CHAIRMAN’S REPORT
The 2018 financial year was pivotal for Clover as it rebounded from a disappointing prior period to deliver an excellent performance by facing challenges head on and mitigating those within its control.
A rigorous series of efficiency improvement initiatives were implemented in the latter part of the 2017 financial year to re-align the business to the new ‘normal’ described previously. These initiatives include, but are not limited to, the unbundling of the volume- driven side of the business through the establishment of Dairy Farmers South Africa (“DFSA”), the launch of Project Sencillo (asset optimisation program), the ongoing roll-out of Project Masakhane, new product launches, and product reformulations to lower ingredients and sugar costs.
MACRO-ECONOMIC BACKDROP
Global economic growth prospects strengthened during the first half of our financial period with a notable recovery in global trade mainly underpinned by a rebound in commodity exports, investment in developed economies and upbeat growth prospects in several emerging markets. The global operating environment was stable up to a point where we started to see an uptick in oil prices, a critical component and cost in doing business. The global environment gradually deteriorated during the second half of our financial year as protectionist and counter protectionism policies worsened trade relations and resulted in trade imbalances.
After a stagnation in Gross Domestic Product (GDP) growth, South Africa experienced an upturn in the second half of 2017 and while expectations were for this to continue in the short-term, the market was dealt a blow when it was announced that GDP contracted by 2.2% in the first quarter of 2018.
Political uncertainty was rife during the second half of 2017 with the private sector hoarding their resources as corruption and state capture allegations eroded business confidence. The appointment of Mr Cyril Ramaphosa as president in February 2018 with promises of the rooting out of corruption, stabilisation of state owned enterprises and an over R1.2 trillion investment drive brought much needed optimism to the country. This optimism was however overshadowed by poor economic growth, policy uncertainty (especially around an escalating drive to accelerate expropriation of land without compensation), high unemployment figures and increasing fuel and electricity costs. These factors weighed heavily on consumers and businesses alike, fuelling competitive trade activity. Added to this, the health promotion levy (sugar tax) and vat increase took effect from April 2018.
From a retail perspective, the quarter to December 2017 was marked by sales growth exceeding market expectations specifically due to the volume increase experienced in November 2017 which was driven by consumers taking advantage of Black Friday promotions. Retail sales in the first half of 2018 were however disappointing following increased pressures on consumers and disposable income. While Clover benefitted from the normalisation of weather conditions in terms of lower raw milk and fruit pulp costs, the cooler and rainy weather in some parts of the country during the first part of December impacted volumes.
For context on the global and domestic dairy industry, readers should refer to the Bureau for Food and Agricultural Policy’s baseline agricultural outlook for 2018 to 2027. It provides a good perspective and is available here.
STRATEGIC DIRECTION
A rigorous series of efficiency improvement initiatives were implemented in the latter part of the 2017 financial year to re-align the business to the new ‘normal’ described previously. These initiatives include, but are not limited to, the unbundling of the volume- driven side of the business through the establishment of Dairy Farmers South Africa (“DFSA”), the launch of Project Sencillo (asset optimisation program), the ongoing roll-out of Project Masakhane, new product launches, and product reformulations to lower ingredients and sugar costs. Clover’s strategic emphasis was centred around consumers, looking at ways to lessen the pressure they faced and to produce products that they value. Accordingly, the decision was taken to plough back savings achieved through the above-mentioned efficiency drives into Clover’s selling prices and to launch products that add value to consumers and for which they are willing to pay a premium.
The executive team diligently executed these strategic initiatives which started yielding encouraging results as evidenced in the positive performance.
Last year I unpacked the DFSA restructuring in detail and I provide an update below. The other strategic initiatives are discussed in detail in the CEO section here of this integrated report while detail on the financial performance can be found in the CFO report here.
DAIRY FARMERS OF SOUTH AFRICA (“DFSA”) RESTRUCTURING
Since listing, Clover has followed a strategy of diversifying away from bulk, commoditised food stuffs, to focus more on value-added, branded products. This year saw Clover moving closer to becoming a fully-fledged FMCG business following the exit and transfer of its non-value added dairy business to DFSA, a separate entity in which Clover retained a 26% strategic shareholding. As part of the agreement, Clover provides production, distribution, merchandising and other services to DFSA who became Clover’s largest principal.
