The finances and accounts of the milk industry

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UK milk industry is a highly competitive and noteworthy sector with the leading three companies taking less than 10% of UK milk market share. Robert Wiseman Dairy PLC. (RWD), who accounts for largest proportion in the leading three milk firms, set a long-term development strategy of "operating efficiently to minimize the amount of resource we require to collect, process and distribute our product" and realize a positive EBIT growth in this challenging year. This attracts the attention of investors and creditors. This essay is an attempt to evaluate the performance and assess the position of RWD through financial statement analysis and corporate governance analysis. Additionally, a recommendation to investors would be given. Based on the annual reports of RWD, the evidence shows that the firm held superior position in UK milk sector in terms of economic performance and corporate governance.

Key words: Financial statement, corporate governance, ownership structure

Section A: Financial Statement Analysis

1. Background

UK milk market is highly fragmented and competitive, with the leading three firms occupying less than 10% of UK milk market share. (Figure 1) and fiscal 2009 has been a challenging year for the UK milk industry. Further economic recession along with world commodity price reduction exerts adverse impacts on the whole industry. (Datamonitor, 2009)

First listed on London Stock Exchange in 1994 (Datamonitor, 2009), Robert Wiseman Dairies PLC (RWD) is engaged in processing milk and milk-associated production. It supplies milk-related products to supermarkets in UK such as Tesco and accounts for 4.1% share of UK Milk Market Value, larger than its UK rivalries.

Source:Datamonitor

Table 1: RWD's Five Year Financial Review

2005

2006

2007

2008

2009

Revenue (th GBP)

489168

568564

605289

721983

847702

Cost of Sales(th GBP)

373400

429883

448594

551829

667309

Net Profit(th GBP)

21551

18450

24156

19320

6581

Profit Margin

5.05%

4.70%

5.71%

4.04%

3.63%

Total Asset(th GBP)

198801

211151

241787

293967

308375

Total Liability(th GBP)

85407

92530

101991

154458

173854

Employers

3340000

3760000

3919000

4262000

4508000

Source:Datamonitor

Source:Datamonitor

On the whole RWD experienced gradual increase in revenue and stability in net profit over the five fiscal year period, however, the profit margin after fiscal 2007 is characterized with considerable decline and reached at a nadir of 3.03% in fiscal 2009. (Datamonitor, 2009)

One of the main competitors of Wiseman is Dairy Crest Group (DCG), a UK manufacturer of more diversified dairy products.

Table 2: DCG's Five Year Financial Review

2005

2006

2007

2008

2009

Revenue (th GBP)

1260600

1161000

1309300

1569700

1647600

Cost of Sales(th GBP)

928000

1033500

908700

1131400

1201700

Net Profit(th GBP)

51600

34800

49200

54700

74300

Profit Margin

5.29%

3.05%

4.93%

4.20%

6.26%

Total Asset(th GBP)

755600

820200

1100400

1205000

1321400

Total Liability(th GBP)

546100

573000

761300

856000

969100

Employers

6810000

7464000

7994000

8342000

8122000

Source:Datamonitor

Source:Datamonitor

DCG generated more revenue and had moderately growing revenue just like that of RWD. Nevertheless, unlike RWD, in fiscal 2009, there was a dramatic rise in the company's margin profit and an increase of 38.6% over 2008 in net profit.

