Robert Wiseman Dairies – How a Takeover Can Create Value

There are various ways that you can make (or lose) money in the stock market.  These returns can be boiled down to:

1. Dividends or other cash payments
2. Changes to the intrinsic value of the underlying company
3. Changes to Mr Market‘s mood (and therefore share prices)

But there is another way.

As a value investor you’re looking to buy companies that are priced attractively, but you’re not the only player in town.

There are other investors and companies out there that also have capital to deploy and if something looks attractive to you it may well look attractive to them too.

That’s exactly what happened with Robert Wiseman Dairies, a company I picked up back in May 2011 for 317p per share.

It seems that I wasn’t the only one out there that thought this major milk company might be worth more than that.  Muller Group (yes, the ones that make the yoghurt) have recently agreed to take over RWD at 390p per share.

What does that look like?  See for yourself:

So I bought in at 317p in mid-2011, just in time to watch the share price drop off (another) cliff down to 250p.  Anyone who invests with a stop-loss would have likely been kicked out and then kicked themselves as they missed the Muller-bounce to 390p.

Let’s go back and see exactly why this industry leader was so attractive to both me and Muller.

Did I use magic powers to see the value in RWD?

No, I used a checklist.

First of all, regarding the company:

Do they bring diversity to my existing portfolio?

Yes, I didn’t own anything like a milk dairy and distribution company at the time.

Are they:

Large?

Not really!  At the time size didn’t matter to me quite as much as it does now (they are listed on the small cap index), but they’re not a tiddler with a market cap of almost £300m.

Leading?

Yes.  They are either the leading milk distributor or they’re one of the big three, depending on who you ask.

Prosperous?

Yes.  They’ve made a profit in every one of the last 10 years and have always paid a dividend in that time.  The trend in earnings over the long term is upwards.

Are they conservatively financed?

Yes.  At the time the interest payments were covered 38 times over and debt was only about 1/3rd of operating profits which is next to nothing.

Do they have a consistent operating history?

Yes.  They are in the milk production and distribution business and have been for a long time.

Are they facing a problem today that might damage their earnings power permanently?

I didn’t think so.  They are currently being squeezed as part of a milk price war between the supermarkets.  However, people will always want fresh milk so somebody has to make it!  RWD have the low cost advantage and so could have potentially remained the ‘last man standing’ in the industry as other competitors gave up on milk first.

Is there a risk of their economic engine becoming obsolete?

Not really.  I think people in Britain will want fresh milk for a long time yet.

You can see the results per share that the company has generated below:

Moving swiftly on to the valuation checklist:

Are they cheap relative to the long term earnings average?

Yes.  At 317p they were priced at only 11 times the 10 year average.  If you’ve been reading my  articles for any length of time you’ll know that the 10 year earnings average can be used as a ‘baseline’ figure of earnings power for relatively stable companies.

Do they have a sustainable high yield dividend?

Yes.  The dividend has a solid history and was well covered by earnings and free cash.  The yield at the purchase price was around 5.7% which is a couple of percent clear of the market.

Are they growing rather than shrinking into oblivion?

Yes.  The long term earnings growth rate is something around 8% or so.  You can see from the table above that revenue, earnings and dividends are all up over 100% in the last decade.  Of course that’s past growth, but what would you rather have, a company with a history of decline?

And that’s more or less it.

It is (was) a relatively large, stable and leading company that had a short term problem in the shape of a supermarket milk war.

Muller probably saw the long term earnings power of RWD’s world class assets (most efficient milk production in the world, super-efficient distribution network etc.) and its future potential rather than the short term problems.

Of course I didn’t KNOW that Muller were going to take over RWD when I got in during May, but by buying a leading company with a long-term future and a proven ability to generate profits, and more importantly by buying them when they were CHEAP, I massively increased the odds that any takeover would make me money rather than lose me money.

Returns breakdown

The total returns over about 9 months were close to 25%.  How does that break down in terms of the drivers of equity returns (dividends, changes to earnings, changes to valuations)?

Returns from dividends = 3.8%

Returns from changes to long term earnings power = 0% (I didn’t even own the shares long enough for a new annual report to come out, so there were no changes to the 10 year earnings average)

Returns from valuation changes = 21.4% (Muller bought the company for 21.4% more than I’d paid for it)

This is a fairly typical pattern for short term returns.  It’s a long-proven fact that the majority of returns (both positive and negative) in the short term come from changes to valuations.

As a long term investor, if you want to maximise the opportunities available to you then you have to focus on all three drivers of equity returns.

Further reading:

1. MITIE – An impressive company at a fair price
2. Balfour Beatty – The construction industry may just be sleeping
3. Tips for overcoming overconfidence

This entry was posted on January 26, 2012 at 12:15 pm and is filed under Case Studies. You can follow any responses to this entry through the RSS 2.0 feed.