Chief FINANCIAL OFFICER’S report

Financial highlights

Distribution of shareholders	2014/15  R’000  unless  otherwise  stated	2013/14  R’000  unless otherwise  stated	%  change
Revenue	9 266 251	8 530 237	8,6
EBITDA	686 659	414 464	65,7
EBITDA (%)	7,4	4,9	2,5
EBIT	509 072	282 276	80,3
EBIT (%)	5,5	3,3	2,2
Headline EBITDA	647 709	410 765	57,7
Headline EBITDA (%)	7,0	4,8	2,2
Headline EBIT	470 122	278 577	68,8
Headline EBIT (%)	5,1	3,3	1,8
Normalised EBITDA	656 181	414 886	58,2
Normalised EBITDA (%)	7,1	4,9	2,2
Normalised EBIT	478 594	282 698	69,3
Normalised EBIT (%)	5,2	3,3	1,9
Net finance cost	(74 064)	(57 809)	28,1
Effective tax rate (%)	22,5	20,9	1,6
Headline earnings	319 343	187 464	70,3
HEPS (cents)	173,6	102,7	69,0
Diluted HEPS (cents)	165,9	97,8	69,6
Normalised earnings	325 443	188 276	72,9
Normalised EPS (cents)	176,9	103,2	71,4
Capital expenditure	489 753	387 999	26,2
Return on equity (%)	14,5	8,6	5,9
Cash generated from operations	160 261	403 067	(60,2)
Dividends per share (cents) – Interim	22,6	16,0	40,6
Dividends per share (cents) – Final	33,4	16,0	108,8

Jacques Botha

We believe the financial statements present fairly, in all material respects the financial position, financial performance and cash flows of the Group and Company in accordance with International Financial Reporting Standards, and are free of material misstatements. The significant accounting policies adopted in the preparation of the financial statements are appropriately described in the financial statements section of this Integrated Report. As members of management of the Group and Company, we believe that the Group and Company has a system of internal controls adequate to enable the preparation of accurate financial statements in accordance with International Financial Reporting Standards and in the manner required by the Companies Act.

OVERVIEW

High cost inflation forced the Group to increase selling prices considerably at the end of the previous financial year. As a result sales volumes and market shares declined in most product categories with the exception of UHT milk, butter and feta cheese. However, sales volumes from the new yoghurt and custard categories assisted in achieving overall sales volume growth of 2,8% (when expressing sales volumes of dairy concentrated products in raw milk equivalent rather than in kilograms, overall sales volumes declined by 0,7%).

Low inventory levels at the start of the year, following the raw milk shortage experienced during the winter of 2014, severely constrained Clover’s ability to supply the market in cheese and UHT milk. This further contributed to volume and market share losses in cheese and hindered the strong volume growth achieved in UHT sales during the year.

The continuing weak volume performance in the beverages segment reflects the reduction in consumers’ discretionary spend evidenced by overall market contraction in the fruit juices category.

On average, the rand strengthened slightly against the euro when compared to the prior year which helped to limit the increase in carton packaging material. The rand, however, weakened considerably against the dollar which was fortunately more than offset by the much lower international oil prices which also indirectly limited the increase in plastic packaging material. In addition the Group benefitted from lower fuel prices.

Farm gate milk prices remained high in relation to on-farm costs throughout the year. This was mainly as a result of the national shortage of raw milk during the last quarter of the previous financial year and volatility in the raw milk market in anticipation of and following Clover’s cessation of raw milk supply to Danone on 31 December 2014. These relatively high farm gate milk prices have resulted in a sharp increase in national milk production during the year. Milk production for May 2015 was approximately 10% more than during May 2014. Clover warned at the release of its interim results during March that the strong growth in national raw milk supply may lead to lower dairy product market prices during the spring and summer of 2015. This has started to materialise even before the 2015 peak production season and in response, Clover has reduced its farm gate milk prices with effect from 1 August 2015 by 12% on average.

Economic viability

In order to remain economically viable, Clover needs to continuously evolve its business, partnerships and products. During the year, Clover continued with its strategy of investing in and concentrating on branded and value-added products. International research shows that traditional dairy companies have operating margins between 3% to 5% compared to their counterparts who place a strong focus on value added products and generally obtain operating margins well above 5%.

In its quest to grow its range of branded and value-added products, the Group frequently identifies and assesses potential mergers and acquisitions or joint venture opportunities with the view of unlocking possible supply chain synergies. These considerations are done in parallel with maintaining Clover’s traditional dairy business. The Group only considers opportunities that will sustainably enhance margin and shareholder return.