2. Ratio analysis

(1) Liquidity ratio

Source: Company Filings

Source: Company Filings

Source: Company Filings

Table 3: Liquidity ratio related data

2006

2007

2008

2009

Current Liability

Wiseman

76170000

81798000

101861000

107173000

Dairy Crest

222300000

317100000

268900000

243800000

Current Assets

Wiseman

56328000

59432000

71607000

80995000

Dairy Crest

350100000

330700000

243400000

444400000

Inventories

Wiseman

7037000

7079000

8887000

10581000

Dairy Crest

192600000

147500000

15900000

197800000

Current Asset - Inventories

Wiseman

49291000

52353000

62720000

70414000

Dairy Crest

157500000

183200000

227500000

246600000

Cash + Marketable Securities + EBITDA

Wiseman

4730157

3427336

4288348

9291899

Dairy Crest

14405040

24892350

40308110

107491420Source: Company Filings

It is clearly evident from the liquidity ratio charts above that RWD's ability to meet short-term cash needs maintains the same under-peer-median level. Specially, in fiscal year 2009, the acid ratio, which measures the extent to which a corporate can quickly liquidate assets and thus cover short-term liabilities, slightly surpassed peer median mark. Furthermore, it is notable that the growth rate of Wiseman's operating cash flow ratio is much higher than its peers. Focusing on the table above, we can investigate that the major contributor to the improvement in Wiseman's liquidity is the considerable rise in Cash & Marketable Securities& EBITDA. Nevertheless, this increase mainly attribute to the current fiscal year being a 53 weeks period, allowing for the collection of more than debtors and the deferral of more trade creditors. (RWD PLC. 2009) On the contrary, there was a substantial upward trend since fiscal year 2007 in the liquidity ratio of DCG. Moreover, DCG's ability of meeting short-term liability significantly outweighs the peer median in current fiscal year. All these charts and data above indicate the obviously advantageous liquidity position of DCG.

Overall, it is noteworthy that Wiseman underperformed DCG and other peers in terms of liquidity.

(2) Efficient ratio

Source: Company Filings

Source: Company Filings

Source: Company Filings

Source: Company Filings

RWD had substantial shorter length of Cash Conversion Cycle (CCC) than Dairy Crest, meaning that Wiseman is much more efficient in operation. This is predominantly a result of the significant above-average inventory conversion period. As milk, the main product of RWD, is usually perishable and thus the storage cost is extremely high, the milk processor tend to reduce their inventories to the minimum. By contrast, DCG had diversified into other dairy products so that it is profitable for them to enhance their inventories.

The other contributors to the extreme low CCC is the short debtors collection period and long creditors deferred period, the former indicates that Wiseman can quickly convert its outstanding receivables into cash, while the latter implies that Wiseman owns high credit and long time limit of payment.

Overall, figures above indicate that RWD is more efficient in converting its products into cash through sales than DCG.

(3) Profitability

Source: Company Filings

Table 4: Profitability ratio related data part 1

2006

2007

2008

2009

Net asset

Wiseman

134981000

159989000

192106000

201202000

Dairy Crest

597900000

783300000

826100000

1077600000

Total Equity

Wiseman

119258000

139258000

139509000

134521000

Dairy Crest

247200000

339100000

382600000

352300000

EBIT

Wiseman

27477000

35659000

31645000

35147000

Dairy Crest

45600000

66900000

74400000

68100000

Long-term liability

Wiseman

16360000

20193000

52597000

66681000

Dairy Crest

350700000

444200000

587100000

725300000

The stable net asset and slightly rising ROCE of Wiseman in current fiscal year implies that Wiseman still experience moderate increase under challenging financial and operating condition. The satisfactory result is mainly attribute to the rise in sales volumes, which climbed by 6.9% to 104 millions. In the total 6.9% increase in volume growth, 2.0% is due to the additional week's sales and the remainder is a result of raising retailer demand in Wiseman's production. (RWD PLC. 2009) It is stated in the 2009 annual report that Wiseman signed the contract with Co-operative Group to supply a further 116 million liters per annum of their business from August 2009. However, the decline in the value of bulk cream, a commodity by-product of liquidity milk process, offsets part of the profit benefiting from volumes growth. (RWD PLC. 2009)

