Dairy processors face hard decisions

 

MOST of the major Irish dairy processors have now cut the milk price paid to farmers by 3p per gallon, and Golden Vale the only major processor not to cut prices yet is expected to follow suit this week.

But a cut of 3p per gallon will be insufficient to compensate for the slump in world dairy markets in the first half of 1996 and further substantial cuts will be required if the processors are even to maintain their margins, never mind improve them.

It will also present major problems for publicly quoted dairy companies, such as Avonmore, Waterford and Golden Vale, as they try to reconcile the conflicting interests of their co-members, who actually produce the milk, and institutional investors, who have, to a large degree, funded expansion since all these companies joined the stock market.

Analysts with Dublin stockbroking firms have warned that if current profit and earnings forecasts are not achieved because the companies are perceived as having paid too much for their milk supplies, then the attitude of investors towards the sector will become even more jaundiced and the current single figures earnings multiples in the sector will continue.

As Davy analyst Mr John O'Reilly has put it. "The co-op tail was at some point always likely to wag the plc dog."

The major milk producers in Ireland are Avonmore, Waterford, Dairygold, Kerry and Golden Vale, and by the end of this coming week all fly companies will cut their milk price for the peak production period by 3p a gallon.

But two of the companies, the Dairygold Co-op and Kerry, have indicated that no further milk price cuts are planned for the rest of the year an option that may not be available to Avonmore, Waterford and Golden Vale, which, unlike Dairygold, have outside investors to keep happy and who are far more dependent on dairy earnings than the likes of Kerry, with its far more broadly spread earnings base.

Golden Vale's chief executive, Mr Jim O'Mahony, pulled no punches at his company's annual general meeting last week when he said that the fall in world dairy prices is equivalent to a cut in the margins on each gallon of milk processed of almost 13p. Nobody seriously believes that milk prices will be cut by 13p a gallon, but the view in the industry is that the Golden Vale chief executive is preparing his milk suppliers for a sharp cut in their incomes for milk.

Today, the Irish Dairy Board is expected to go into detail on the fall in dairy prices since the beginning of the year. Last year, dairy prices reached record levels, accompanied by a corresponding record milk price for farmers. But mince the beginning of the year, the prices of key dairy commodities such as milk powder have fallen by 10 per cent. World butter prices have fallen 14 per cent from last year's peak and are now slightly below EU support prices.

Dairygold with no outside shareholders to satisfy has usually been content to accept some squeeze on margins and effected the subsidise the milk price paid to its members. That policy will probably continue this year.

It already has a strong balance sheet and effectively subsidising milk producers will have only a limited impact on the co-op's ability to spend on acquisitions and capital expenditure.

Kerry with well over half of its earnings coming from food ingredients has also traditionally taken a benign approach to milk prices and Denis Brosnan has already said that this month's 3p per gallon milk price reduction will be not be followed by other price cuts.

Kerry already enjoys a premium rating in the market and this will be only reinforced by the planned move to take the co-op stake down to 39 per cent though a £130 million share swap for its co-op share holders. "Milk price is largely, incidental for Kerry's earnings, one fund manager told The Irish Times.

But Avonmore, Waterford and Golden Vale have some fundamental decisions to make in the months ahead, especially as there are no indications that the current slump in world dairy prices will be reversed. At some stage, all three companies will have to decide on whether to cut milk prices further, a move that will be unpopular with their co-op shareholders but popular with investors.

If those hard decisions are not taken, then the old analogy of co-op tails wagging plc dogs will be voiced more frequently and the sector will be downgraded in the market. Difficult times ahead.