Milk price crash can only signal an increase in tempo for the slow dance of dairy processing marriages
The collapse in milk prices has hit dairy processors and farmers hard. With further price falls likely, the pressure for rationalisation of the sector will intensify
Published 15/05/2016 | 02:30
Two years ago the Irish dairy sector was on a roll. In 2014, the processors paid farmers an average price of 36 cent per litre for their milk. With EU quotas, which had capped annual Irish milk output at 5.4 billion litres since 1984 due to be lifted at the end of March 2015, farmers and processors geared up for a massive expansion in dairy production.
Things haven't quite worked out as planned. Sanctions on Russia for its aggression against Ukraine and economic uncertainly in China mean that the new Russian and Chinese customers upon whom the Irish dairy sector was relying to consume all of the extra milk we would produce after the end of quotas have failed to materialise.
The result has been a rout. Dairygold cut its milk price by a further 1 cent to 23 cent in March while Glanbia, the country's largest dairy processor, paid 24 cent a litre (including a 1 cent subsidy from Glanbia Co-op) for April milk - the prices paid by the processors to farmers are slightly misleading, as they are inclusive of VAT at 4.8pc, which adds just over 1 cent a litre at current levels. And milk prices are almost set to fall even further.
The latest EU figures show that European milk powder prices fell by between 6.2pc and 7.9pc in the second half of April, cheese prices were down by another 1.6pc and butter prices by 1.4pc. Most analysts now reckon that market returns for milk are now down to 20 cent or even lower with the processors having to dip into their reserves to make up the difference.
Seamus O'Donohoe, chief executive of the co-ops' representative organisation ICOS, reckons that his members spent €100m supporting milk prices last year. Dairygold, the largest fully farmer-owned processor, spent €20m of this. And the cost keeps adding up. A Glanbia spokesperson says that the Glanbia co-op will spend up to €30m supporting milk prices this year.
Propping up milk prices in this way is at best only a temporary measure. Even the best-managed processors have only limited reserves and once they have been spent, they're gone. As one seasoned observer of the dairy sector observed: "You can't eat the same meal twice." The euphoria which surrounded the abolition of quotas just 14 months ago is now just a distant memory.
Earlier this month, ICMSA president John Comer called for the introduction of "voluntary" milk supply reduction schemes, which sound suspiciously like quotas, in Ireland and other EU countries.
According to Mr Comer, it costs farmers 28 cent to produce a litre of milk even before the cost of their labour is included.
"This just can't go on and policymakers telling farmers that this is simply a trough in the market, to cut costs and to restructure loans to survive is simply pointless. Repayment capacity has been wiped out and even if loans were restructured, many farmers simply cannot survive at these prices levels. What we need is a viable milk price that, at a minimum, covers the cost of production".
While the processors' situation is not quite so desperate as that of the dairy farmers, it is still pretty grim. Propping up the prices it paid to farmers reduced Dairygold's 2015 operating (pre-interest) profits by almost one-third to €19.2m.
While most of the Irish dairy processors are farmer-owned co-ops, two of the largest, Kerry and Glanbia, are corporate hybrids with the original co-op retaining a significant shareholding in the PLC - 13.7pc at Kerry and 35pc at Glanbia. In addition, ownership of Glanbia's Irish milk processing assets is split 60:40 between the co-op and the PLC.
This hybrid structure hasn't always found favour with co-op purists but it has indisputably generated enormous wealth for the original farmer co-op shareholders. A Kerry spokesperson points out that the co-op's remaining PLC shareholding has a market value of €1.9bn. That doesn't count the seven spin-outs of PLC shares to co-op members since 1993. Kerry reckons that another 30pc of the PLC's shares, worth another €4bn, are held in what it calls the "broader community" in counties Kerry, Limerick and Clare.
It is a similar story at Glanbia where the co-op's remaining PLC shareholding is worth €1.7bn and where co-op shareholders received shares worth more than €170m in last year's share spin-out.
Which is what makes last week's dramatic events at Kerry so intriguing. On Tuesday, news broke that the Kerry CEO Stan McCarthy had stepped down as chief executive of the Kerry co-op. This was the first time since Kerry floated on the Stock Exchange in 1986 that the PLC chief executive wasn't the co-op boss also.