Comprehensive income

Headline earnings

Headline earnings increased by 70,3% or R131,9 million to R319,3 million. This increase in headline earnings constitutes:

• headline operating profit, which increased by 68,8% or R191,5 million;
• net finance costs which increased by 28,1% or R16,3 million;
• headline income tax which increased by 79,3% or R40,8 million. The effective tax rate based on headline profit before tax and headline tax increased by 1,4% to 22,7% which is still well below the 28% companies tax rate as explained under “Profit for the year” below;
• share of profit of a joint venture which decreased by 23,5% or R3,4 million; and
• non-controlling interests which decreased by 302,2% or R7,0 million.

Headline earnings per share increased by 69,0% (70,9 cents) or 1,3% less than headline earnings as a result of equity settled share appreciation rights during the year.

Profit attributable to shareholders of Clover Industries Limited grew by R31,8 million more than the growth in headline earnings mainly due to profits of a capital nature of R31,0 million, after tax, which are excluded from headline earnings.

Revenue

Revenue improved by 8,6% or R736,0 million to R9 266,3 million. The cessation of raw milk supply to Danone Southern Africa (at cost with no contribution to profit) at 31 December 2014, however, masks the real revenue growth of 13,7% when excluded. Raw milk sales declined by 70,1% to R152,8 million as the supply of raw milk to Danone was systematically phased out and ceased on 31 December 2014.

Sale of products increased by 15,0% to R8 272,1 million on an overall volume increase of 2,8%. Overall average price inflation and mix changes, mostly due to the new higher value yoghurt and custard sales, accounted for 12,2% of this revenue growth.

Services rendered to principals contributed R838,1 million to revenue which was 2% higher than the previous year. Notwithstanding annual tariff increases and additional contract manufacturing income from the Group’s Bethlehem creamer factory, the phasing out of the services rendered to Danone Southern Africa during the second half of the year caused the low growth in this revenue. Most services to Danone were completely phased out by the year end.

Cost of sales

Cost of sales increased by 3% or R191,0 million. Similar to revenue the cessation of raw milk supply to Danone Southern Africa at 31 December 2014, however, skews the real growth in cost of sales of 9,5% when excluded.

The aggressive selling price increases necessitated increased cooperative advertising and hence charges against sales increased by R28,3 million or 18,8%.

The cost of raw materials and finished goods acquired for resale increased by 0,8%. However, if the raw milk sales to Danone are excluded, these costs increased by approximately 13,2% mainly as a result of the full year effect of the 15% milk price increases during the third quarter of the previous financial year and a further 6% on average farm gate milk price increase in the third quarter of the year under review. Average raw milk prices were 12,4% higher than during the previous year.

During the third quarter of the prior financial year local plastic prices rose by 14% followed by a further 4,8% increase during the first quarter of the 2014/15 financial year. A portion of plastic packaging prices are directly linked to oil prices and the collapse in the international oil price at the end of 2014 led to a 14% reduction in the plastic component of local high density polyethylene prices during the third quarter of 2014/15. Unfortunately this relief was again undone by a 14,7% strengthening of the oil price during May and June 2015 followed by a matching increase in plastic costs. A portion of the cost of most of the Group’s carton packaging is linked to the rand/euro exchange rate. The rand weakened in excess of 19% from July 2013 to February 2014 of which 12,5% occurred during the period December to February 2014. Carton packaging costs for the 2014/15 year reached very high levels early on before the rand recovered gradually until April 2015, with accompanying gradual carton packaging cost reductions, followed by a further decline towards year end. As a result packaging costs for the year increased by 11,6% on volume growth of 2,8%.

Lower fuel prices and the cessation of raw milk supply to Danone drove the 11,4% reduction in milk collection costs despite annual inflationary cost increases.

Manufacturing costs increased by 10,4% when compared to the prior year. The newly acquired ex Dairybelle yoghurt, ex Dairybelle UHT and ex Nkunzi MilkyWay factories together with the further costs to service the additional creamer contract manufacturing, mostly accounted for this above inflation increase. The year however started with very low inventory levels following the raw milk shortage experienced during the autumn and early winter of 2014 and as a result, factory throughput during the year was significantly higher than usual in order to restore inventory levels. Due to the predominantly fixed nature of manufacturing costs and the excess capacity available, unit manufacturing costs reduced markedly. This cost reduction was further augmented by savings achieved from the consolidation of the Group’s Parow and Stikland factories.

