Interim results 2010: Financial overview

The Group has performed well in the half year despite significant challenges from the market. Group revenue is up 8.4% to £6.9bn, compared to £6.4bn in the first half of 2009. The year on year comparison of profit before tax is distorted by volatile or one-off costs and credits. These predominantly include the impact of financing adjustments on the fair value of financial instruments, last year’s profit before tax being enhanced by one off profits arising from the disposal of stores related to the Somerfield acquisition and integration costs associated with Somerfield and Britannia.

As a result, profit before payment to members (equivalent to the pre-tax profit of a plc) is £169.2m against £244.5m the previous year. However, stripping out the volatile one-off impacts (see page 14 for details), underlying Group operating profit increased by 14% to £307m (£269m) and underlying profit before payments to members is up 17% to £260m reflecting a strong core trading performance.

Our Food business delivered an excellent result given the difficulties currently being experienced by the market as a whole, and important contributions were also made by our Financial Services, Funerals and Pharmacy businesses. Our balance sheet remains strong and our cash position well managed. Our net debt of £1.4bn remains well within our agreed facilities, and is also lower than planned due to the excellent trading performance of our business, combined with tight working capital management. In CFS, total operating result was £109.3m, compared to £81.4m in the first half of 2009.

All the comparatives (excluding Financial Services) in the divisional results on the following pages are on an underlying basis and have been adjusted to reflect a 26-week period instead of the 28-week period which was reported in the last Interim Report.

Food

In flat and increasingly tough market conditions, our Food business delivered a strong performance in the half year, with sales up £406m (11.5%) to £3.9bn and underlying trading profit up £19.0m (12.6%) to £169.7m.

Like-for-like sales in the Group’s pre-Somerfield acquisition stores were up by 4.1%. However, as expected, this result was adversely affected by a fall in sales in Somerfield stores, caused by the unavoidable disruption that comes with large-scale integration. As a result, like-for-like sales for the total estate, including the results of the Somerfield stores post-acquisition, were down 1%. Nevertheless, like-for-like sales in the 2,500 stores refitted under the Co-operative brand, including Somerfield stores after conversion, grew by a healthy 2.5% over the period. The brand roll-out will be completed across the entire estate in the early part of 2011, delivering with it further benefits to the combined business.To date, over half of the Somerfield stores have been converted to the new brand, along with 88% of the pre-acquisition food store estate.

We are also reaping considerable benefits from our new found scale - 7.6% market share - with better buying terms being reflected in keener prices. When we acquired Somerfield we said that to be successful the integration needed to be done at pace – “one business within two years”. That is still our plan and we are on track to deliver it by Q1 2011.

The Somerfield acquisition has been a catalyst that has allowed us to perform a root-and-branch overhaul of the business, which can be seen in the implementation of a new workforce management system (itself a Somerfield learning) and the roll-out of a new store structure that will better segment the customer offer throughout the estate.

Other important developments in our Food business include the great progress we have made in our supply chain, which is currently in the midst of a consolidation that will greatly benefit the business long term, and the planning for roll-out of our SMART programme, which will see store replenishment and range controlled and managed centrally, thereby allowing store managers to concentrate greater efforts on customer service and on colleague engagement. We will also be introducing a range management tool which  we have developed from Somerfield. This will help drive real improvements across our own-brand offer.

Our Food business has also picked up a number of important awards in the half year, including being named Green Supermarket of the Year at the prestigious Grocer Gold Awards, beating off competition from Tesco, Ocado and Morrisons. We were also named Responsible Retailer of the Year for the third year running in the Oracle Retail Week Awards and beat a number of major competitors to scoop two Gold and three Silver Awards at the 2010 Grocer Own Label Food and Drink Awards. The British Sandwich Association made us the Sandwich Convenience Retailer of the Year 2010.

Financial Services

In a world where the traditional financial services model has been tested and found wanting, the Co-operative Financial Services (CFS) is proud to be different. As a member-owned, customer-led and ethically-guided business, CFS has increasingly differentiated itself by its prudent financial stewardship, its consistent approach to customer service and its concern for its impact, not just on customers but on communities and the environment as a whole. This ‘co-operative difference’ was recently recognised by the Financial Times in naming CFS the Most Sustainable Bank.

As a sustainable alternative to the traditional financial services model, CFS has shown itself well placed to capitalise on current market conditions. Over the last twelve months, following the merger with Britannia Building Society, CFS has successfully integrated two complementary businesses. An active integration programme launched in the wake of last year’s merger, has already delivered significant cost synergies.
Total operating result was £109.3m, compared with £81.4m in the first half of 2009, and represents an increase of 34.3%. These results reflect the merger with Britannia and the success of CFS in strengthening underlying profitability despite the challenges of the current economic environment. On a like-for-like basis (comparing 26 weeks of the first half of 2009 and including Britannia), CFS generated growth in both income and operating profits with costs held at 2009 levels. Impairment charges on a like-for-like basis (before fair-value credit protection) were 7.7% lower than 2009. Total impairment has fallen by 41.1% in 2010.

