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05/04/2016
There has been plenty written about the dramatic slump in the earnings and milk price outlook for Australia’s largest farmer-owned dairy company. I don’t wish to add to the newsprint or website column space on what, why or how that happened at Murray Goulburn. It is now fact, it can’t be undone, and there is little merit or therapy gained in maintaining the rage and spending time on recriminations.
What’s more useful is to consider the effect of this sudden downturn in available milk prices from MG on the Australian dairy sector as a whole, and on individual producers considering the market and industry outlook. The outcome has implications for almost every dairy farmer in the industry, who can expect milk prices in the coming years to be lower than what might have been in prospect if MG had managed to deliver on this year’s forecasts.
This event has a number impacts – on leverage, confidence and reputation – in that order. Leverage
“Leverage” in the context of dairy refers to the ability of a large farmer-owned milk buyer to positively influence milk prices paid by its competitors. In recent years, MG has focused on improving performance in milk prices, forcing its competitors to match or better it.
When the major farmer-owned buyer of milk has been weakened, effective leverage at farmgate can’t be sustained. Almost every dairy farmer in the eastern seaboard of the industry is adversely affected, in terms of available milk prices, by a weakening of the major co-operative.
In the short-term it seems that Murray Goulburn’s competitors will continue to honour milk price estimates for the current 2015-16 season which were made prior to 27 April. They will do this with some difficulty given the realities of the dairy commodity markets.
It’s the coming seasons that matter. Despite what will be claimed, with a 20-30c/kg milk solids finance charge against their largest competitor’s milk pool, Bega, Warrnambool, Fonterra and others will be under significantly less pressure to optimise farmgate prices – other than the need to ensure they can reliably collect enough milk for their business needs. That was the situation in the industry prior to 2013 and that will be the case for the next two seasons at least as the effects of this event are unwound. Confidence
Years of research into what mostly affects the confidence of dairy farmers have shown that a positive belief in the industry’s future depends on the outlook for milk prices. While MG’s balance sheet will be used to sustain most of the current season’s promised milk price, the prospects for the next few seasons matter most for producer confidence.
Dairy commodity prices drive the value of milk in the industry – despite lower industry exports than previously we are still inextricably part of a global market place. Dairy companies have different business models, product and market mixes – and different abilities to flex. Over time, some will do much better than others in outperforming the price extracted from a commodity manufacturing base – “adding-value” as it is unfortunately termed.
By our reckoning, the commodity value of milk is close to A$4.50/kg milk solids (kgms) in 2015/16. At present, with spot and forward prices in the market, the commodity value of milk is worth about A$4/kgms. We have trouble getting our estimate of commodity returns for the 2016/17 season to land above $5/kg milk solids. Dairy product prices – on average – will have to rise more than 15% (as a season average) to get there, but by 25% before we can be confident milk is worth more than $5.50 again. If the A$ falls – as currency punters are suggesting – that farmgate price result will be easier to achieve. Companies can and will add to this commodity return via their various activities. But it all comes back to what the biggest player can achieve, and how much of the strategy can deliver in additional income.
What are the chances of either of those market outcomes? On our present outlook, a recovery in dairy prices is gradually underway, but won’t really make any headway until early next year when slower growth in Europe and New Zealand ensures global export supply slips behind import demand. Right now, those supply and demand totals are running neck and neck currently, but stockpiles of powder and cheese are still building. Talk of the $A falling into the low US70c range has been going for ages, but recovering mineral commodity prices may work against that.
There has been an expectation created in Australia’s production sector that outperformance of the commodity value is readily achievable. In reality it is difficult for a dairy company with a large pool of milk to sustain that outperformance over time, but some have been very good at it. It needs a combination of outstanding management execution, high-quality assets and strong market and/or product and process innovation. Promising outperformance without consistently ticking all those boxes eventually leads to disappointment, despite the pledges and bravado.
What also unsettles confidence is a broken promise or shattered belief. Time and actions to ensure performance exceeds expectation will be required to fix that in the future. Some milk will move between companies, but overlaying shattered belief on difficult seasonal conditions and threats to irrigation supplies could shrink milk intake for the co-operative, making recovery harder.
But what of the confidence of investors – providers of debt and external equity? Investors in the dairy farm sector are always interested in the capacity for Australian processors to perform well on milk prices, and despite this latest stumble, comparisons with our neighbours over the ditch are still favourable. Reputation
The news of this event quickly went across the dairy world. I was in meetings with US and European industry participants in Chicago when news broke, and it quickly became the talking point of the event. All of a sudden the external perception of the Australian industry was in discussion.
Does this make Australian milk supply any less attractive to international customers? No.
Does it make them question the stability of milk production over time? Perhaps.
Does it mean we might figure less in their plans for securing a growing pool of high-quality milk supply in future? Maybe. This aspect of reputation won’t be enhanced in the short-term, but this also comes back to confidence, and whether milk producers can take stock, adapt and press on. Time will tell.
MGC Price at posting:
$1.13 Sentiment: None Disclosure: Held