This being a substantial transaction, and a change from the norm for the past 120 years, some teething problems were experienced. I appreciate the hard work by both Clover management and the board of DFSA in bedding down the restructure. The bulk of DFSA products are exposed to the cyclical nature of the dairy industry and as such, the underlying business performance of DFSA can only be evaluated over time once a full cycle has been completed.
Due to the current supply and demand cycle in the dairy industry, DFSA reported a loss during the review period as can be seen here in the financial section of this report. Clover’s exposure to this business lies in the significant principal fee income from DFSA, as well as the supply of working capital. Given the strategic nature of the relationship and the important inter dependencies, Clover has to provide ongoing support to DFSA in the form of subordinating a portion of the working capital revolving facility to DFSA in favour of other creditors until such time that the DFSA assets, fairly valued, exceeds its liabilities. On 11 September 2018, the board received unexpected notification that DFSA’s CEO has resigned with effect from 30 April 2019. I understand that the huge conflict between losing market share or losing milk producers during what has been a particularly challenging time for the dairy industry in general played, a large role in his decision.
Subsequently, DFSA’s chairman also tendered his resignation, providing the DFSA’s producer shareholders an opportunity to appoint their own, independent CEO and chairman. The DFSA board will begin the process to identify replacements and the current CEO will stay on to assist with identifying a suitable replacement and to ensure a seamless handover.
Based on this information, Clover’s board deemed it prudent to adopt a conservative approach and provide for the full impairment of the R439 million revolving credit facility it extended to DFSA as at year-end, although the accumulated loss at 30 June 2018 is only R133.2 million.
The impairment of the revolving credit facility will be assessed on a continuous basis, taking into consideration the lien that Clover holds over the DFSA inventory and debtors’ balances that is being controlled/managed by Clover as part of Clover’s services rendered agreement, as well as the DFSA board approved plans to manage the business through the cycle.
More detail on our decision in this regard is available in the report on governance, risk and compliance, directors’ report and note 13 to the annual financial statements.
Due to the fact that Clover sources all its raw milk requirements for its value-added products from DFSA and the fact that DFSA is its largest principal, DFSA and its milk producers will remain an extremely important business partner and stakeholder to Clover.
REGULATORY ENVIRONMENT
The health promotion levy (“sugar tax”) was introduced with effect from 1 April 2018. Most significantly, both intrinsic and added sugars will now be included when calculating the tax. In addition, Treasury has implemented a threshold that would make the first 4g of sugar per 100ml beverage exempt from the sugar tax. An important step forward includes the fact that 100% fruit juices and milk products will be considered exempt from the tax. We have been working tirelessly to reduce the impact of the tax by revising the composition of some of our products to ensure that we do not compromise on quality or taste whilst reducing the overall sugar content.
Additionally, the Minister of Finance announced an increase in the VAT rate to 15% with effect from 1 April 2018. This too will add to the pressure being felt by businesses and consumers alike.
TRANSFORMATION AND EMPOWERMENT
Clover’s Broad-Based Black Economic Empowerment (B-BBEE) status was assessed in September 2017 and we maintained our rating as a level 4 contributor. New B-BBEE codes for the broader agricultural sector were gazetted and legislated with effect from 8 December 2017. The verification process is underway and based on our internal assessment Clover will temporarily drop to a level 8 given the new minimum requirements for priority elements (ownership, skills development, enterprise and supplier development), however, plans are in place to move to a level 6 within the next 12 months. Clover is fully committed to achieving B-BBEE as outlined by the Department of Trade and Industry and is taking steps to align itself with the new codes as a priority. For further detail on Clover’s transformation journey see here in this report.
THE ENVIRONMENT AND OUR COMMUNITIES
During the reporting period, our industry suffered a regrettable incident with one of the largest outbreaks of listeriosis which resulted in the loss of many lives and brought into question the safety of food in general. This incident emphasised the importance of quality control measures at all stages of the food value chain. Clover takes this very seriously and takes every precaution to ensure that its products are safe for consumers and of the highest quality.