When we contacted Kerry for comment on Mr McCarthy's resignation from the co-op, we were assured that all was sweetness and light. "Stan stepping back from the co-op has nothing to do with our commitment to farmers," said the spokesperson, who pointed out that the co-op had nothing to do with collecting, processing or paying for milk.
"Stan will continue to be available to all shareholders and milk suppliers," he said.
Nothing happening here, move along folks.
Then on Thursday, the Farmers Journal, which can usually be relied upon to get these things right, ran an obviously well-sourced story that a mediator had been appointed to resolve a dispute between the PLC and farmers over the Kerry milk price.
According to the Journal, the milk suppliers allege that Kerry is not honouring its commitment to pay the "leading" milk price in Ireland and that the Kerry milk price is 1.4 cent a litre lower than that paid by Carbery, the dairy processor owned by the four West Cork co-ops.
Whatever the rights and wrongs of the matter, the dispute makes one thing clear: If even the mighty Kerry - by far the most successful and diversified of the Irish dairy processors - is feeling the strain from the milk price collapse, then no-one is immune.
Dairying is a cyclical business. The last price collapse in 2009 was almost as severe as the current one. However, this trough has lasted much longer than previous dairy busts. Since peaking in early 2014, European butter prices have halved, milk power is down almost 60pc while Cheddar cheese prices have fallen by "only" 45pc.
And there seems so to be no end in sight. In fact, things could get even worse before they get better. US dairy exports have doubled over the past five years. About 15pc of US dairy output is now exported, with plans to increase this to 20pc by 2020.
This could be very bad news for Irish farmers and dairy processors. The full impact of the milk price collapse wasn't felt until mid-2015 when most of that year's milk output had already been collected and processed. This year will be different, with farmers pressuring processors to subsidise a full year's dairy production. Having already spent up to €100m propping up milk prices in 2015, the cost to processors could be even greater in 2016.
If they are forced to do so then the implications for many processors could be extremely serious indeed. It is no secret that, compared to most other major milk producers, Ireland is seriously over-endowed with dairy processors. As well as a "big four" of Glanbia, Kerry, Dairygold and Lakeland there is a plethora of second-tier processors to handle a 2015 milk output of 6.4 billion litres.
By comparison almost 95pc of New Zealand's annual milk output of more than 19 billion litres is processed by just one company, Fonterra. It is a similar story in other major dairy producers such as the Netherlands (12 billion litres) and Denmark (5 billion litres) where just one company, FrieslandCampina in the Netherlands and Arla Foods in Denmark, processes the vast bulk of total milk output.
The continuing survival of a multiplicity of Irish dairy processors bears more than a passing resemblance to what has been happening in the health service where the political imperative of keeping local hospitals open often trumps best medical practice.
"The name over the door and who is in control is still very important," observes one long-time dairy analyst.
As a result of these strong local loyalties, consolidation in the dairy processing sector has tended to be a very slow and gradual process. Aurivo (formerly Connacht Gold) took over Donegal Creameries in 2012, Glanbia purchased Wexford in 2013, Lakeland acquired Fane Valley's dairy processing business earlier this year while it is no secret that Dairygold boss Jim Woulfe has been casting covetous eyes at the neighbouring Arrabawn co-op.
A sustained period of lower prices could dramatically speed up the pace of dairy processing consolidation. A Lakelands merger with Aurivo has long been mooted while Dairygold's Arrabawn tie-up could finally be consummated.
However, the process of consolidations almost certainly needs to go much further than such incremental deals. Other second-tier processors including Carbery and Centenary will almost certainly find themselves participating the dairying's very own version of musical chairs.
Also likely to find itself in the mix is Ornua, formerly the Irish Dairy Board, whose executive pay levels recently attracted unfavourable attention. While there was a clear need for a co-ops' co-op to sell Irish dairy products in export markets when there were dozens of dairy processors, might not a future single super-processor decide to do the job itself?
With farmers, farm organisations and banks all likely to pile on the pressure, dairy consolidation is only getting started.
Sunday Indo Business