Primary distribution costs benefitted from the lower fuel prices during the year, the move of the Group’s Mayfair factory to Clayville during the previous year and the consolidation of the Stikland and Parow factories, resulting in an 8,3% reduction in primary distribution costs.

Gross profit

Cost of sales increased by only 3% or R191,0 million in contrast to the 8,6% or R736,0 million growth in revenue. This resulted in the gross profit percentage increasing from 26,2% to 30,0% and gross profit increasing by 24,3% or R545,1 million. When excluding the effect of raw milk sales revenue increased by 13,7% compared to a 9,5% increase in cost of sales with a resulting increase in the gross margin from 27,9% to 30,5%.

Other operating income

Other operating income of R58,0 million mainly constitutes:

• profit on the sale of PPE and scrap – R44,9 million; and
• R9,8 million of foreign exchange gains.

Selling and distribution costs

Selling and Distribution costs increased by 12,8%. The above inflation increase is mainly attributable to the Group’s entry into the yoghurt and custard categories in both selling and distribution costs as well as the conversion of labour broker staff to permanent staff as required by the amended Labour Relations Act.

The Group in total spent 31,8% or R64,6 million more on advertising, marketing, research and development costs during the year.

Administrative expenses

Contrary to the previous financial year, the Group achieved and exceeded its profit targets set by the board and accordingly a provision was raised for profit based short-term incentives to staff. This provision of R66,9 million makes up 33,1% of the 58% increase in administrative expenses.

In addition, uninsured damages at two factories of R8,5 million, the reversal of R5,5 million of previously straight-lined lease costs on the cancellation of a lease during the prior financial year and R14,8 million additional spend on training and conferences further contributed to the above inflation increase in administration costs.

Restructuring expenses

During the year, R8,2 million was spent on retrenchment costs which is classified as restructuring expenses.

Operating profit

Operating profit increased by 80,3% to R509,1 million. Excluding capital profits, headline operating profit grew by 68,8% to R470,1 million. However, the Group’s restructuring costs decreased by R7,6 million and after taking this into account, normalised operating profit increased by 69,3% to R478,6 million.

The operating margin improved to 5,5% from 3,3%. The normalised operating margin (normalised operating profit as a percentage of revenue excluding raw milk sales) similarly increased from 3,3% to 5,2%.

Profit for the year

Profit for the year ended 82,9% or R156,7 million higher at R345,7 million after the R226,8 million increase in operating profit, a R16,3 million increase in net finance charges, a R50,5 million increase in the income tax expense and a R3,3 million reduction in the share of profits from the Clover Fonterra Ingredients joint venture.

An increased investment in working capital and capital expenditure largely contributed to a R378,3 million increase in interest bearing debt which caused the increase in net finance charges.

The effective tax rate came to 22,5% which is well below the 28% normal corporate tax rate. The effective tax rate was reduced by 3,0% through the recognition of deferred tax assets relating to historical tax losses in subsidiaries not previously allowed and by a further 1,2% after tax deductions claimed on the equity settled share appreciation rights. Further the disclosure of the Group’s share of CFI’s net after tax income, above the profit before tax line, contributed a 0,7% reduction in the effective tax rate. In addition, prior year tax adjustments accounted for a further 0,5% reduction in the effective tax rate.

Return on equity

Together with the increased profitability the Group’s return on equity improved from 8,6% to 14,5%.

Dividends

The Company declared and paid an interim dividend of 22,6 cents per share during April 2015. A final dividend of 33,4 cents was declared by the board, which will bring the final dividend for the current financial year to 56,0 cents.

The board previously stated that it will during the medium term progressively reduce the dividend cover to lower levels. The total dividends for 2014/15 represent a dividend cover of 3,1 times compared to the 2012/13 dividend cover of 3,75 times. The dividend cover for 2013/14 was 3,2 times but for that year the dividends were maintained at the 2012/13 level in line with the board’s policy to as a minimum maintain dividends in the event that HEPS are less than the previous year.

Financial position

Non-current assets

Clover’s Finance Department oversees and prioritises profitable projects targeted to increase operating margins and returns to shareholders, which would be funded while maintaining an optimal debt to equity ratio.

Capital expenditure on tangible assets was R468,1 million which net of the depreciation charge accounted for a R335,3 million increase in property, plant and equipment from June 2014.

