Blue chips beat dairy blues with A-brands and innovation: Rabobank

On a multi-year basis, such firms as Nestlé, Danone and Emmi had managed to increase margins significantly, Rabobank’s analysts said (in ‘Global Dairy Outlook: Show Me the Money!’), which more than offset a small decline in asset turns.

As a result the financial services provider said that ‘FMCGs’ had boosted their return on capital employed (ROCE) by 200% since 2006, increasing the “performance gap”​ between themselves and the rest of the pack, with the exception of Southeast Asian companies.

Authors Tim Hunt, Hayley Maynihan and Mak Kern picked out the latter (Alaska Milk, Dutch Lady, Ultrajaya, Vinamilk) as the “darlings of the global dairy industry”​, which despite low value-add products and heavy reliance on imported dairy commodities, had almost doubled ROCE in the four years to 2010.

Their success, Rabobank said, was due to skillful by margin increases by leveraging a high market share, successful roll-outs of lower cost product lines, and occasional trading-up to successful in higher margin products such as growing-up milk.

Value-added products​

Rabobank said FMCGs had focused over many years on value-added products, which meant that raw material costs accounted for a lower share of sales than most other dairy businesses, and also limited the impact of the first commodity boom.

“The fact that they had also been refining their product portfolios to focus on A brands left FMCGs less exposed to private label competition,”​ the authors wrote.

Between 2006 and 2010, FMCG players continued to trade up further, Rabobank said, and since many of them were major multinational businesses had the ability to invest heaviliy in product innovation and then roll out such innovations over a broad market base.

“They have also invested heavily in rapidly growing developing markets such as Southeast Asia and limited their exposure to maturing products and regions, building lead positions in the most profitable markets,”​

Finally, Rabobank said, FMCGs had successfully stripped costs from their businesses to defend Earnings Before Interest and Tax (EBIT) margins.

Elsewhere, cheese makers (examples within the category include Saputo, Glanbia, Milk Link) were hit hard during the 2008 recession as they battled to pass on cost increases, while asset turns shrank as sales volumes fell and inventories jumped.

But in general, between 2006 and 2010 rising EDIT margins had offset reduced asset turns, driving a 160% ROCE improvement.

Rabobank attributed this to lower operating costs (with bigger firms investing in larger, more efficient plants), logistics and supply chain improvements and better use of whey byproducts following price surges in 2007.

Liquid milk challenges​

As the “most challenged”​ sector across a range of countries in the last four year, liquid milk processors (Dairy Crest, Dean Foods, Parmalat), were at the sharp end of problems facing the dairy industry as a whole, the authors said.

These included rising retail power, private-label penetration, maturing markets and constraints on innovation.

Since raw milk accounted for a high share of sales value, there was significant exposure to rising milk prices in the sector, while processors had to negotiate margins with “extremely powerful retail customers”,​ Rabobank said.

“Since milk is a heavily commoditized product with ‘traffic building’ potential for retailers, private label penetration is high and rising in many countries, with retailers willing to periodically drop own brand prices to loss-making levels to attract customers.”​

Falling sales volumes in saturated markets such as the US and Japan made it difficult to achieve efficient asset utilisation, the authors added.

Strict regulations on what was classified as milk in most countries also meant that processors had little wriggle room when it came to altering milk to improve functionality, nutritional profile and flavour, Rabobank said.

Survival strategies included consolidation to reduce costs and increase market power, a ‘cost plus’ model in dealings with retailers and the buying-in of alternative or rival product lines, such as organics and soy, almond or rice milks.

Developing markets dominate​

Rabobank said it saw a future for dairy characterised by solid market growth dominated by developing markets – China, India and Southeast Asia are tipped to account for 80% of volume growth – with many dependent on outside assistance to supply sufficient product.

This would sustain an era of trade growth and provide opportunities for farmers, traders and processors in export regions, Rabobank said.

Tim Hunt, global dairy strategist, Rabobank, said: "Tapping into emerging market growth will present a particular challenge for many of the world's dairy processors, most of which are domiciled in, and still focused on, the EU and US markets"​

Economic, demographic and dietary trends meant that cheese sales, for instance, would grow more slowly in volume terms than the broader dairy market, Rabobank said, where it predicts 2.4% annual sales growth over the next five years.

“With sales of higher-end whey products hitched to a faster moving wagon, the strategic value of ‘whey pools’ is rising rapidly, justifying a re-evaluation of ingredient production and sourcing strategies,” ​Rabobank said.