Milked dry

The global dairy industry’s rapid consolidation threatens to terminate any hopes of a major Australian player emerging.

Summary: Australia’s ever-shrinking locally owned dairy industry is in danger of missing out on huge supply contract opportunities in Asia, which are being snapped up by major offshore players including from New Zealand.
Key take-out: While the dairy industry can undoubtedly grow under overseas ownership, Australia will miss out on the taxable income and, moreover, domestic investors will have fewer avenues to profit from it.
Key beneficiaries: General investors. Category: Commodities.

The number of dairy assets being sold to overseas investors is picking up pace, adding to fears Australia is missing out on the growing appetite for milk products in Asia.

In the same week that Woolworths announced a key 10-year supply contract with New Zealand’s Fonterra, Italian-owned Parmalat Australia bought out privately owned Harvey Fresh, Western Australia’s biggest dairy exporter, for $120 million. Harvey Fresh produces about 130 million litres of milk a year, of which a quarter is exported.

The move is the last in a series of takeovers over the past few months: in February Hong Kong entrepreneur William Hui took control of United Dairy Power, Australia’s largest-owned milk processing company, for $70 million; and in January the much publicised takeover of Warrnambool Cheese & Butter (WCB) by Saputo was finalised.

In June last year Eureka Report highlighted how rising demand from China and record-high milk prices created an opportunity for Australian dairy companies to export larger volumes of milk produce and grow the industry in the years ahead.

Despite farm gate milk prices lifting 25% on last season and China lapping up more milk than ever since that article was published, Australia has failed to seize the opportunity, with milk production trailing slightly behind the volumes produced in 2012-13.

“We’re missing out in terms of having the quantity of product to sell and being able to maintain our share in [overseas] markets,” says John Droppert, industry analyst at Dairy Australia.

Australia exports roughly 40% of its total milk production, amounting to a 7% share in world dairy trade. But since our milk production has slipped almost each year for the past decade, our total exports have also declined.

Droppert says why milk production has suffered in Australia is “the million-dollar question”, but points to the deregulation of milk prices, adverse weather, poor cash flow in the industry, low confidence and increased debt servicing requirements for farmers. Following the GFC, farmers have been less inclined to invest in growing their operations, and domestic investors haven’t stepped in.

“We need a lot of foreign investment to help fund the future growth of our [dairy] industry because Australian investment community have a very short-term view and aren’t willing to put in patient money and look through the cycle,” says Belinda Moore, RBS Morgans’ senior agricultural analyst.

As Australia’s dairy industry has fallen in recent years, New Zealand’s has thrived. Though New Zealand has also experienced drought, it still managed to lift its market share of dairy exports to 36% from 15% in the last 10 years. Further, its production is expected to grow 6-8% this season.

New Zealand has benefited greatly from a federal government that has made a concerted effort to maximise the country’s dairy potential. Its free trade agreement with China, for example, effectively means it has to pay half the border tariffs Australia currently pays. As a result it has seen a six-fold increase in the total volume of dairy exports to China, while Australia has only experienced modest growth.

Meanwhile, Woolworth’s new partner Fonterra, which produces 90% of New Zealand’s milk, told the market in January that it can’t increase production enough to meet Chinese demand, particularly for milk powders.

While China is currently responsible for 33% of the growth in demand for fresh milk globally, it’s responsible for 80% of whole milk powder growth. Not only is there a shortfall of supply in China, but the growing middle class are more inclined to buy imported products, particularly infant powder. The relaxing of the ‘one child’ policy is expected to boost demand even further.

And New Zealand’s dairy market alone cannot fully capture this growth. Droppert says much of the marginal cost of expanding dairy further in the country is always increasing, and there are issues surrounding nutrient run-off and community opposition to dairy development.

The question posed by Eureka Report in June last year is still relevant: Can Australia seize the opportunity to significantly expand its dairy market?

“Australia is in a good position to be one of those countries that can step up to take this next level of demand out of Asia,” Droppert says.

But whether that dairy will be Australian-owned is another matter. Rather than growing, the number of Australian dairy companies appears to be shrinking. While the dairy industry can undoubtedly grow under overseas ownership, Australia will miss out on the taxable income and, moreover, domestic investors will have fewer avenues to profit from it.

Without a dairy giant of our own, it’s getting to the point that even Australian retailers are awarding contracts to international companies.

Woolworths' contract with Fonterra enables the New Zealand dairy producer to supply private label milk to its supermarkets for the first time after a competitive tender. Woolworths also awarded a 10-year private contract to Parmalat in Queensland.

After Saputo’s takeover of Warrnambool, Bega Cheese (BGA) remains the last listed company on the ASX solely focused on dairy. But unlike Warrnambool, Bega doesn’t have as much exposure to the international dairy market. Further, Fonterra already has a 9% stake in the company.

Separately, Murray Goulburn dairy group has its own ambitions: It was also a losing bidder for Warrnambool Butter. However, as a cooperative company, Murray has severe restrictions in any plans to become an international player.  

In summary, the global dairy sector is having its moment in the sun, but Australia’s residual dairy sector – which never produced a Fonterra or a Parmalat – looks at severe risk of being left in the shade.

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