Merger with Arla – Milk Link Secures Stronger Future for Farmer Owners

The proposed merger between Milk Link and Arla has been warmly applauded by dairy industry watchers, and rightly so.

Against a background of ever stronger retailer power, increased globalisation by major players with turnovers in the £billions, and a realisation that dependence on commodity markets usually means erratic profits it was becoming more and more obvious that Milk Link, a company with sales of around £700m operating in one country and without the benefit of strong brands, was unlikely to deliver the returns that investors deserve. And so it has proved. For years Milk Link’s price to farmers on a pence per litre basis has consistently languished near the bottom of the league table.
The merger with Arla means that Milk Link is allying itself with strength.  Arla, as has been pointed out is big, innovative and invests heavily in the industry. It is also highly commercial and unafraid to take the tough decisions in order to provide the best returns to its farmers as shown by its announcement last week that it intends to cut its cost base by some 500 million Danish Kroner to ensure it remains competitive.

No doubt there will be tough decisions ahead in the UK as the two businesses are streamlined, eliminating over capacity in production and duplication of ack office services such as administration, finance and IT.

The Arla Milk Link move follows aquisition of Wiseman by German company Mueller and it will force remaining companies in the dairy industry to examine future strategies with some urgency. First Milk will need to do some hard thinking, and even relatively strong Dairy Crest, which is publicly quoted and therefore more in the spotlight will be facing close questioning from investors.

The existence of larger, well capitalised, forward thinking processing companies selling higher added value products should result  in bigger profits. With that should come increased returns to farmer owners, and not before time.

Strong Brands Win Again - Dairy Crest Outperforms Robert Wiseman

Half year profit results from Robert Wiseman and Dairy Crest once again show the perils of being a one product, one sales channel company operating in a commodity market.

Wiseman’s who sell only fresh milk saw pre tax profits drop by 42%, from £20.2m last year to £11.8m, on a turnover which climbed by 1%. The profit problems arose because the price they paid to farmers rose three times this year, and energy bills rocketed, but supermarkets, on whom Wiseman depends for nearly all their sales, refused to pass these costs on to consumers. Indeed many will recall that retail prices have been slashed of late.

By contrast, Dairy Crest who sell big brands such as Country Life butter and Cathedral City cheese alongside fresh milk reported a profits rise of 9% on a revenue increase of 2%.

Its just as well that Dairy Crest has these brands.  Profits in their dairy division which sells the milk saw profits plummet by 89%, from £10.9m to £1.2m, a shocking performance which puts the fresh milk supply problem into sharp relief.

By contrast profits in the cheese division jumped by 32% due to higher selling prices, and butters and spreads profits grew by 16.5%.

For whatever reason, Wiseman seems to have held a the difficult milk situation together better than Dairy Crest,  possibly because of scale (Wiseman supplies about a third of all fresh milk). But as previous blogposts have indicated, the Wiseman story continues to be a tale of erratic performance, and it is difficult to see how their current business model of one product and one sales channel can be made reliable and sustainable.

Some investors point to their strong cash position, and much has been made of their new venture with New Zealand company A2 which may deliver innovative products such as a more easily digested milk for those who think they have a lactose intolerance. Then again though, Arla seems to have solved this issue with Lactofree.

Dairy Crest with its brands, its presence in cheese, butter, and spreads as well as raw milk, and its sales through more than just supermarkets seems better able to deliver the steady, predictable performance that suppliers, customers and investors like to see.

Dairy Crest v Wiseman – Where Would You Put Your Money?

Dairy Crest and Robert Wiseman Dairies have just announced annual results. Both process huge quantities of milk (2.1 billion litres for Dairy Crest and 1.6 billion for Wiseman) but their business models could not be more different.

Wiseman supplies only fresh milk, sold mainly under a retailer’s own brand name. Dairy Crest is diversified, selling fresh milk, plus cheeses and spreads. It owns well known brands such as Cathedral City and Country Life, it also processes for retailers' own brands, and is present in France as well as the UK.

A glance at this years results might suggest backing Wiseman. Its sales were up 4.5%and profits up by nearly 60% although this is flattered by some one off benefits. It has very low debt, and strong cash flow.

Dairy Crest saw sales fall 1%, with profits before exceptional items up 5%. Debt is being paid down but is still £337m.

Investors responded by marking Wiseman’s shares down 1.8p to £481.5, Dairy Crest’s shares rose 8.9p to close at £362.5p. Those into share movements will know that Wiseman sells on a higher multiple than Dairy Crest, but even so, it’s an odd reaction.

