OVER the past 10 years, the £50 billion European dairy industry has reduced farm sizes, built up larger dairy herds and higher milk yields. But, according to a detailed report from ABN/ AMRO Hoare Govett an associate of Riada Stockbrokers "the European dairy industry is fundamentally fragmented and intrinsically incoherent".
The report states that the European dairy sector has been sheltered from the rigours of the free market by the EU quota and price support system, but that CAP reform in the face of GATT and EU enlargement "will act as the catalyst of continuing restructuring of the milk processing sector".
As well as analysing the industry, the report also looks closely at the 16 publicly quoted companies involved in the dairy processing sector, including three Irish processors - Kerry, Avonmore and Waterford. Kerry is one of the five companies given a "buy" recommendation by ABN/ AMRO, mainly because of the group's success in broadening its base in food ingredients away from basic milk products. Just 23 of Kerry's total sales come from dairy products, the lowest proportion of sales in the entire sector with the exception of Unilever.
Both Avonmore and Waterford, which derive 55 per cent and 80 per cent of their total sales from dairy products are given "hold" recommendations. The report suggests, however, that both Avonmore and Waterford should benefit from a recovery in their British liquid milk margins in 1996, while their domestic dairy interests confront more difficult bulk product markets.
The focus of the ABN/ AMRO report is "Raiding the Added Value", but the report states bluntly that European dairy processors have not been particularly successful in adding more value to their product base, with the exception of value added cheeses.
"There has remained a huge reliance on the basic commodity products, such as liquid milk, butter and milk powder," says the report. It adds "Too many processors, and notably the co operatives have been too concerned with handling the raw milk and insufficiently focused on how to build new end product markets.
"Yet the opportunities in international markets are real. Even in domestic markets, there is substantial scope to lift sales of added value, branded short life dairy products," the report states. As milk prices in the EU progressively fall to world levels ABN/AMRO analysts believe that it will be the major branded players who will benefit most from lower input costs.
Trade patterns in the sector are expected to change with a progressive shift towards the developing markets, although Western Europe, Australasia and North America will continue to dominate world exports. "This will mean that the EU share of world dairy markets, historically above 50 per cent, will fall to below 45 per cent by the year 2000, mostly to the advantage of Australia, New Zealand and the USA (the major net beneficiaries under GATT)," says the report.
Noting that the dairy market is dividing into low value commodity products where growth prospects are poor on higher value added branded products, the report warns that co ops have a particular problem because their nonprofit making traditions have often resulted in a lack of financial know how and resources. "Many (co ops) are still heavily skewed towards the more vulnerable commodity end of the dairy products spectrum," the report adds.
"Changes in this area are already leading to some co operatives and unlisted enterprises making radical changes to their capital structures, becoming more market orientated and producing more added value products. This, in turn, will change the weaker brands of the listed dairy manufacturers."
The report warns that pressures on company profitability in the sector will grow. "In general, too much milk is being processed by businesses which have little choice but to carry on. Fresh dairy processing presents fewer barriers to entry due to its relatively low capital intensity while much of the commodity processed product is unbrandable."
