An interesting takeover battle is under way in the Australian dairy industry that should be analysed by all those involved in the Irish milk industry.
Its unfolding asks important questions about how the sector in Ireland should prepare for the challenges and opportunities that lie ahead.
Warrnambool Cheese and Butter is now the subject of a three-way bidding contest that has pushed its valuations to astronomical levels. The latest bid, from Canadian dairy firm Saputo, values Warrnambool at 22x trailing Ebitda. To put this in context, most traditional dairy companies trade at Ebitda multiples of between 5x and 7x. The reason for the excitement — China.
A fast growing middle class and a rising appetite for dairy-based consumer products produces eye popping forecasts for the consumption of milk. Australia has become the fourth largest exporter of dairy products and, along with New Zealand, has geographic proximity to the world’s largest growth market for dairy products. A feeding frenzy among dairy companies and co-ops positioning for the Chinese future is under way.
For Ireland, this is a fascinating market development. We have some of the attributes those in charge of Chinese dairy policy covet, including; (1) clean grass-based production systems with high levels of traceability; (2) a long tradition of exporting safe milk products around the world, and; (3) none of the water or land availability issues that threaten other potential producers including parts of Australia and the US.
We also have a knack of establishing valuable relationships with key growth markets like China. Already China’s No 1 and No 2 leaders have been here and smelt the silage. These powerful decision makers are casting a warm eye over Ireland as a strategically important asset for the long term.
All of this is powerful stuff as 2015 fast approaches and the milk quota cap in the EU is removed. If Chinese demand continues to grow at this pace then output of dairy products will find a ready market. That is true, but we should not kid ourselves into confusing volume and efficiency as this process unfolds.
It is now reckoned that a commercial dairy farmer in Australia needs about a 200 cow herd to make a living. In New Zealand it is probably more and that is despite being close to China.
The fact is that despite dairy market volumes growing over time, the price at which that milk is being exchanged may not rise at all as various parts of the world, including Ireland, limber up for the future.
There are analogies in the air travel sector, another commodity like capital intensive industry. It’s volume (measured by air passengers) has grown remorselessly for the past 50 years yet average fares have not just stayed flat but have actually declined as technology, competition and new entrants have delivered a bigger market at lower prices.
So, if I was a shareholder in Warrnambool Dairy I would sell out to Saputo and find something better to generate wealth. And if I was an executive or board member in any Irish dairy concern, I’d be planning capital expenditure and expansion on the basis of growing volumes but turbulent pricing.
Finally, if I was a dairy farmer planning to participate in this growth process, it would be undertaken only with controlled debt levels that can absorb the inevitable price shocks.
We need to exploit all opportunities to grow the Irish economy and food is a key part of that process. However, we need to be clever too and engineering an expansion strategy that keeps borrowings under tight control ought to be the key objective. Anything less risks severe disappointment down the road.
Joe Gill is director of corporate broking with Goodbody’s Stockbrokers. His views are personal.
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