Message in a bottle

Despite the outcry over the BSE crisis, there are plenty of good reasons for buying into the dairies

If there is little respite for the nation's cows from the vagaries of mad cow disease, its impact on the stock market, and especially Northern Foods and Unigate, the two big quoted dairy producers, has receded. After a fall of 10 per cent in their share prices when the scare broke in March, both have recovered some lost ground.

Even so, new imponderables for investors continue to arise. Last week Dairy Crest, Britain's third biggest dairy producer, and the residual business of the old Milk Marketing Board, announced its plan to float this summer. It brings a powerful new competitor to the quoted fray. Dairy Crest will be valued at up to pounds 275m, against around pounds 1bn each for its two rivals.

The news created a stir, as previous indications had suggested a flotation was still a year or two down the line. It also suggests Dairy Crest is confident the ruckus between the Government and Brussels over British beef - and any remaining BSE fall-out - will be minimal.

The Office of Fair Trading is still examining the workings of the milk market - one of the reasons Dairy Crest has sought a listing in the first place - to decide if Milk Marque, which sells farmers' milk to processors, constitutes a monopoly against the consumer. It seems likely that the OFT will decide not to refer Milk Marque to the Monopolies and Mergers Commission. Instead, it will try the gentle art of persuasion to convince Milk Marque to relax its grip on the market. Another problem, and one the OFT will only touch upon, is the artificial nature of the UK milk market. An unholy creation of the bureaucrats in Brussels and the National Farmers Union, milk production is strictly controlled by quotas handed down from the European Union. With inflexible supply, if demand rises, the result is either higher imports of dairy products, or a higher price for domestic milk.

Whatever the OFT decides, it should lead to a fall in the price processors pay for their milk - good news for Unigate, Dairy Crest and Northern. But there are still plenty of pitfalls. Investors must contend with the politics of food and the rampant media outcries these can generate, as both BSE and the baby milk scare have demonstrated.

However, there is no denying the quality of the Dairy Crest business, which boasts an enviable portfolio of consumer products. As well as Clover, a leading dairy spread, and Country Life butter, it also makes Frijj, the milk drink. A tie-in with Sodiaal of France, means it supplies the best-selling Petit Filous fromage frais.

Of the significant players, Northern Foods has fared worst in recent years. Its shares have lagged the FT-All Share index, as our graph shows, and investors have seen share value decline by more than 60p to 183p over the last three years. Much of the problems stem back to the decline in doorstep milk deliveries. Both companies have been squeezed between farmers on the one hand, and higher milk prices and supermarket price wars on the other.

But Northern has fought back. As well as thousands of job cuts, from milkmen to factory workers, it also took a pounds 90m restructuring charge at the time of its interim figures last November. Milk sales now account for 25 per cent of total sales, from a peak of 35 per cent.

Unigate, by contrast, has been far the better performer - almost bang in line with the market. Its fortunes have been helped by a protective cash pile and greater diversification. It owns a substantial transport and warehouse division, Wincanton, chiefly concentrated on foods and milk, and source of almost a quarter of group profits.

Hopes that Northern's restructuring strategy can pay off, however, look to be justified. Chris Haskins, its chairman, has yet to lose the respect of investors. The rate of decline in doorstep milk has slowed. And the industry as a whole seems to have reached the end of its investment in non-returnable milk - although there continues to be overcapacity in bottling and carton plants.

Dairy Crest's flotation will strengthen its hand against its two larger rivals. But the sector as a whole looks to be moving ahead to better times.

Of the two, Unigate looks to be fully valued. The upside, if there is one, lies with Northern. The fruits of its rationalisation are yet to show through in the share price, but the benefits should become clear in the next couple of years. Northern's price, however, reflects the view that growth will be lacklustre. As some compensation, the shares trade on a decent yield, while downside risk is minimal. Time to order another pinta; the shares are a buy.

Northern Foods Unigate

Share price 186p 402p

Prospective p/e 10.8* 11.1*

Gross dividend yield 6.0% 5.8%

Year to March 31

1994 1995 1994 1995

Turnover pounds 2.04bn pounds 1.97bn pounds 1.98bn pounds 1.89bn

Pre-tax profits pounds 157.2m pounds 16.4m pounds 102.4m pounds 58.3m

Earnings per share 20.51p 0.10p 31.4p 19.8p

Dividend per share 8.8p 8.8p 17.3p 18.2p

*NatWest Securities forecasts