Source: Company Filings

Table 5: Profitability ratio related data part 2

Costs of Sales

2006

2007

2008

2009

Wiseman

429883000

448594000

551829000

667309000

Dairy Crest

842700000

908700000

1131400000

1201700000

According to figure 12, the below-average EBIT margin of RWD begun to decline in 2007, followed by a downward trend. The result seems to contradict with that of ROCE, which indicates that Wiseman substantially eclipsed its peers in the aspect of profitability. However, this conflict is due to the rising cost (table 5), which leads up to the high revenue and low profit. As stated in the annual report, the prolonged upturn in oil prices account for the boomed plastic resin costs. For 95.7% of Wiseman's products are packed with polybottles, the increase in the global demand for HDPE resin dramatically increased these costs by 24% in the first half of the year. (RWD PLC. 2009)

Overall, RWG held superior position in efficiency with which capital and shareholders' investment is utilized to generate revenue.

(4)Stability

Source: Company Filings

Source: Company Filings

Table 6: Stability ratio related data

Dairy Crest

2006

2007

2008

2009

Long-term Debt

350700000

444200000

587100000

725300000

Cash

14400000

24900000

40300000

107500000

Source: Company Filings

The debt ratio of DCG is dramatically higher than that of RWD, reflecting the different financial structure of these two firms. Together with table 6, it could be concluded that DCG converted most of the increased borrowing into cash, which enhances the firm's liquidity and also raising financial cost. However, the substantially high-than-peer-mean liquidity ratio indicates that the excessive debt lowered the profitability of DCG.

The interest cover shows an enormous decline from 12.15% in 2008 to 7.82% in 2009. This change is on account of a significant £1.9 million increase in interest cost, which comprises £1.8 million adverse impact of fair valuing interest rate swaps and £0.1 million interest cost of the increased bank borrowing. (RWD PLC. 2009) The former reflects that the unexpectedly rapid decline in interest rate brought potential cash costs of unwinding £20 million of interest rate hedges.

To sum up, Wiseman is in a noticeably better stability position than DCG although the advantage is declining.

(5) Investment Ratio

Source: Company Filings

Source: Company Filings

Robert Wiseman

2009

2008

2007

2006

2005

EBIT

35147000

31645000

35659000

27477000

25077000

Interest Expense

4514000

2617000

1163000

821000

278000

Taxes

24186000

9864000

10436000

8276000

3670000

Net Income

6581000

19320000

24156000

18432000

21551000 Table 7: Investment ratio related data

Source: Company Filings

The Basic EPS reduced substantially and P/E ratio boomed for Wiseman as a result of dramatically decreased net profit. Considering the moderately increased EBIT, the drop in net income is attributed to the increased interest costs and more than doubled taxes cost. The boosted tax is due to £17.1 million impact of withdrawal of Industrial Building Allowances (IBAs). However, "There is no immediate cash impact of this change, as the £17.1 million represents the additional tax payable over the 25 year period during which the allowances would have been available to the Group." (RWD PLC. 2009) Thus the underperformance of Wiseman in terms of EPS is supposed to be temporary.

3. Horizontal analysis

Table 8: RWD's income statement ( Horizontal analysis)

2009

2008

2007

2006

2005

Net Sales

173.29%

147.59%

123.74%

116.23%

100.00%

Cost of Sales

178.71%

147.78%

120.14%

115.13%

100.00%

Gross Profit

155.82%

146.98%

135.35%

119.78%

100.00%

Operating Income

140.16%

126.19%

142.20%

109.57%

100.00%

Interest Expense

1623.74%

941.37%

418.35%

295.32%

100.00%

Taxes

659.02%

268.77%

284.36%

225.50%

100.00%

Net Income

30.54%

89.65%

112.09%

85.53%

100.00%

Source: Company Filings

Table 9: DCG's income statement ( Horizontal analysis)

2009

2008

2007

2006

2005

Net Sales

130.70%

124.52%

103.86%

92.10%

100.00%

Cost of Sales

129.49%

121.92%

97.92%

90.81%

100.00%

Gross Profit

134.06%

131.78%

120.44%

95.70%

100.00%

Operating Income

81.07%

88.57%

79.64%

54.29%

100.00%

Interest Expense

179.88%

159.76%

117.07%

101.83%

100.00%

Taxes

155.38%

67.20%

60.75%

30.11%

100.00%

Net Income

143.99%

106.01%

95.35%

67.44%

100.00%Source: Company Filings

Source: Company Filings

From fiscal 2005 to 2009, RWD evidently outperformed DCG in the terms of EBIT growth rate. The EBIT of RWD surged to £35.15 million with more than 1 growth rate since fiscal 2005. By contrast, the EBIT of DCG stayed at a level lower than that in 2005 over the period spanning 2005-2009.

