Chief Executive’s review

Fit for the future

This has been an exciting year for Dairy Crest. We have consistently delivered on our strategy of brand investment, cost reduction and cash generation, and have strengthened the business for the future. During the year, we have increased operating profits and significantly cut our borrowings, and at the same time continued to develop our key brands and other added value sales. We have demonstrated our commitment to our Dairies business by announcing a major capital investment programme. In addition we have continued to innovate with further developments in our new doorstep internet proposition. We have substantially reduced our pension scheme exposure and completed the important work we have been doing to set out our corporate Vision and Values. We believe we are in a strong position to continue this progress in the future.

Financial results

Strong growth in sales of key brands and liquid milk to retailers, which together increased by £52 million, were offset by planned lower sales of dairy ingredients and lower sales to doorstep and middle ground milk customers. The Group’s revenue for the year ended 31 March 2010 was £1,630 million (2009: £1,648 million).

Adjusted Group profit before tax was up 5% at £83.5 million (2009: £79.5 million). After adjusting for £4.0 million of net exceptional profit (2009: £26.4 million), £0.5 million other finance expense (2009: £6.9 million credit) and £9.2 million of acquired intangible amortisation costs (2009: £9.6 million) reported profit before tax was down 25% at £77.8 million (2009: £103.2 million). Adjusted basic earnings per share fell by 1% to 44.5 pence (2009: 45.0 pence).

Group net debt at 31 March 2010 was £337.2 million, which was better than expected and £78.6 million lower than at 31 March 2009 when the debt was £415.8 million.

Increased profits and lower borrowings

Operating profits have increased and at the same time we have invested more in innovation and marketing our key brands. This has been possible because our focus on cost control has delivered efficiency improvements and strong cash generation. This in turn has led to lower borrowings and reduced interest costs.

Our Dairies division has performed strongly and has benefited from lower costs and higher cream returns during the year. This has been partly offset by lower profits in our Spreads and Cheese divisions where, in line with our strategy to continue to grow our key brands, we have spent more on advertising and promotions during the year.

We are confident that this ongoing marketing investment leaves our brands well placed for further profitable growth.

It is particularly pleasing to be able to report overall profit growth without cheese stock profits, which in 2008/09 contributed around £10 million to operating profit. The increase has also been achieved without a contribution from our 49% stake in Yoplait Dairy Crest which was sold in March 2009.

Growing added value sales

We continue to grow sales in three areas of strategic importance.

1. Key brands – our five key brands (Cathedral City, Country Life, St Hubert Oméga 3, Clover and FRijj) have continued to perform strongly against very tough prior year comparatives. Together they have increased volume by 13% and value by 9%. Over recent years we have driven consistent growth in these combined brands and have outperformed the market. Our sales of these brands are nearly 50% higher than three years ago.

We have used a number of different methods of marketing our brands from ‘traditional’ television advertisements to internet campaigns. The sustained increase in marketing investment has led to higher consumer awareness for all our brands and has helped us get our key messages across. For example more consumers now think that Cathedral City is one of the best cheeses money can buy (up 15% over the past two years), that Country Life is a superior tasting product (up 22%) and British (up 23%), that Clover is a good balance between health and taste (up 100%) and FRijj has cool packaging (up 33%).

We are particularly pleased with the ongoing success of our French business, St Hubert, which has delivered ahead of expectations and has again made a significant contribution to the profitability of the Group. We have improved St Hubert’s performance under our ownership, sharing best practice with our UK businesses and driving purchasing synergies. It has a strong management team who are capable of generating further improvements.

2. Fresh milk to major retailers – we have maintained good year on year growth in milk sales to major retailers. These have grown by 9% in volume and 8% in value. Alongside a steady increase in conventional milk sales to these customers, sales of organic and flavoured milk have also grown strongly. During the year we have also made good progress in developing sales of milk in bags using our innovative patented jug, JUGIT. Sainsbury’s was the first retailer to launch national distribution of this product, which contains 75% less packaging than a standard 2 pint plastic milk bottle and we expect to gain listings with other major retailers. We have also trialled this concept successfully with our doorstep customers and expect to increase distribution of milk in bags through this channel during 2010/11.

3. milk&more – our doorstep delivery internet proposition, milk&more, continues to show strong momentum. We are delighted that we now have over 250,000 registered customers, which is in line with the challenging target we set when we fully launched this service last September. The initial success of milk&more has already contributed to a lower decline in doorstep sales.

Cost reduction

Cost reduction remains a key part of our strategy. It has allowed us to grow underlying profits and increase investment across our business while at the same time maintain high levels of customer service. We continue to set ourselves challenging targets to reduce our costs and are confident further improvements remain possible.