Backing a company is not about the past though, it’s all to do with likely future performance.

So, if you like the sound of a diversified portfolio where poor performance in one segment can be offset by better news in another, or if you feel that brands are best, despite requiring huge advertising and promotional spend, because they give you more control than being at the whim of a retailer contract renegotiation, and debt does not scare, then Dairy Crest is for you.

If on the other hand you are confident that the company supplying retailers’ own brands is the lowest cost producer in the market place and so cannot be undercut on price, that it has the management talent to read the market place and anticipate where the major retailers are likely to want to introduce own label versions of a product, and the company has sufficient cash to invest in the new technology required, then Wiseman is the way to go.

Both companies have been successful with their chosen business model. Dairy Crest announced a 9% rise in sales of their 5 major brands, and chief executive Mark Allen, being interviewed about the results, made a point of stressing that diversification is good as the cheese division had a very difficult year whereas dairies performed well, conversely he reckons that over the next year cheese will recover but dairy struggle.

Wiseman competes effectively in the own label supply market, having increased share of liquid milk from 28% to 31%. It seems to be valued by retail partners, winning several “best supplier” awards, and chosen by Tesco to process its filtered milk competitor to Cravendale.

However, there are issues with both. Having already got 31% of a low growth market it is difficult to see how Wiseman will continue to expand its revenue, and Arla’s billion pound processing plant may mean that Wiseman loses it lowest cost supply status and struggles to defend what it already has. The company acknowledges the challenge of growth but feels the way through is to supply higher margin, more profitable products.

Dairy Crest’s 9% growth in sales for its key brands disguises the very heavy costs of advertising and promotion. The issue of costly promotions was addressed in my blog post in January, and work done by Bidwell’s Agribusiness on behalf of Dairyco shows that in the year to March 2009, 73% of Cathedral City was sold on promotion, 52% of Clover, and 60% of Country Life. They too face stiff competition from global dairy processors.

Despite the issues there is room for both business models in the short term, and longer term too, possibly helped by sensible pursuit of mergers and acquisitions.

Pricing Power - A Tale of Two Companies With Lessons for UK Milk Coops.

Two dairy companies reported profit results in the last few days and the difference between the two is stark. Robert Wiseman gave a profits warning for 2008. Dairy Crest oozed confidence and said it will have another good year.

The make or break factor is the ability of each company to implement price increases sufficient to cover the huge rises in costs they both face. Basically, Dairy Crest has managed to get price increases through to the customers it supplies, but Wiseman has not. A Wiseman spokesperson said "We are operating in a very tough market at the moment, and in a tough market it takes a while to negotiate a settlement from your customer base." They declined to say exactly how much of their rising costs they had passed on so far. Dairy Crest said "To date we have been successful in implementing price increases to our customers", and Mark Allen their Chief Executive added that he was confident the company would be able to pass inflation costs on to retailers "as and when" it became necessary.

Whilst Dairy Crest is bigger than Wiseman, and operates in spreads, yoghurts and cheeses as well as liquid milk, the difference in pricing power between the two companies boils down to brands and spread of customers.

Dairy Crest has built big brands which consumers want to buy like Cathedral City Cheese, Utterly Butterly and Country Life. Brands like these can go up in price without much impact on sales, but if prices did go up too far and consumers buy less, Dairy Crest has the option of reducing them through promotions. They are in control. Contrast this with Wiseman who sell almost all their products under supermarkets' own brand names, and face the problem of supermarkets being reluctant to put prices up in case they lose their reputation of offering their customers good value for money. Wiseman has no control over what the supermarkets do.

Yes, Dairy Crest supplies milk under supermarket brands too, but I'd bet that when it came to price negotiations, Dairy Crest got alot less of an increase, if any, on liquid milk than they did on their brands. What they will have done is hike up the price of their own brands much higher than on supermarket ones, and ensure on average that costs were recovered. Wiseman does not have this flexibility and has suffered.

Dairy Crest is further helped by selling not just to big supermarkets but to smaller stores and door step delivery where it is easier to pass on increases. Wiseman has 70% of it volume going through the big supermarkets, and has less than 1% of its business through doorstep. Again it lacks flexibility.

And the lessons for Milk Coops? They need strong brands and a spread of customers. At present they are individually too small to afford to build brands and a broad customer base. They need to merge, and use the cost savings to invest in the market place. Just like Friesland and Campino with 5 times the farmers operating across three countries have managed to merge.

What is it with our Coops that they find this so difficult?