Business Irish

Tuesday 23 September 2014

Jim Power: Glanbia venture will open door to further expansion

Jim Power

Published 11/11/2012 | 05:00

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With the removal of milk quotas in 2015, these are heady times for the Irish dairy industry, writes Jim Power

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IN the middle of the economic gloom that has enveloped the country in recent years, one sector has stood out as a beacon of light: the agri-food sector.

It's a very diverse area that takes in many levels of activity -- from primary farming to artisan food production to multinational corporations and much else in between.

The real advantage of this sector is that the value added to the Irish economy is strong as a significant portion of the inputs are sourced locally and it has a high labour content. It makes a significant contribution to the national economy in terms of employment and output, but more importantly it is the mainstay of rural and regional local economies.

Pat Spillane, in his new role as chairman of the new rural economic development body, will hear a lot about the sector and its potential as he travels the country next year. Its relationship with tourism has to be an area of particular focus and one that Ireland is not exploiting to anything like the same extent as France or Italy.

However, perspective is needed. The agri-food sector is a tough business characterised by tight margins, intense domestic and external competition, consumer resistance to higher food prices, one that is subject to the vagaries of global commodity prices, and one that is a victim of the dangerous concentration that has been allowed develop in the grocery sector.

Notwithstanding the challenges facing the industry, it has been making headlines for all the right reasons.

Last month, Kerry Group announced the creation of 900 jobs in Co Kildare by 2016; Dawn Meats in Waterford has landed a major contract with McDonald's, adding 300 jobs to its workforce; and Glanbia has just opened a new €21m investment at its milk processing facility (one of the largest integrated dairy processing facilities in Europe) in Ballyragget, Co Kilkenny.

Glanbia has also engineered a diversified business model, with the food nutritional business and the dairy processing in the US helping to make it Ireland's most successful multi-national. Ireland has had too few multi-national successes, so Glanbia's exploits should be applauded.

The domestic landscape for dairy processors such as Glanbia is about to experience a dramatic change. In 2015, milk quotas will be removed and with them will go one of the main constraints to dairy production. The Irish dairy industry will then face the choice of continuing to produce the same quantity of milk as under the quota regime, or to increase production.

In the context of global trends in demand for dairy, particularly from developing economies, the dairy industry has decided to pursue the latter course. This appears to make sense in the context of a global economy that will need 70 per cent more food by 2050.

With strong natural advantages in food production (not least our international reputation), it would be remiss of Ireland not to seek to fully exploit this potential.

If one assumes that farmers will be able and prepared to ramp up milk production, the dairy processors will have to ramp up capacity to cope with the increased production. Of course, farmers would be best advised to expand in a prudent way and not take on too much debt in an environment where milk prices are likely to be more volatile.

It would not make commercial sense for Glanbia to make the investment required to increase processing capacity. The return on capital in the dairy part of the business is around 4 per cent, compared with a return of up to 16 per cent in the US nutritionals business.

Given Glanbia's responsibility to all its shareholders, investing €180m in dairy processing capacity would not make a lot of sense.

In recognition of this, Glanbia has proposed a somewhat complex joint-venture model to allow it expand its processing capacity. It is by necessity quite complex, because the interests of farmers, the Co-Operative Society, and the Plc shareholders have to be accommodated.

This week, farmers now have the opportunity to vote for the joint venture and sell 3 per cent of their stake, and then follow up by voting for the second proposal to sell a further 10 per cent, with 3 per cent going towards ensuring that Glanbia Society will become debt-free and a further 7 per cent to be shared among Society shareholders, to do with as they see fit.

Despite the reduction in the Co-op's ownership in the Plc from 54.4 per cent to 41 per cent, if both votes are carried, Co-op members will still be able to reap the potential rewards from the Plc's performance in higher-margin markets, and in addition, many may decide to hold on to the 7 per cent spin-off shares.

Furthermore, they are not taking on board all of the risks of the new joint venture as the Plc will still own 40 per cent of the joint venture.

Importantly, the Co-op will have the option of buying out the Plc's 40 per cent holding within six years. The pension liability of the joint venture has also been clarified, which is important given that this issue played a key role in a defeat of the proposal made two years ago.

If the joint venture is accepted by farmers, it is estimated that the new plant in Kilkenny would result in a boost of over €500m to the local economy by 2020 and add up to 1,850 jobs. This would be a welcome development, giving Glanbia's milk suppliers greater control over the product they produce.

Jim Power is chief economist with Friends First

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