Dairy Crest positioned itself potentially to extend the round of consolidation in the UK dairy industry as it unveiled a $540m deal to sell its French spreads business to Montagu Private Equity.

The UK dairy group said it had "agreed in principle" to sell its St Huberts operation to Montagu, whose diverse portfolio also includes the UK's College of Law, retailer Maplin Electronics and waste group Biffa.

The proceeds of the E430m ($540m, £344m) deal will initially be used to reduce the Dairy Crest borrowing, a move which Panmure Gordon said would "virtually eliminate" its net debt.

However, Dairy Crest said that it was stopping short of buying back loan notes, and entrenching its low-debt position, in order to retain the financial flexibility to expand its UK foods business, owner of brands such as Cathedral City cheese and Country Life butter, and its flagging dairy operations.

'Synergistic acquisitions'

"Dairy Crest will consider a range of options, taking into account the interests of all stakeholders," the group said.

Mike Allen, the Dairy Crest chief executive, said that this could include takeovers, with the funds meaning the group "will be able to consider a wide range of opportunities, including synergistic acquisitions in the UK".

The UK dairy market has already witnessed two major deals this year, with the takeover of Robert Wiseman Dairies by Germany's Theo Muller group, while Milk Link has merged into the Nordic-based Arla Foods empire.

The takeovers come against a backdrop of weak margins for dairy group, which have been stuck between supermarket pressure to squeeze out lower prices for hard-pressed consumers, and relatively resilient farmgate milk values.

And, indeed, many investors believe the group will pursue an acquisition further down the value chain, of a branded foods producer.

Milk price cuts?

However, there are signs that the pressure in dairy may be easing, with dairy farmers braced for a fresh wave of price cuts.

"It is expected that Wiseman this morning will announce a reduction in the price paid to farmers for raw milk by circa 1.7p," Panmure Gordon analyst Damian McNeela said.

"We would expect both the other major processors, Arla and Dairy Crest, to follow suit shortly."

Shore Capital's Clive Black said: "It is our view that prices could fall further in 2012, much to the chagrin no doubt of dairy farmers."

'Returns frankly inadquate'

Furthermore, a revival in dairy commodity prices has lifted prices of the cream produced as a byproduct from skimming milk, and an important part of processors' revenues, while lower oil costs have cut pressure on the plastics used for packaging.

Meanwhile, Dairy Crest itself has been attempting to boost the performance of its dairy business through measures including focusing on price over volume in sales, and closing two factories, a drive viewed "encouraging" by Shore Capital.

"The margins remain low, and the returns frankly inadequate on the capital that is required to compete in the difficult liquid category," Mr Black said.

"However, progress is been made to build profits, those profits may appear more quickly than we first thought."

Share reaction

The sale of St Hubert, which Dairy Crest bought for roughly £250m in 2007, was welcomed by Panmure Gordon, which lifted its target for the group's shares to 385p.

"Given the transformational effect on the balance sheet and low implied rating of the business post completion, we upgrade from 'hold' to 'buy'," Mr McNeela said.

Dairy Crest shares stood 0.6% higher at 330p in morning deals in London.