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)
