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KPMG study reveals profit issue at co-ops

The low profitability of the Irish processing sector may force it to switch to a different milk pricing system.

This is one of the conclusions that can be drawn from the KPMG study of the dairy sector that is to be finally revealed to leaders of the Irish dairy industry at an ICOS meeting in Portlaoise tomorrow.

The €450,000 study was commissioned in the wake of the Food Harvest 2020 report which set out a target of a 50pc increase in output for the Irish dairy sector. It selected 17 'peer' processors from Denmark, Holland, Germany, France and New Zealand to benchmark Irish milk processors' performance.

In a copy of the report's key findings seen by the Farming Independent, the authors state that "profitability in the Irish dairy sector appears low compared to international peers". It points to the seasonality of grass-based milk production systems and the resultant dependency of the industry on low-margin products as the main reason behind the relatively low revenues per litre processed.

However, the figures reveal that the gross margins are similar for co-ops selling either high revenue or low revenue products. The gross margin in both cases tended to range from 6-7c/l in 2009.

According to the report, while most of the peer companies studied internationally managed to turn a profit in 2009, Irish dairy processors on average showed a loss for that particular year.

The low margins in the sector will be the key challenge for the future expansion of the industry, according to the report.

Poor margins may also be responsible for the low marketing and R&D spend in Irish dairies compared to international competitors.

This has "hampered growth in value added products" for the sector, but the report also notes that this implies a "potential future upside" if reversed. While the authors stopped short of stating how these issues could be addressed, it did make some key observations. It notes that Ireland has one of the lowest "densities of milk production" in terms of milk output per hectare of farmed grassland compared to its biggest competitors, indicating huge scope for the expansion of the dairy sector. The number of cows/ha in Ireland is currently a sixth of that of New Zealand, according to the report.

It also points out that Irish processing costs are "relatively low compared to peer countries", at a forecasted average of 6.7c/l for last year.

In addition, the authors say that with milk prices paid to farmers comparable to those across Europe, "grass-based production should provide a higher return to Irish suppliers [farmers]".

Reflecting this milk-price/supply-cost scenario, the report concludes that the industry has "derived key benefits from the co-op model".

However, it adds that because of product mix and high export dependence, Ireland would be better suited to the "competitor/market model" for milk pricing. This model, which mirrors that employed by Fonterra and Friesland Campina, would return a milk price based purely on international auction prices and what competitors in other countries were paying.

The report took more than six months to complete, largely due to delays in some processors supplying information. It's noted that the "analysis of balance sheet information has been undermined by the lower level of response to this part of the study".

Despite this, KPMG was still able to identify a huge variation in the performance of the 13 Irish processors taking part.

Operating profit in 2008 ranged from 3pc to a loss of 19pc in the case of one co-op. While this gap has halved since then, the figures show that while most co-ops made a profit last year, some still made losses of up to 6pc.

The seasonality of the sector is highlighted as one of the reasons why the return on investment in the processing sector was "sub-optimal for all but a small period of the year". Ninety percent of processing capacity is used at peak production during last year. This figure is closer to 43pc for the six-month period from October to March.

"There is a requirement for the industry to find solutions to this challenge, which would have favourable consequences not just on production and usage metrics but also to the associated financing needs," the authors concludes.

The report also notes that there are significant pension deficits in many of the defined pension schemes operated by the co-ops.

Indo Farming