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 which joined the UKVI model portfolio back in May 2011 for 317p per share.

It seems that I wasn’t the only one out there who 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:

I bought the shares 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.

Finding value in Robert Wiseman Dairies

I always use checklists when making investment decisions because they bring consistency, repeatability and discipline to an incredibly important task.

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, the minimum size for companies being added to the model portfolio was £100 million, whereas now the rule is that they are listed on the FTSE 350, which usually means they’re at least worth hundreds of millions.  But Robert Wiseman was not a tiddler with a value of almost £300m.

Market leading?

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

Prosperous?

Yes.  It made a profit in every one of the last ten years and always paid a dividend in that time.  The trend in earnings over the long term is upwards.

Is it 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.

Does it have a consistent operating history?

Yes.  It is in the milk production and distribution business and has been for a long time.

Is it facing a problem today that might damage its earnings power permanently?

It is 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 lowest production costs 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 its economic engine becoming obsolete?

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

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

Moving on to the valuation checklist:

Is it cheap relative to the long-term earnings average?

Yes.  At 317p, it was priced at only 11 times the 10-year average earnings.  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.

Does it 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.

Is it 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?

So to summarise, it was a relatively large, stable and market-leading company that had a short-term problem in the shape of the 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 was going to take over RWD when I picked the shares up in May.  However, by buying a leading company with a long-term future and a proven ability to generate profits, and more importantly, by buying the shares when they were cheap, I massively increased the odds that any takeover would generate a profit rather than a loss.

Returns breakdown

The total returns over about nine 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.