During 2009/10 we achieved cost reductions that in total will deliver annualised savings of approximately £20 million. These range from appointing a new media-buying agency to redesigning our spreads tubs. We have also driven efficiencies in our dairies and distribution depots and continue to identify further opportunities.

Strengthened financial position

As a result of the focus we have put on cash generation, our reported borrowings are the lowest they have been since 30 September 2006.

In addition we continue to reduce risk in order to stabilise and simplify the business.

We have made significant progress in reducing the risks associated with our defined benefit pension scheme. This has now closed to future accrual.

During 2009/10 we have processed significantly lower volumes of milk into commodity ingredients than we did in 2008/09 and are confident we can maintain this in the future. We are also in the process of reducing our stake in our Irish cheese business, Wexford Creamery Limited. The prospective purchaser, Wexford Milk Producers Limited, will be shortly seeking its members’ approval to the transaction. When completed, this transaction will largely complete our withdrawal from commodity cheddar.

Finally, we have offered new longer term, fixed price contracts to some of our milk suppliers. Milk purchased under these contracts will be used to meet milk&more sales demand and will increase price stability between our suppliers and us.

Vision and Values

Although it is only fourteen years since we started life as a plc, we have a history that stretches as far back as the creation of the Milk Marketing Board in 1933. Today we buy milk directly from over 1,350 dairy farmers and have around 8,500 employees and franchised milkmen. We operate factories in rural areas where they play a significant role in the local economy. We aim to produce healthy and convenient products that are enjoyed by millions of consumers across Western Europe and they expect us to continue to innovate and develop our products and services, while at the same time caring for our environment.

During the year we have completed the development of our corporate Vision and Values which recognises the needs of these different stakeholders in our business and sets out how we can do the best we can for them all – and as a result maximise returns for shareholders. I am really pleased with this. In particular we have linked our Vision and Values with key performance indicators which will allow us to monitor our progress.

Market environment

Retail markets in the UK and France remain dominated by concerns over consumers’ reaction to financial pressures caused by the global recession. We have reacted to this by promoting our brands more in order to provide value to our consumers. We expect this to continue during 2010/11.Dairy markets and UK milk prices have been relatively stable over the past year. Recently dairy commodity prices have started to increase and this may put upward pressure on milk prices in coming months.There are also signs that some other commodity costs are starting to increase. We continue to drive efficiencies to offset these and believe that our track record demonstrates that we can deal with this challenge.

Looking forward

This has been a year of progress for Dairy Crest in which we have strengthened the business for the future. Against this background we expect our key brands to continue to grow. As noted above, we have grown sales of these brands by nearly 50% over the past three years and consumers’ spontaneous awareness of these brands has increased significantly. We will maintain this momentum by continuing to invest in marketing and innovation.

The benefits from being a broadly based dairy business have been clearly demonstrated this year. We have taken the opportunity created by strong cash generation to initiate a £75 million capital investment programme in our dairies that will support our business with our key liquid milk customers. This expenditure will allow us to increase capacity, reduce costs and accelerate innovation. We expect to make this investment over the next three years and to achieve a minimum of a four-year payback on this investment. In addition, as we continue to improve all aspects of our Dairies Division, we would look to benefit by selling more milk to our key customers, who recognise that the cost, quality and service we provide is of the highest level.

We are excited about the prospects of our doorstep delivery internet proposition, milk&more. Although we are breaking new ground here we have already achieved our first stretching target of 250,000 customers. We now want to grow the amount each customer buys from us and believe that we can do this. However it is difficult precisely to predict how milk&more will change our business. From what we know today it is possible that in the future milk&more could eliminate doorstep decline and eventually provide growth in total doorstep sales at acceptable margins.

Supporting all these developments that will provide added value sales growth is an ongoing programme of cost reduction. In our Household business we have the opportunity to simplify and centralise our depot administration. This project is progressing well and will lead to substantial savings in our cost base.

Additionally we continue to revisit our central overheads to reduce the administration costs for each litre of milk that we process.

In 2010/11 we intend to continue to increase profits, generate cash and further reduce our borrowings. We anticipate that our borrowings at 31 March 2011 will be meaningfully lower than at 31 March 2010, despite planned higher capital expenditure and increased dividend payments.

Trading at the start of the new year is in line with our expectations.

Dairy Crest has changed from a predominantly commodity focused, UK based business to an added value dairy food company with a significant profit stream from continental Europe. We have shown that we can grow added value sales both organically and through acquisitions and we are well placed to do either or both.

We are fit for an exciting future.

Mark Allen Chief Executive
17 May 2010