CHAIRMAN'S REPORT
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Werner Büchner |
On behalf of Clover’s Board, it gives me great pleasure to present the 2015 Integrated Annual Report. In accordance with the International Integrated Reporting Council (IIRC) framework, Clover is already in its second year of adoption of the six capitals for the purpose of Integrated Reporting. As a board we acknowledge our responsibility to ensure the integrity of the Integrated Report. These capitals provide insight into Clover’s strategy and our ability to create value over the short, medium and long term. We value the nature and quality of the relationships with our key stakeholders, and in order to create value over time, we take into account their legitimate needs and interest.
The concept of value therefore focuses on Clover’s ability to respond to relevant matters from the Board as well as the key stakeholders.
The Board appreciates that these capitals are interlinked and therefore continuously seeks a balance between short-term earnings with long-term growth aspirations, specifically for the providers of financial capital. We have included information about matters that substantively affect Clover’s ability to create value, in the context of the six capitals throughout this Integrated Report.
OPERATIONAL OVERVIEW
As discussed in my previous report, Clover had
to increase its selling prices to recover significant
escalation in especially raw milk and other cost, as well
as traditional inflationary increases in costs. The Board
decided that it was prudent to apply a pragmatic
approach to selling price increases in order to limit
market share and volume losses.
The year under review saw Clover being successful in implementing these selling price adjustments. The resulting increase in prices and profitability nonetheless resulted in volume and market share losses in some product categories as anticipated. Volume losses to some extent was offset by the exceptional sales of Clover’s range of yoghurts and custard following our entry into the market during January 2015, after the expiry of the restraint of trade on 31 December 2014 with Danone and the acquisition of the Dairybelle yoghurt and UHT businesses. Current yoghurt production capacity is being expanded to meet the unanticipated market demand.
Given Clover’s strong brands and price elasticity, finding an optimal balance between volumes, market shares and price points are ongoing. Consumers remain under pressure, as evidenced by the overall market contraction in the Group’s beverage categories. A more detailed discussion on this can be found in the Chief Executive’s Report.
As a result of exceptional competition for raw milk for cheese manufacturing in the Eastern Cape, as well as Danone’s entrance into the market for raw milk (after their milk supply agreement with Clover lapsed at the end of December 2014), farm gate milk prices saw above inflationary increases during the last quarter of the previous year. These high prices in relation to on-farm costs saw substantial increases in raw milk production in comparison to the previous year. On the positive side, Clover has managed to restore its inventory levels, but the growth in national milk production is still far above the growth in the demand.
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Manufactured Capital: Dairy Industry Overview |
Global overview |
The impact of fluctuating weather conditions
has been evident throughout agricultural markets over
the past decade. Particularly in the dairy industry, it has
been a key driver of market volatility, due to its impact
on both the cost of feed and productivity of the global
dairy herd.
Unlike most agricultural commodities, only about 8% of dairy production is traded in the global market. Dairy markets are often characterised by seasonal and cyclical patterns, as price and production peaks induce a supply response that often creates market price volatility. The steepness of these cycles in recent years reflect dramatic changes in weather conditions, at times combined with macroeconomic instability that created supply and demand dynamics that induced drastic shifts in dairy markets.
International dairy commodities traded at record high levels during the start of 2014, while feed grain prices traded at low price levels for most of the past twelve months. This created the platform for favourable supply conditions, but this also coincided with reduced demand as the Russian ban on dairy products from the European Union (“EU”) was introduced, and demand from China stagnated. The result of these factors is that by June 2015, the Food and Agricultural Organisation (“FOA”) dairy price index had fallen to levels not observed since 2002. Powder prices in particular have fallen sharply on the back of booming production levels.
The effect which the abolishment of the EU system of milk quotas will have on global supply is still uncertain although the OECD-FAO outlook projects a smooth transition. It might, however impact on the dairy industry in South Africa sooner than we think, as quite a number of big players have identified Sub-Saharan Africa as a future market and are already opening offices in South Africa and the rest of Africa.
Local overview
As in the global market, seasonality and production cycles are mirrored in the South African dairy sector. In line with global trends and the perishable nature of the products concerned, trade continues to represent a very small share of fresh dairy consumption domestically, resulting in a tight balance of supply and demand and consequently a volatile domestic market.
South African milk production is utilised in two different market segments; liquid milk products (including pasteurised milk, UHT milk, yoghurt and buttermilk) account for just under 60% of total dairy consumption, while concentrated products (including cheese, butter, milk powders and condensed milk) make up the balance.
The volatility evident in the market for fresh products is significantly reduced in concentrated products, mainly due to the nature of these products, which allows a greater role for international trade in correcting domestic supply and demand imbalances.