4. Vertical analysis

Table 10: RWD's income statement ( Vertical analysis)

WISEMAN INCOME STATEMENT

2009

2008

2007

2006

2005

Net Sales

100.00%

100.00%

100.00%

100.00%

100.00%

Cost of Sales

78.72%

76.43%

74.11%

75.61%

76.33%

Gross Profit

21.28%

23.57%

25.89%

24.39%

23.67%

Operating Income

4.15%

4.38%

5.89%

4.83%

5.13%

Interest Expense

0.53%

0.36%

0.19%

0.14%

0.06%

Taxes

2.85%

1.37%

1.72%

1.46%

0.75%

Net Income

0.78%

2.68%

3.99%

3.24%

4.41%Source: Company Filings

Table 11: DCG's income statement ( Vertical analysis)

DC INCOME STATEMENT

2009

2008

2007

2006

2005

Net Sales

100.00%

100.00%

100.00%

100.00%

100.00%

Cost of Sales

72.94%

72.08%

69.40%

72.58%

73.62%

Gross Profit

27.06%

27.92%

30.60%

27.42%

26.38%

Operating Income

4.13%

4.74%

5.11%

3.93%

6.66%

Interest Expense

1.79%

1.67%

1.47%

1.44%

1.30%

Taxes

1.75%

0.80%

0.86%

0.48%

1.48%

Net Income

4.51%

3.48%

3.76%

3.00%

4.09%Source: Company Filings

Source: Company Filings

The costs of sales proportion in RWG and DGC experienced steady decline and reached the lowest point in 2007, followed by a gradual rise. This trend reflected the difficult economic environment. Furthermore, DG outweighed Wiseman in controlling costs and the gap went up in fiscal 2009, resulting from the diversification of DG's production compared with Wiseman's.

5. Conclusion

The financial statement analysis of RWD shows that the company withstood the challenge of global economic recession. Wiseman experienced a moderate increase in EBIT while most of its peers suffered substantial EBIT decline in fiscal 2009. On the whole, Wiseman occupied favorable position in milk industry as it outperformed DCG and peer median in the terms of efficiency, profitability and stability. However, the relative low liquidity exerts adverse impact on the advantageous position of Wiseman.

The rapidly rising EBIT enhanced the confidence of Wiseman's shareholders. On the one hand, the high ROCE implies that the firm had above-average profitability, which increases the estimation of positive future earnings stream. Moreover, the longer CCC indicates that Wiseman is more efficient in management. On the other hand, the relatively low debt ratio is an index of low risk and high credit grade of the firm. Nevertheless, it is noticeable that the steep drop in net profit would not significantly influence the position of Wiseman, as the drop is due to some unexpected factors such as the loss of interest rate swamps and some temporal factors such as the impact of withdrawal of IBAs. Overall, RWD is highly recommended to investors on account of its superior performance, relatively low risk inherent in capital structure and high expected future earnings stream.

Admittedly, the difference in the size and products of the two companies may leads to incorrect conclusion. For instance, the low cost of DGC generated from the relatively low storage cost of cheese compared with milk reduces the comparability of cost-associated ratio such as EBIT margin. Nevertheless, financial statement analysis provided us an effective tool in valuing company in spite of the existence of some inevitable bias.

In a nutshell, it could be generally concluded that RWD experienced superior performance in fiscal 2009 and occupied advantageous position in UK milk sector.

