levels. (Analysts should note that trade receivable days outstanding cannot be deduced from the financial statements as the full receivables of certain distribution Principals are included in trade receivables, while the revenue of such principals is not included in the statement of comprehensive income. Only fees earned from providing the services involved are included in revenue).
Cash decreased by R112,7 million to R711,5 million from R824,2 million at 30 June 2011. Spending on Project Cielo Blu and other capital projects together with the repayment of R155,0 million of long-term debt, utilised the cash as intended at the time of the listing on the JSE.
Non-controlling interests
The reduction of R7,7 million in non-controlling interests stems from the acquisition of the minority shareholdings in Clover Botswana and Clover West Africa.
Non-current liabilities
In terms of the Memorandum of Incorporation of the Company the preference shares will be redeemed during June 2013 and the full preference share debt of R259,4 million has accordingly been classified as a current liability in the 2012 statement of financial position. In addition, the last tranche of R150,0 million of the long-term debt securitised matures in March 2013 and has also been classified as a current liability. A decision on whether to renew this funding is pending, given the Group’s current strong cash position. The senior funder of the debtors’ securitisation transaction has already obtained credit approval and committed to renewing its funding, if required by Clover, at rates much lower than those currently applying.
Current liabilities
Trade and other payables increased by R248,0 million or 23,2%. Increased farm-gate milk prices, increased principal sales, creditors for capital projects and the year-end, which occurred over a weekend resulted in this above-normal increase. Principal sales are included in trade receivables, with a corresponding liability included in trade payables reflecting the amount payable to principals for their sales.
R155 million of the short-term portion of interest-bearing debt was repaid during December 2011. Together with the reclassification of the preference share debt of R259,4 million and the R150 million of long-term debt to short-term debt, as explained above, it increased the short-term portion of interest bearing debt by R247,6 million to R421,4 million.
Gearing
Gearing at 30 June 2012 was 23,4% (2011: 34,6%). Net of cash, the Group was negatively geared at 14,2% (2011: 12,4%). Group gearing is currently conservative and well within its ability to service interest and repayments.
Cash flow
The reclassification of the preference share debt and the last remaining tranche of the debtors securitisation funding as current liabilities reduced Group liquidity with net current assets decreasing from R927,9 million to R576,4 million. Excluding inventory, net current assets decreased from R467,7 million to a net current liability position of R25,6 million. Cash generation from operations over the next year is expected to be sufficient to maintain a healthy liquidity position.
Cash generated from operations, before working capital changes, is R444,6 million compared to R379,5 million reported in the prior year. During the year under review, working capital absorbed cash in the sum of R28,2 million. The reasons for the working capital changes are discussed under current assets and liabilities above.
Investment activities consumed R256,2 million in cash. Capital expenditure on project Cielo Blu amounted to R83,2 million and capital expenditure of a recurring nature and other capital projects amounted to R190,5 million. R27,2 million was utilised to acquire the minority interests and associated goodwill in Clover Botswana and Clover West Africa.
Finance costs, dividends and debt reduction absorbed cash of R273,0 million of which the bulk relates to the settlement of R155 million of long-term debt during December 2011.
The Group ended with a net decrease in its cash position for the year of R112,7 million.
Segmental performance
The segmental information is only disclosed to margin on materials (“MOM”) level as the Group’s assets and operations are largely integrated between segments making the allocation of overhead costs to the different segments impracticable. Overheads are managed at Group level. MOM refers revenue less raw material, ingredients and packaging costs.
Dairy Fluids’ external revenue, excluding raw milk sales, increased by 4,5% on volume growth of 2,6%. The MOM % weakened from 41,5% to 39,6%. Selling price increases were insufficient to recover the increase in raw material costs, and in particular the increase in raw milk prices during the second half of the year, to maintain the MOM%. A higher than normal national autumn and early winter milk supply constrained attempts to increase selling prices further, which would have risked volume losses. MOM, as a result, decreased to R1 225,3 million or 0,2%.
The Concentrated Dairy Products segment consists of cheese, butter, condensed milk and retail powders. Volumes increased by 0,1% and external revenue by 10,7%. The volume of the bulk commodity product component further reduced by 19,5% in line with the Group’s strategy. The branded component volume, however, increased by 15,6%. The improved mix and the higher selling prices increased the MOM% to 29,5% from 24,3%. MOM increased to R300,8 million or 34,2%.
International dairy ingredient prices weakened substantially during the second half of the year, affecting the volumes of milk powder sales due to the availability of cheaper imported product. Ingredient volumes consequently decreased by 13,1%, albeit from an already low base in line with the Group’s strategy. A much higher butter component, however, caused revenue to increase by 29,0% and the MOM% to only reduce slightly from 21,5% to 19,6%. MOM increased by 17,5% to R83,9 million.
The Beverages segment performed very well, with sales volumes increasing by 8,6% and revenue by 21,0%. The MOM% increased to 51,7% from 51,0% and MOM by 22,7% to R805,6 million. This resulted from the higher selling prices and tight control over raw material costs.
Jacques Botha
Chief Financial Officer