Underlying capital and liquidity positions remain strong, laying the foundations for stable growth. Customer deposits have seen excellent growth of £1.4bn (4.2%) in the first half of 2010, reflecting 97% retention of fixed-rate ISA balances and the attraction of significant new funds, whilst a customer-funding ratio of 110% shows a substantial increase (104% at December 2009). Customer lending balances have increased, reflecting CFS’ continued support to families and small businesses during these difficult times, advancing £1.1bn to mortgage customers and £0.4bn to businesses.

Retail operating result was £11.1m. Excluding the increased costs of project expenditure, which are expected to generate future benefits, operating result was 41% higher than 2009. Within Retail, the banking result was broadly stable year-on-year, despite the low interest-rate environment and the general insurance business has achieved a healthy growth in both gross written and net earned premiums (18.4% and 7.1% respectively). The long-term business, run solely for the benefit of policyholders, saw sales figures increase 5% in 2010 compared with 2009 levels, with new-business profitability reaching £8.5m compared with £4.1m in 2009.

Corporate and Markets (CAM) business profitability has more than doubled to £80.7m, an increase of £43.4m compared with 2009, driven by a significant improvement in underlying performance and the merger with Britannia. During 2010, CAM continued its focus on a balanced approach to lending and deposit growth resulting in £0.7bn of new customer lending and a £0.8bn increase in customer deposits. Impairment reduced to £10.4m, from £23.5m in 2009 reflecting the continued focus on credit quality across the portfolio.

During the first half of 2010, the strength of the retail customer proposition has once again been recognised by a number of awards. CFS was named a ‘recommended provider’ by Which? Magazine, and won multiple categories at the Moneywise Customer Service awards. The Co-operative Bank received the highest rating from the Forrester UK bank website benchmarking survey (beating NatWest, Santander, Barclays, Lloyds TSB and Halifax), while the Co-operative Insurance won the ‘Best Online Motor Insurance Provider 2010’ at the ‘Your Money’ Awards.

As UK consumers increasingly question the financial services ‘status quo’, CFS’ member-owned, customer-led and ethically-guided business model is well placed to establish itself as the UK’s most admired financial services provider.

Pharmacy

Pharmacy delivered an excellent result in the first half of 2010, with an operating profit before significant items of £18m which represents an increase of £3.7m (26.1%) year-on-year. We have made progress this year by improving our efficiencies and controlling distribution costs through the National Distribution Centre (NDC). Our new flagship branch in St Helens opened in March 2010, showcasing the future of community pharmacy. This not only strengthens our customer offer, but builds links with local GPs and surgeries which helps deliver a wide range of services to our customers. We plan to complete a further 17 relocations during 2010.

Once we have received approval from the Medicines and Healthcare products Regulatory Agency (MHRA) during 2010, our pharmaceutical generics manufacturing plant in China will go into production with a predicted output of approximately 650 million tablets/capsules per year. Our Pharmacy branches are expected to receive their first products before the year end.

The launch of the Co-operative Pharmacy Ethical Strategy highlights our dedication to go the extra mile to support the health of our local communities. It also demonstrates our dedication to not only support UK communities but looks to lend a helping hand on serious health issues in Global communities. For example our Unicef sanitation project in Togo and the Oxfam mobile phone recycling initiative which will see us donating £300,000 over a three year period.

Funeralcare

Funeralcare has delivered a good result in the first half of the year, with sales up by £10m to £167m and an operating profit before significant items of £32m, £4.7m (17.2%) higher than this time last year.

These results are down to good cost control, improvements to debt management but most importantly to the continued effort in providing the very best of funeral care to clients therefore building a strong reputation within the communities we serve.

Funeralcare’s employees are vital to its success and an internal survey showed that 97% of employees believe Funeralcare is a good business to work for. This year, Funeralcare launched a new position of Specialist Funeral Director, providing an exciting career opportunity within the industry.

Significant investment in the Funeralcare brand continues including TV advertising which was aired at the beginning of the year. This summer, Funeralcare attended several county shows, giving over one million people the opportunity to meet with the UK’s leading funeral business in an informal setting.

Funeralcare continues to innovate and has launched a new children’s book in partnership with bereavement charity Brake. The book is designed for children to read with a parent, teacher or carer to help them understand feelings of grief following the death of a loved one. The book has been distributed to hundreds of schools and secured regional and national media coverage. The book is available from Funeralcare branches across the country with over 2,000 free copies given away so far this year.