Despite the normalisation of weather patterns across most regions during the reporting period, the drought in the Western Cape proved to be particularly stubborn, giving rise to the prospect of Day Zero – when water would no longer be available in the region. Thankfully Day Zero did not materialise. Clover is however well protected against any future water shortages having made the necessary investments in alternative water supply and identified contingency plans for production at our affected factories.
Throughout our endeavours to create shareholder value and growth, we remain cognisant of our responsibility towards our stakeholders and our operating environment. Our report on six capitals detailing how we interacted as a corporate citizen with our stakeholders is available here in this report.
GOVERNANCE
King IV™ is the latest code on corporate governance which builds on the principles contained in King III, aligning the approach to integrated thinking across all six capitals, new governance structures, emerging risks and opportunities, from new technologies and new reporting and disclosure requirements.
The new reporting requirements in terms of King IV™ have been adopted for this report as per the JSE Listings Requirements and further details around our compliance can be found on the Company website www.clover.co.za.
This year corporate South Africa experienced a number of governance failures which impacted its reputation. Corporate governance has been under a magnifying glass since, with the market scrutinising every aspect that it involves.
Clover has a strong board with a high emphasis on governance and risk control while allowing sufficient room for innovation and entrepreneurial spirit. Avoiding over-regulation and achieving this balance is important for a growing business, like Clover.
I am pleased to report that Clover’s consistency in practicing good corporate governance has paid off. For the third consecutive year, Clover has been acknowledged as the country’s most reputable company in the Reputation Institute’s Reptrak© South Africa 2018 survey. This accomplishment is testament to the astute leadership of Johann and his executive team. The board commends them for upholding Clover’s reputation across all spheres of the business during a particularly challenging number of years.
BOARD CHANGES
Mr Elton Bosch resigned as financial director at the beginning of the period under review to pursue personal interests. He leaves a legacy at Clover, having contributed significantly to the risk and governance areas of the business, over and above his financial acumen. On behalf of the board, I thank Elton for his valued contribution.
Mr Frantz Scheepers was appointed as CFO designate with effect from 1 November 2017 and formally assumed the role of CFO and executive director from 1 January 2018.
We further strengthened the Clover Board of Directors with the appointment of Dr James Wellwood (Whitey) Basson and Mr Flemming Morgan as independent non-executive directors with effect from 1 January 2018.
These gentlemen bring a wealth of experience to the board in their respective fields of expertise.
The fresh insights that these members have brought to the board have been most beneficial.
For more information about our governance structure and processes, please refer to the governance report here in this report.
DIVIDEND
The Company declared and paid an interim dividend of 26,56 cents per share during April 2018. A final dividend of 48,68 cents per share was declared by the board, which will bring the total dividend for the current financial year to 75,24 cents, representing a divided cover of 2,75 times on a normalised basis.
LOOKING TO THE FUTURE
Tough macro-economic and trading conditions are expected to continue for the year ahead and are expected to deteriorate in some respects. Inflationary cost pressures, specifically for sugar, fuel and electricity continue to take their toll while the Rand has significantly depreciated against major currencies and the outlook for economic growth is unclear. Policy uncertainty remains in force locally while threats of trade wars between the US and certain emerging economies have had a knock-on effect on other markets including South Africa.
This environment requires tight cost controls and innovative ways of doing business. Clover’s drive to derive value from efficiency improvements and growth through the expansion of its value-added product portfolio continues to be the main focus for the year ahead. Management remains committed to improving on the positive performance this year and the board believes that measures put in place will buffer the business for the future and support sustainable value creation.
APPRECIATION
Thank you to my fellow board members for their support and contribution and to Johann and his executive team for their grit and tenacity in managing the business through the downward cycle to ensure the recovery and stability of the business through achieving significant efficiencies and driving savings throughout the supply chain. I also extend my appreciation to the rest of the Clover employees for their resilience, commitment and incredibly hard work demonstrated during a very trying period. This collective effort demonstrated the spirit of the Clover Way Better philosophy.
Werner Büchner
Chairman of the board
26 September 2018
