Seeing John Lydon, formerly Johnny Rotten in the Sex Pistols, the popular beat combo, fronting a £5 million television advertisement for Country Life butter may be hard to stomach, but the stock market found a profit warning from the butter’s heavily indebted producer even worse. Shares in Dairy Crest fell by more than a quarter yesterday as the mid-cap food producer said that full-year earnings would miss forecasts.

Like its rival Robert Wiseman Dairies, which last week said much the same, the company is being squeezed by falling ingredients prices. Dairy Crest converts surplus liquid milk into skimmed milk powder, which it sells commercially, but with the price of that powder having fallen 25 per cent over the past three months – in line with a retreat in other commodity foodstuffs – last year’s returns will be hard to match.

There are other woes. Dairy Crest is starting to feel the effects of the consumer downturn. Although volumes and sales of its branded foods are holding up well, the company is anticipating tougher times by spending more heavily on promotional and marketing activity, which is hitting margins. Elsewhere, Dairy Crest’s doorstep milk business is being hurt by customers’ belt-tightening. Underlying volumes have fallen by 10 per cent since May, when it last raised prices. Finally, the group has supplemented profits of its dairies division by selling surplus properties for residential redevelopment – an option that is temporarily untenable, given the state of the housing market.

Not all was gloom. Six of Dairy Crest’s brand categories are showing double-digit sales growth; its UK spreadable butters, chilled yoghurts and flavoured milks are growing three times as quickly as their markets, or faster. Further, although Dairy Crest’s net debt has risen to £490 million – against a stock market value of £325 million last night – it should start to fall, with capital expenditure reverting to the level of depreciation after completion of heavy investment in a new cheese-packaging plant in Nuneaton. That also implies that the dividend is also safe for now. Having been maintained at the half-year stage, the shares now offer a prospective full-year yield of 10.2 per cent.

The problem for investors is that profit growth has stalled. Indeed, once property profits are stripped out, the company’s dairies business had a small first-half loss on sales of £540 million. Secondly, there is reason to think that, despite the strength of its branding, Dairy Crest’s cheese profits could come under pressure from increased European milk supply.

Tempus advised “avoid” at 478½p after Dairy Crest’s previous profit warning, in March. Even at 243½p, or only five times forecast earnings, the company’s high financial gearing and strained bottom line suggest that this advice still holds good.

Cable & Wireless

If there was a surprise in the first-half results from Cable & Wireless (C&W) yesterday, it was not in the telecom carrier’s decision to postpone its demerger but in its raising of full-year forecasts.

In contrast to the alert from BT Group last month, C&W said that it continued to trade strongly and had nudged its earnings estimates towards the top end of consensus. Operating profits in the six months to September 30 were up by 26 per cent to £357 million, and the interim dividend was raised by 13 per cent. The shares gained 5 per cent, extending their outperformance against both the stock market and the sector.

How long can that strength be maintained? John Pluthero, the chairman of Europe, Asia and US, contends that the cost savings that C&W can offer its corporate customers mean that recession should be a stimulus for his division. Should that prove not to be the case, C&W has the scope to offset any weakness in revenues through further cost reductions in the wake of its Thus acquisition. C&W’s international business, which offers mobile and fixed-line services from Macau to Monaco, is more directly vulnerable to slowing GDP growth. Here, C&W is benefiting from an appreciating US dollar but first-half cashflows were surprisingly weak.

C&W boasts a strong balance sheet, a highly incentivised management team and a solid 6.1 per cent dividend yield. However, at 142p, or 15 times current-year earnings, there will be better times to buy.

Dignity

A week after Service Corporation International of the US gave warning on profits, Dignity – the British quoted undertaker from which it was spun off – proved it could still provide the sort of predictability for which its investors are paying. Revenues in the year to date are up 9.6 per cent, with operating profits ahead 10.5 per cent. Current trading in the fourth quarter remains in line with forecasts.

Apart from that consistency, the encouragement must be that Dignity’s long-running efforts to expand its crematoriums division through local authority outsourcing are beginning to pay off. It has finally taken over the running of Rotherham’s crematorium and cemeteries and is the preferred partner for a similar deal in Weymouth and Portland. It also continues to buy privately run facilities, as shown with yesterday’s bolt-on purchase in Scotland.

So far, there is no evidence that families are choosing lower-price funerals, or that demand for pre-paid packages is dropping off. That leaves higher energy prices as the only immediate pressure on profitability. Tempus advised “take profits” at 740p in August. With the shares having since fallen back to 609½p, up 36p yesterday, or a more reasonable 14 times 2009 earnings, long-term investors should buy on weakness.

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