Following a steady decline from 2008 to 2011, farm gate milk prices turned sharply upwards in 2012 in response to elevated feed prices that coincided with unfavourable weather conditions and firm demand for dairy products. While these elevated price levels induced the expected supply response, demand remained firm and consequently nominal prices have also been on an upward trend since 2011. Despite the decline in international prices of dairy products, South African prices have remained firm as a result of significant exchange rate depreciation and by March 2015 the producer price of raw milk, in nominal terms, had reached record levels.
Despite the volatility in the market, South African milk production has reflected an upward trend, expanding in response to rising demand over the past decade. By 2014, raw milk production in South Africa approached 3 million tons, and in the early part of 2015, milk deliveries reached unprecedented high levels in response to the recovery in milk to feed price ratios in 2014.
Considering seasonality typically evident in milk production, 2015 looks set to be a year of record production in excess of 3 million tons.
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FINANCIAL CAPITAL |
Overview |
As a result of increased selling prices across
market categories the gross and operating margins
improved considerably. This resulted in a headline
earnings per share (“HEPS”) increase of 69,0% to 173,6
cents (2014: 102,7 cents). Earnings per share (“EPS”)
commensurately increased by 86,1% to 190,4 cents
(2014: 102,3 cents). The improvement in HEPS and EPS
was further supported by the recognition of deferred tax
assets in group subsidiaries which were not previously
recognised. This contributed 5,8% towards the increase
in HEPS and EPS over the prior year.
As mentioned, gross and operating margins improved considerably to 30% (2014: 26,2%) and 5,5% (2014: 3,3%) respectively.
Foreign Shareholding
During the year under review, Clover continued with its Level I Sponsored ADR programme through the Bank of New York Mellon. This programme provides for the active promotion of Clover’s investment case in the USA at no additional cost to the Company.
Since listing, the Group has noticed a steady increase in foreign based institutional holdings, especially from the USA and Canada. Currently foreign fund managers constitute just under 25% of total fund manager holdings, with US based fund managers holding 13,3% and Canadian fund managers holding 5,6% respectively.
Secondary listing on the Namibian Stock Exchange (NSX)
On 22 April 2015, Clover successfully listed on the NSX under the share code CLN. The Company’s primary listing remains on the main board of the Johannesburg Stock Exchange.
The Board believes that the NSX listing will broaden Clover’s investor base by enabling Namibian investors to invest directly in Clover’s shares. The listing will further assist in building relationships with Namibian stakeholders, especially considering the Group’s long-term strategic plans which include further expansion into Africa.
Dividend
The Board targets a dividend cover over the medium term based on headline earnings per share, which is more comparable to the sector within which the Group operates. A progressive dividend policy will be generally applied whereby dividends are maintained or grown at least by the same percentage as the growth in headline earnings per share, until such time as a comparable dividend cover is achieved.
In line with this policy, the Board declared a final dividend of 33,4 cents per share, bringing the total dividend for the financial year under review to 56,0 cents per share, an increase of 75% on the previous financial year total dividend of 32 cents per share.
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INTELLECTUAL CAPITAL |
In January 2015, Clover launched its traditional
brand of yoghurt as a premium product under
“The Classic” brand. This yoghurt is richer and creamier
than ordinary yoghurt and has been exceptionally well
received by the market.
Following the acquisition of DairyBelle’s yoghurt business during the year under review (effective 1 January 2015), Clover has revitalised the “Fruits of the Forest” brand and expanded its market reach, with excellent uptake by the market.
In addition, Clover also re-entered the custard market also under “The Classic” brand, after selling its Ultra-Mel brand to Danone in 2007.
Clover’s acquisition of the DairyBelle brand included the Bliss range of double cream yoghurt. Dessert ranges were one of the value added growth categories identified by Clover as part of its diversification strategy. A range of Bliss desserts, currently manufactured in Italy was launched late during the year under review, with encouraging uptake.
On 23 April 2015 the Competition Commission approved Clover’s acquisition of the business of Nkunzi MilkyWay Proprietary Limited (“Nkunzi”). The acquisition saw Clover entering the Ayrshire milk market, where it will manufacture and pack fresh milk, cream and other dairy and non-dairy products for Woolworths at the acquired Nkunzi facility as well as its Clayville plant in Midrand, Gauteng.
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HUMAN CAPITAL |
Over the past number of years, Clover has
actively worked on improving its Broad-
Based Black Economic Empowerment
(B-BBEE) status. I
am therefore excited to report that significant headway
has been made in this regard. During the year under
review, Clover achieved a Level 4 Contributor Status for
the 2014 financial year – a noteworthy step up from the
prior year’s Level 6 contributor status.