Section B: Corporate Governance

1. Main Corporate Governance Mechanisms

RWD complied with all provisions contained in the revised Combined Code on Corporate Governance. In accordance with the independence requirement of the Code, the board of Wiseman leading by the Chairman consists of four executive directors and five non-executive directors. Alan Wiseman, the chairman of the Board, is responsible for the overall strategic development of the group and the efficient engagement of the board. With the authority delegated from the board, the chief executive in charge of all operational matters of Wiseman. Other three executives in the Board are considered to be highly independent, who are engaged in Finance, Commercial and operational activities respectively. (RWD PLC. 2009)

The five non-executive directors comprise three independent directors and two associated directors. Of the three independent directors, Norman Murray as a Senior Independent Director enhances the relationship between shareholders and the board through addressing the neglected concerns of shareholders. The other two independent non-executive directors are previous executives of other firms and now serve as advisors in both public and private sectors. The two associated non-executive directors are Beverley Hodon and the chairman. Beverley Hodon holds the post as a representative of First Milk, Wiseman's largest single supplier who holds 15.7% share of the Company. (RWD PLC. 2009)

The board committees of RWD have three sub-committees including audit remuneration and nomination committees.

Under the guideline of the principle of "pay for the performance", Remuneration Committee implemented a series of remuneration policies to motivate and incentive directors to endeavor to maximum the interest of shareholders. One of such policy is Long Term Incentive Plan (LTIP), an award on the condition of above-median Total Shareholder Return and constant favorable Earnings per Share performance over a three year period. The LTIP encourages directors to achieve superior long-term performance for the interest of shareholders.

2. Ownership Structure

Source: Company filings

RWD is a typical management ownership company with directors owning 36% of the Company's ordinary share capital. Noticeably, Robert Tennant Wiseman and Alan William Wiseman have interests amounting to 17.53% and 15.24% of the firm's share, which enables the two directors of RDD to be the top two major shareholders.

The management ownership closely aligns the objective of managers with the interest of outsider investors. Jensen and Meclding (1976) put forward the convergence-of-interest hypothesis, under which managers will not divert resources away from value maximization and endeavor to increase the value of the firm, which is consistent with the interest of outsider shareholders. They stated that management ownership can efficiently reduce the costs of controlling agency problem and significantly reduce the costs of derivation from shareholders' desire. However, according to Demsetz (1983), the costs reduction is a result of market discipline rather than the management ownership structure.

Morck et al. (1988) contended that the "entrenchment" caused by high level of management ownership could exert negative impact on firm performance. As management ownership puts the voting power in the hands of corporate directors, managers have sufficient control to consume perquisites such as a high salary without the fear of discipline of external shareholders. Nevertheless, Morck et al. (1998) pointed out that the relation between managerial ownership and firm performance is positive when the insider's ownership level is below 5% or beyond 25%. The directors of GWD occupy 36% of the corporate shares, substantially high than 25%, therefore, it seems to be clearly demonstrated that superior performance can be achieved by the high level management ownership structure of RWD.

3. Audit Report Opinion & Non-audit Service

In accordance with International Standards on Auditing, Deloitte LLP audited Wiseman financial statements and part of the Directors' Remuneration Report. It is stated that the Group and Parent financial statement and the audited remuneration report comply with IFRs and give a true and fair scenario of the company.

Besides the £107000 for the audit service, £83000 is paid by Robert Wiseman for public accounting firms' non audit service including the tax compliance service and tax advisory service. The tax-related non-audit service expense may be could benefit third party's knowledge of the sharply increased tax in fiscal 2009.

However, it is argued that the provision of non-audit service will impair auditors' independence. SEC (2000) asserts that auditors who provide non-audit services tend to avoid giving fair but negative assessment to retain their clients, when the benefit acquired from the client overweigh the costs of sacrificing auditors' independence. Wines (1994) used Australian publicly available accounting data and noted that the provision of non-audit service and auditors' reporting decisions co-integrated a positive relationship.