Specialist Retail Businesses

Travel

2010 has been arguably the most challenging year the travel industry has faced, resulting in sales falling 6.6% to £126m and with profit down 70% to £0.4m. The year began with the heavy snow that stalled the traditional early booking period, and continued with an earthquake in Chile, riots in Bangkok, civil unrest in Greece, BA strikes and finally the unprecedented volcanic eruption in Iceland, which brought the industry to a standstill for a week. Margins remain under pressure in what is a fiercely competitive market. Work on the Co-operative Academy at Brownhills in Tunstall, Stoke-on-Trent continues to progress well. The Academy sponsored by Travel, will open in the existing school buildings in September.

Legal Services

The Co-operative Legal Services is continuing to grow strongly, with revenues up by 24% and profit up by 11%, compared with last year. A key focus this year has been to develop our accident management proposition which we launched at the British Insurers Brokers Association annual exhibition in London in May, to great effect. Developing and maintaining a strong business-to-business pipeline is a key strategy for longer term growth, and we have continued to bring new clients on board, particularly in the financial services sector.

Life Planning

The Co-operative Life Planning (CLP) business continued to thrive, with operating profit of £3.2m, £0.3m up on the previous year. CLP is now the market leader in annual sales of Funeral Planning products, and is set to become the marker leader of ‘live’ Funeral Planning plans after more than doubling our ‘book’ in the past three years of business. The Funeral Planning market continues to show growth both from a sales perspective and just as importantly, in the number of interested distribution partners. The Co-operative Life Planning team continues to lead the way with product innovation to meet a broad range of customers’ needs.


Specialist Commercial Businesses

The four businesses in our Specialist Commercial Division – car dealerships, Sunwin Services Group, E-Store and Clothing – have delivered a good set of results, in spite of the challenges presented by the different markets in which they operate. Our car dealerships performed well in the midst of a volatile market, turning a loss last year of £0.2m into a profit of £2.0m this year. We expect the rebranding, which has seen the business’ 19 dealerships adopt The Co-operative brand will help drive further improvements towards the year end. Sunwin Services Group, which comprises CIT Services, ATM Support, E-Solutions, Sunwin Security and Aegis Guarding, has had a good first half, reporting an operating profit of £2.6m. E-Store has delivered an operating profit of £0.7m, a decrease of 18%. January was a tough start to the year with snow affecting sales and profit in a normally busy trading month. While the electrical sector is being affected by the recession, E-store has been working on several initiatives, including linking up with credit unions and extending ranges to ensure we have a strong second half performance. The Co-operative Clothing has recorded a profit of £0.3m compared to only just breaking even this time last year.

Estates

Our Estates business has come back well, following the challenges of the property market downturn with a trading profit of £9.1m. The underlying investment portfolio increased by £6.9m resulting in a half-year position of £311.0m. In terms of disposals, we have sold investment properties and surplus stores that have generated £79m of disposal proceeds for the Group. During the last six months, a huge amount of work has taken place with teams from across Estates, BAM, our first phase construction contractors, and the external consultants and design teams on the new head office in Manchester. We have also established a separate Property team for Food to ensure we are aligned to the strategy of the Food business, and are able to add value to that business – which means the right property in the right place, at the right time and at the right cost.

Farms

Our Farming business has delivered a solid result in the first half of the year with a profit of £1.3m, despite a significant number of challenges, largely as a result of extreme weather conditions. The packhouses, for example, had a strong start to the year, keeping Food stores in supply of potatoes despite the weather, with high sales recorded as a result of people using their local store to shop rather than hazard a drive in the snow. Blairgowrie lost some of its strawberry crop in the harsh winter frost which has meant a slightly later start in packing at Longforgan. The weather has been very dry this spring and we have been irrigating potatoes but there was little we could do with cereal crops and we were pleased to get the rain when it came. Cereals on heavy land have done better than on light land and we expect to see significant variability in yield. We have also seen extreme weather conditions globally which have driven up cereal prices and this may offset any negative impacts. Our Farms business has also planted 6,000 vines at Down Ampney which we plan to use to kickstart wine production in three years’ time.

Outlook

We have seen a period of extensive expansion and acquisition over the course of the last three years and, as a result, we now find ourselves in the midst of a period of integration and consolidation. All of the integration work currently under way will strengthen the business and cement our position as the fifth biggest player in the food market. The diversity of businesses that comprise the Group make for specific and particular challenges across a broad range of markets and this means that the effects of the recession have hit us in a variety of ways. As we expected, 2010 has been challenging so far, and we do not expect to see the signs of recovery until late 2011 at the earliest. Our focus is, as ever, upon our members and customers who are feeling the pinch due to the ongoing impact of the recession. Consequently, we have to be even more focused on delivering excellent value for our customers across all our businesses.