The Group's focus regarding empowerment is to target the broadest possible base, and therefore the areas where Clover reported the most improvement include Skills Development, Preferential Procurement and Enterprise Development.
Going forward, Clover may benefit from its Level 4 Contributor Status by becoming eligible for incentives such as the Manufacturing Competitiveness Enhancement Programme (MCEP) administered by the Department of Trade and Industry (DTI).
These requirements, amongst other, lie at the heart of Clover’s strategy and the Company believes that these incentive opportunities will assist it in increasing its competitive advantage to the benefit of customers and other stakeholders.
During the review period, Clover successfully concluded wage negotiations at a 7,25% annual increase.
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NATURAL CAPITAL |
Growing demand for natural resources
will force fast moving consumer goods
companies to process products more efficiently
through lowering its carbon and water footprint. Clover
has implemented a number of initiatives to reduce its
water, electricity and fuel consumption in addition to
minimising waste.
I am proud to announce that we are making good progress, and in most cases we are nearing international best practice in relation to utilising natural resources. More information on these initiatives and improvements in this regard can be found here in this Integrated Annual Report.
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SOCIAL AND RELATIONSHIP CAPITAL |
The Competition Commission initially
expressed concern over the impact of the Nkunzi
acquisition on small farmers and employment when
it was first announced. I am very happy that through
continued engagement we could address these issues
satisfactorily and establish a win-win environment.
In terms of the approval, Clover undertook not to retrench any employee as a result of the acquisition. In addition, Clover will invest in production capacity and facility upgrades, which will in part be driven by Woolworths’ 2020 growth strategy.
Clover has also taken over Nkunzi’s supply agreements with producers on the same terms and conditions, or renegotiated supply agreements on an individual basis with producers.
The Group understands its responsibility to its customers and the communities in which it operates. More information on Clover's corporate citizenship and interaction with communities at large – including the acclaimed Mama Afrika initiative – is available here in this Integrated Annual Report, as well as on the website, www.clover.co.za.
GOVERNANCE
Clover’s approach to governance is discussed in the Report on Governance, Risk and Compliance here in this Integrated Annual Report.
In line with the six capitals, and in particular Relationship Capital, Clover's interactions with stakeholders are outlined in the Report on Governance, Risk and Compliance on here of this report. More information on Clover's shareholders is also available here in the Overview section of this document.
Clover’s board composition takes into account its strategic objectives against the identified six capitals and as such offers sound independent counsel, extensive in-depth industry knowledge and experience including the aptitude to drive the Company’s transformation objectives.
OUTLOOK
As reported during the half-year results, milk flow in South Africa has been much higher on a month-on-month basis than in comparative prior year periods. According to statistics published by the Milk Producers Organisation, milk production in South Africa during the first six months of 2015 was 10,6% higher than during the same period last year. This oversupply of raw milk negatively impacts local market prices, which are further exacerbated by current very low international dairy commodity prices.
Although Clover’s unique milk procurement system (CUMPS) maintains a balance between its milk intake and sales, the Group will be exposed to downwards pressure on overall market prices.
All services supplied to Danone Southern Africa were phased out during 2014/15 which will lead to a revenue reduction during 2015/16, as well as, available capacity in Clover’s supply chain. The group intends to replace this revenue and utilise the available capacity over time with revenue from its own product sales, selective new principals and acquisitive growth. In addition certain cost savings will mitigate the effect on profit to some extent.
With effect from 1 June 2015 Clover commenced with providing sales, distribution, merchandising and credit control services to Dairybelle (Pty) Ltd which will further lessen the impact of the loss of revenue from Danone.
THE FUTURE: VALUE CREATIONShort-term
The Group’s immediate strategy will continue to focus on the revision and revitalisation of its marketing strategy by growing its brands and overall brand basket including maintaining existing market shares as far as possible.
New products will either be developed by Clover’s inhouse Product Innovation and Technology Department or in co-ordination with joint venture-like partnerships.
Medium to long-termAs part of Clover’s growth strategy the Company continuously monitors potential mergers and acquisitions and joint venture opportunities with the view to unlock potential synergies in its supply chain, provided that it meets internal hurdle rates.
The extent to which the Agri Sector codes will be amended in accordance with the new amended BEE Codes released in October 2013 remains uncertain. The Group however continues to evaluate a number of government incentives available in Agro processing to benefit milk producers whilst supporting black farmer development.
APPRECIATIONI would like to thank my fellow Board members for their support during the year and commend Johann Vorster, his executive management team and all the Clover staff for their continued diligence and hard work that culminated in solid results for the year.
Werner Büchner
Chairman of the Board
15 September 2015