Nevertheless, Barkess and Simnett (1994) use similar data but got conflicting result. Craswell (1999) established a logit model of qualified audit opinions and found that non-audit service did not significantly threaten the independence of auditors. Furthermore, audit committee implemented a series of policy to safeguard auditors' independence when the non-audit service is provided. For instance, audit committee set a level of fees spent on non-audit service, the engagement of the non-audit services "must be approved by the Committee in advance if the fees payable is expected to exceed the level". (RWD 09 Annual Report)

4. Role of Audit Committee

Audit Committee comprises all independent non-executive directors and plays a critical part in the corporate governance such as reviewing the effectiveness of the Group's internal control. (RWD PLC. 2009)

The Audit Committee serves as an intermedia between external auditors and the board. It bridges corporate management with auditors. The board of directors becomes the "client" of the public accounting firms through the Committee.

Besides, the credibility of corporate published reporting is significantly enhanced through the work of Audit Committee, as the committee efficiently supervises the audit and prepare of corporate financial statement. On the one hand, the committee functions as a monitor of corporate audit system. RWD's Audit Committee takes sustained surveillance on the company's internal and external auditors. One of the major responsibilities of Wiseman's audit committee is to review the activities and effectiveness of corporate internal audit department and external auditors. On the other, the Committee examines and advised the Board on the published corporate information directly. (RWD PLC. 2009)

Additionally, the auditor committee endeavors to protect the independence of external auditors. For one thing, Wiseman's audit committee exerts increased oversight of potential independence conflicts. The external auditors must report regularly to the committee the effort they made to comply with the Auditing Practices Board's Ethical Standard. (RWD PLC. 2009) This policy efficiently prevents potential independence conflicts and maintained external auditors' independence. For another, the audit committee has the authority to select external auditors. In fiscal 2009, the Audit Committee of Wiseman participate the selection of the audit engagement partner for the next year with Deloitte LLP, in accordance with the requirement of best practice independence guideline. (RWD PLC. 2009) This participation strengths the independence of audit partners.

5. Evaluation of Voluntary Disclosures

Voluntary disclosures provide an effective tool for the measurement and communication of information about a company's influence on "triple bottom line", which are profits, people and planet.

The environmental disclosure of Robert Wiseman is valuable and informative. Put into more detail. The voluntary firstly give the third party a clear view about the Group's environmental objectives, which is to maximize the efficiency in operation and thus realize the environmental sustainability. (RWD PLC. 2009) Then it demonstrates the organization's environmental policies such as New Vehicle Programme and Carbon Management Programme. (RWD PLC. 2009) The third part of the environmental disclosure shows a summary of five-year environmental performance data. In this part, the annual report also candidly present the disappointing results of increased electricity consumption and CO2 emission, the voluntary presentation of negative information implies the high credibility of this voluntary disclosures. Moreover, it is noticeable that the company adjusted the methodology of environmental disclosures to be consistent with UK dairy peers in order to enhance the comparability of voluntary disclosures. (RWD PLC. 2009)

However, Wiseman's environmental disclosure did not give the third party any information about the sensitivity of the Group. It is suggested that all the considerable direct and indirect environmental factors of the group should be given in the company's environmental statement.

Overall, in spite of lacking the description of the Group's sensitivity, RWD's environmental disclosure is of high quality.

The explicit and positive environmental disclosures such as RWD's inform the public and shareholders that the company is pursuing long-term benefit and thus enhance the reputation of the company as well as the leading position in the sector. Furthermore, high-qualified voluntary disclosures would efficiently reduce information asymmetry costs and triggers investors' preference effect. According to the ''good news'' hypothesis in discretionary disclosure theory, high-level environmental voluntary disclosures impress investors with "a proactive environmental image" and thus trigger the upward trend of corporate stock price. (Al-Tuwaijri, 2004, pp.470)

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