Major Capital projects during the year were:

	R’m
Clayville chilled warehouse expansion	114,4
Tropika 125ml/200ml UHT Prisma line	38,4
Queensburgh plastic UHT capacity expansion	32,7
Port Elizabeth fire protection	11,6
Port Elizabeth auto palletising	10,1
Bloemfontein yoghurt production facility upgrade	8,5
Clayville Futurelife product capacity	5,2
Parow/Stikland consolidation	4,4
Ixopo milk procurement depot expansion	2,8
Nestea relaunch	2,3
Manhattan Ice Tea relocation to Inhle	1,7
Electrical Power Emergency Supply	1,0

Clover has aligned itself with Government initiatives to increase manufacturing capacity and local business competitiveness and to reduce the consumption of natural resources, especially energy and water. In order to achieve this, the Group makes use of current Government grants such as the Department of Trade and Industry’s Manufacturing Competitive Enhancement Program (MCEP). During the year the Group received R38,1 million in government grants of which R1,6 million was recognised as income through the income statement and the rest applied to reduce the cost of the assets purchased. These grants received are dealt with in terms of section 12P of the Income Tax Act.

Current assets

The raw milk shortage experienced during the last quarter of the previous financial year depleted UHT and cheese stocks to a large extent at 30 June 2014. During this year raw milk became available from the phasing out of milk supply to Danone which enabled the Group to restore its inventory levels with a resulting significant increase in inventory. The Group’s new yoghurt, custard, ex Dairybelle UHT milk and ex Nkunzi MilkyWay products further contributed to the increase in inventory. In addition the Group built up some excess milk powder stock which will be utilised in the manufacturing of its products during the 2015/16 financial year. Together with the 6% farm gate milk price increases during the year, inventory increased by R372,3 million.

Trade and other receivables were 18,8% higher than at June 2014 resulting from:

• the 12% effective price increase resulting from selling price increases and mix changes mostly caused by the introduction of the higher values custard and yoghurt products;
• the additional VAT included in accounts receivable caused by the introduction of the vatable custard and yoghurt products; and
• a temporary increase of the debtor days outstanding after the implementation of a new ERP system during the year.

Trade receivable days outstanding and bad debts remained at very low levels when compared to the combined sales of Clover and those principals for which it provides credit management services. (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).

Equity

The share premium account increased by R103,9 million from the prior financial year after the settlement of vested share appreciation rights in terms of Clover’s SAR Scheme through the issue of new ordinary shares.

Non-current liabilities

An increased investment in working capital and capital expenditure largely contributed to a R378,3 million increase in interest bearing debt.

Other than the aforesaid, non-current liabilities ended largely at the same levels as the previous year with the exception of the deferred tax liability that increased by R9,2 million resulting from accelerated wear and tear allowances.

Current liabilities

Raw milk prices during June 2015 were 12,4% higher than in June 2014 and together with the new yoghurt, custard and desserts (launched during June 2015) activities accounted for the R159,7 million or 13,4% increase in trade and other payables.

Gearing

Group gearing increased from 38,6% to 48,6% at 30 June 2015. The increased investment in working capital was brought about mostly from the restored stock levels and the working capital requirements of the new yoghurt, custard, dessert and Clover MilkyWay businesses. The Group’s gearing is well within its ability to service interest and repayments and it has further capacity to extend its gearing to fund future growth.

Cash flow

The net current assets ratio weakened from 1,6 to 1,4. Excluding inventory, the position weakened from 1,22 to 0,9. The funding of the Dairybelle yoghurt and UHT businesses and the Nkunzi MilkyWay business from operating cash flows were largely responsible for this reduction.

Cash generated from operations, before working capital changes, was R566,7 million compared to R338,4 million reported in the prior year. The higher cash generation followed mostly from the higher profit for the year. However, during the year under review, working capital absorbed R406,6 million of cash compared to a cash release of R64,7 million in the prior year. The restoration of the inventory levels, to a large extent depleted at the end of the previous year due to a milk shortage at the time (which greatly improved cash flow for that year), was the main cause of the difference in working capital changes between the current and prior years.

Investment activities consumed R556,8 million in cash compared to R351,7 million in the previous year after the acquisitions of the Dairybelle yoghurt and UHT businesses and the Nkunzi MilkyWay business.

R154,7 million was paid for finance costs and dividends (2013/14: R134,4 million). R378,3 million of additional debt was utilised at the end of the year when compared to the previous year to fund the shortfall in cash generated after investing activities, finance costs and dividends.

The Group reported a net decrease in its cash position for the year of R178,5 million as a result.

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 impractical. Overheads are managed at Group level. MOM refers to revenue less raw material, ingredients and packaging costs. The entry into the yoghurt, custard and desserts categories necessitated the introduction of a new product group being the fermented products and desserts group. This product group contains the yoghurt, custard, maas (previously included under dairy fluids) and dessert products.

