A profit warning provides an opportunity to buy value.
This month we added market-mauled Robert Wiseman Dairies (LSE: RWD) to our portfolio of 'Fantastic Family Firms'. Wiseman's share price has plummeted 30% since a shock profit warning in September.
Bad news can be good
From the start of our project I encouraged my son, Sim, to pay attention to the world around him, Peter Lynch-style. He soon spotted that our local convenience store's milk, which he drinks by the gallon, is supplied by Wiseman.
As such, we had a look at the company early on and found it to be an easy-to-understand and well-run business; but it never came up as a value contender in the period before the profit warning.
Since then we have pondered the question of whether the market has over-reacted to the bad news in the short term, making Wiseman an attractive investment for the long term.
The profit warning was in the following terms:
As a result of recent intense competitive pressures across all sectors of the market operating profits will be impacted. Whilst anticipated volumes for the year remain unchanged, operating profits will be impacted by around £7 million in the second half of the year to 2 April 2011 and, assuming no improvement in margins or volume gains, by approximately £16 million in the full financial year to 31 March 2012.
Questions
In these situations I ask myself a number of questions:
- Does the issue which led to the profits warning suggest a fundamental adverse change to either the macro-picture for the industry or the company's position in it?
- has the company faced the same, or other, issues in the past?
- if so, has it accurately estimated profits shortfalls, or understated the extent of the problem and been forced to issue further profits warnings?
The milk industry
Wiseman's business is focused exclusively on liquid milk and cream. It has over 30% of the UK fresh milk market.
The population of Britain is forecast to rise by about 15% of the next 20 years, so, on demographics alone, overall milk consumption should increase. Furthermore, Wiseman hasn't yet attained its objective of UK-wide coverage. In particular, there is scope for it to expand its production capabilities to service the south and east of England.
Operational efficiency through technological innovation is one of Wiseman's traditional strengths and it has just embarked on a five-year plan to reduce gas used per tonne of milk processed by 30%, electricity and water by 25%, and transportation fuel by 15%.
Looking even further out it is already alert to the prospect of oil-derived polybottle packaging coming under increasing economic, environmental and regulatory pressures.
Nothing in the profit warning suggests that the milk industry has suddenly gone into a terminal decline, or that Wiseman's long-term prospects have been delivered a mortal blow.
Profit setbacks
Food producers are generally considered to be one of the more defensive sectors of the market, but Wiseman has seen fairly regular short-term profit setbacks over the years, as a result of pressures from both the raw materials side and the customer side.
Volatile oil prices affect the company directly in terms of the diesel used by its fleet of 1,400 commercial vehicles and indirectly via high-density polythene (HDPE) resin, which is the raw material of the ubiquitous polybottle.
On the customer side, the company faces tough bargaining from the big supermarkets and over the years there has been a veritable merry-go-round for dairy firms of won and lost contracts and improved or reduced terms.
Wiseman's latest profit warning, it's widely believed, comes as a result of being squeezed by its biggest customer, Tesco (LSE: TSCO), which is currently engaging in a milk promotion war with Asda.
In 2008 Wiseman suffered from high raw materials costs and in 2004 took a hit from the customer side when it lost a contract with Asda worth £70m a year. On both occasions the share price fell by a similar order to the latest collapse.
What's important, though, is that Wiseman has bounced back on each occasion in the past, with the hefty share price falls representing good buying opportunities in what has been, as the chart below shows, a decade of outperformance.
A clue to Wiseman's 'bouncebackability', can be found in its 2008 troubles. At the start of the company's financial year it suggested operating profit could be hit to the tune of £8.5m by rising raw materials costs, and at the interim stage it announced that weak cream prices could impact profit by up to £7m in the second half.
Ultimately, though, operating profit for the year was down little more than £3m on the previous year, suggesting that in such circumstances Wiseman routinely guides on a conservative worst-case basis.
Indeed, the precise wording of the profit warnings also indicates the same. The guidance in the latest is assuming no improvement in margins or volume gains."
Knee-jerk analysts
Analysts' forecasts have given full weight to the worst-case scenario. Investec immediately cut its current year earnings-per-share (EPS) estimate to 36p, down 16% on its previous forecast, and reduced EPS for the following year to 28p (down 36%).
At the time we were weighing it up, Wiseman's share price was 315p, representing a prospective price/earnings (P/E) ratio of 9, rising to 11 for 2011/12. The company has already committed to a maintained 18p dividend for the current year, a level which would still be covered over 1.5 times by Investec's forecast 2011/12 earnings. That gives an attractive prospective yield of 5.7%.
Moreover, all this assumes no volume gains or improvement in margins. Yet we know that Wiseman has bounced back in the past, and, if a press report quoting an unnamed company spokesman is to be believed, we can be optimistic that it will do so again:
"We've painted the worst-case scenario. We hope we can eat into the numbers that we've put out today."
The buy
We were slightly disgruntled that the share price spiked up on our scheduled investment day using The Motley Fool ShareBuilder service. But, given our analysis, we were happy to make Wiseman the fourth constituent of the Family Firms Portfolio, which, at the time of writing, looks like this:
| Company | Buy date | No. of
shares | Avg cost
per share* | Current
price | Book cost | Current
valuation | Profit/
loss |
|---|
| Hunting (LSE: HTG) | 7/7/10 | 32.4 | 462.6p | 638.5p | £150 | £207 | +38% |
| Halstead (LSE: JHD) | 5/8/10 | 22.8 | 658.8p | 735.0p | £150 | £167 | +12% |
| Thorpe (LSE: TFW) | 7/9/10 | 24.0 | 624.3p | 650.0p | £150 | £156 | +4% |
| Wiseman | 7/10/10 | 45.1 | 332.5p | 324.3p | £150 | £146 | -2% |
| Total | | | | | £600 | £677 | +13% |
* The average cost per share figure includes all associated dealing costs
Look out for the report on Sim's fifth investment this time next month.
More family firm articles:
> G A Chester & Son hold shares in F W Thorpe, Hunting, James Halstead and Robert Wiseman. G A Chester holds shares in Tesco.
> With The Motley Fool's Share Dealing Service, you can buy and sell shares in real time for a flat rate of just £10, or set up a regular ShareBuilder purchase plan for £1.50. Open an account for free today.