Dairy Fluids

The dairy fluids segment is now made up of fresh milk, UHT milk, steri milk, ultra-pasteurised milk and cream but no longer includes maas which is now reported under fermented products and desserts.

Dairy fluids volumes grew by 2,4% for the period. The South African market for drinking milk during this year saw a reverse of the trend of the last number of years with fresh and ultra-pasteurised milk’s 3,9% growth exceeding the 2,3% growth of UHT milk. Clover’s UHT volumes increased by 11,1% whilst fresh and ultra-pasteurised milk volumes declined by 6,5%.

Included in the dairy fluids segment is the sale of raw milk to Danone at cost. Therefore, it has no MOM impact and should be excluded from any analysis of this segment’s performance. Excluding this revenue, the MOM margin improved by 1,8% to 39,5%, mainly as a result of price increases exceeding cost increases. MOM for fluids increased by 22,3% to R1 738,3 million. Price inflation was 14,4% on average while the cost of materials and packaging increased by 10,8% net of the volume effect following the higher (12,4%) average raw milk prices for the year.

Concentrated products

The concentrated dairy products group consists of cheese, butter, condensed milk and retail powders.

Clover’s concentrated dairy product volumes reduced by 1,9% following from:

• significant competition in the market as traditional bulk cheese (Clover exited this category during 2009) volumes are being replaced by price competitive 800 or 900 gram bulk pre-packed cheeses;
• imports on the back of very low international prices;
• the delisting of certain pre-packed cheese stock keeping units by a retailer early during the year;
• gouda capacity constraints;
• low inventory levels at the start of the year as a result of Clover’s milk shortage during the winter of 2014;
• Clover’s average price increases of 13,5%; and
• a 60,1% further decrease in bulk cheese volumes after a strategic exit from the diced/grated cheddar market early during the year.

Feta cheese and processed cheese slices volumes increased by 12,1% and 9,1% respectively but prepacked natural cheese volumes reduced by 21,3%. Butter volumes were up by 10,9% while condensed milk volumes were down by 14,4%.

Revenue for this product group grew by 11,6% based on average price inflation of 13,5%. The price of packaging and raw materials increased 6,1% or 8,0% net of the volume effect. MOM as a result increased by 26,1% and the MOM margin gained 3,7% to end the year on 32,0%.

Ingredients

Although Clover is not an active participant in the international dairy ingredients market, it still produces (as part of seasonal milk balancing and cheese production) and normally sells excess skimmed milk and whey powder into the local ingredients market every year.

Very low international dairy commodity prices forced Clover to rather hold back on its skimmed milk powder stock for use in its own products during 2015/16 and consequently sales volumes shrunk by 4,3%. On average prices increased by 7,7% mostly due to creamer price increases. Material and packaging costs were slightly lower net of the volume effect and mostly due to the lower cost whey powder’s bigger contribution to total sales volumes. Revenue increased by 3,5%, MOM grew by 28,5% and the MOM% increased by 6,3% to 32,2%.

Non-alcoholic beverages

The Group’s sales of fruit juices, dairy fruit mixes, flavoured milk, water and ice tea are recorded in this segment.

Beverage volumes decreased by 1,7% on the back of a continued overall market contraction in the fruit juice market of 9,5%. Dairy fruit mix and fruit juice volumes declined by 1,3% and 6,6% respectively when compared to the previous year. Water, ice tea and flavoured milk volumes were flat on the previous year.

Prices were 8,7% up on the previous year resulting in revenue increasing by 7,0% and the MOM% improving by 2,8% to 53,2%.

Fermented products and desserts

This product group houses the Group’s yoghurt, maas, custard and other desserts products. All these products were launched since January 2015 with the exception of maas that was previously included in dairy fluids.

The comparative figures for 2013/14 were restated to reflect maas in this product group.

Volumes grew by 123,5% on the previous year that contained only maas. Maas volumes increased by 6,9%.

Overall product group revenue was up 188,0% following the introduction of higher value yoghurt, custard and desserts and the MOM% improved from 19,0% to 25,3% for the same reason.

Conclusion

At the time of writing, the Rand exchange rate continued to weaken against major international currencies on the back of a slowdown in the Chinese economy that has led to fears of lower growth in most emerging markets. From a South African dairy perspective, although a weak Rand buffers the industry from imports, it significantly impacts on on-farm and secondary industry input costs.

Consumers remain under pressure and discretionary spend will further be affected by rising inflation and resultant interest rate increases.

Jacques Botha
Chief Financial Officer

15 September 2015