Milk start-ups take on Fonterra

In less than three weeks fledgling dairy exporter Synlait will fire up its new plant at Dunsandel south of Christchurch.

About the same time Dairy Trust's new factory at Awarua, near Invercargill, will start production with the Affco-offshoot planning to open three more plants in Taranaki, Waikato and Northland in the next few years.

Also in Southland, another new dairy entrant, Mataura Valley, aims to be processing 200 million litres of milk by the 2010-11 season at a planned factory outside Gore while back in Canterbury the Russian-owned New Zealand Dairies will this season ramp up production at its plant at Studholme near Waimate.

The arrival of this new crop of dairy exporters means that for the first time since it was formed in 2001 Fonterra is facing a significant challenge to its ability to continue growing its local milk supply and by extension its capital base.

But are the new processors just the first wave of increasing non-Fonterra investment in dairy processing in New Zealand or is the window of opportunity that has allowed them to set up already starting to close?

John Shaskey says the high international demand and prices for dairy products, the deregulated New Zealand environment and the country's strong dairy brand will drive more investment.

After 30 years of working for Fonterra and its predecessors, culminating in his role as Fonterra's managing director of ingredients, Shaskey left the co-op last year to set up Global Dairy Network a dairy trading and consulting business.

In his new job he consults to Mataura Valley and is helping to develop international markets for all of the new dairy companies. "Fonterra will still by far and away be the biggest player in New Zealand," Shaskey says.

"But you are going to see the establishment and it may not necessarily be the ones that are here now of some reasonably strong competitors to Fonterra."

All the current new crop of dairy companies have significant foreign shareholders and Shaskey says there will be more offshore investment in processing in New Zealand.

"The brand value that New Zealand's got in the international dairy market is very significant. People will invest in dairy in New Zealand to be part of that brand."

More locals setting up dairy-processing operations is also likely, says the NZX. "There's a high level of interest," says NZX markets development manager Geoff Brown.

"In the last couple of weeks I've had conversations with three potential dairy companies interested in raising equity capital," he says.

"Two of those would be of a scale that they'd be looking at NZX listings, raising amounts in the tens of millions of dollars, while the other is smaller and looking at an AX (New Zealand Alternative Market) listing."

All three groups are ones not currently on the radar, Brown says.

Fonterra currently collects around 95 per cent of New Zealand's milk but Shaskey expects this to erode over time as new companies set up and expand.

"I don't want to be unduly harsh on Fonterra but I think they could actually end with something in the order of 70 per cent in five to 10 years. That's not an unrealistic expectation in the longer term."

But Federated Farmers' vice-president, Frank Brenmuhl, says that while the current crop of new dairy companies will probably do well future new entrants will find it more difficult.

"Within a fairly short space of time we are going to see some constraints on newer players coming in which have not been on the ones which are currently setting up," he says.

"Every one of these companies we've got now has come in around the time Fonterra's fair value share price was around $6.80," he says.

The recent sharp drop in Fonterra's share price to $5.57 changes the picture in that it means that Fonterra shareholders don't have to pay so much to increase the amount of milk they supply, Brenmuhl says.

Fonterra's competitive response to the new companies and possible changes to the Dairy Industry Restructuring Act (DIRA), currently under review, also look set to make the going harder, he says.

At the moment, under the Act, Fonterra is obliged to supply competing processors with 50 million litres of milk a year each. This effectively gives new entrants a leg up in getting established and was aimed at ensuring Fonterra did not have an indefinite monopoly in sourcing New Zealand milk.

Synlait Milk general manager John Roberts admits it would have been tough for Synlait to get established without the DIRA milk even though it owned some of its own supply.

"It would have been difficult because we would have been fighting with the big guy to get the milk and you've got to get your milk before you get funding and start a project."

The DIRA obligations are finite, meaning Fonterra ceases to have to supply competitors once a certain amount of milk is being processed by independents. With the current expansion plans of the new players this is likely to be about five years away.

But 2013 is a long way off, says director of Fonterra milk supply Barry Harris.

"Our shareholders have a real difficulty in what the government is trying to achieve with the DIRA regulations. They are creating a non-level field in the name of competition. We're giving a free ride of these companies coming in and regardless of whether that comes off in a few years time that may be too late."

In response to long-running complaints from Fonterra the Government is currently reviewing the DIRA regulations looking at whether Fonterra should have to provide milk to start-up companies and also looking at what price should be paid for the milk.

Fonterra claims the current system means competitors get its milk at a subsidised price but this is rejected by Open Country Cheese director Wyatt Creech.

"I think Fonterra has been quite successful in its PR campaign to convince people that this is cheap milk," he says. "If you say something often enough it tends to take on some truth. But it's actually the farm-gate milk price and I think it's demonstrably meeting that test."

As well as seeking a change to the DIRA Fonterra is aggressively defending its milk supply from its new competitors.

"The main approach is reinforcing the importance of the Fonterra story and the value to our shareholders in remaining with Fonterra," Harris says, "and also making sure we are performing as an organisation and paying a milk price that gives confidence that staying with Fonterra is the right thing to do."

But the co-op is also expanding its use of tactical pricing paying more to contract suppliers in areas where there is competition. This is currently the subject of a Commerce Commission investigation after a complaint from Open Country Cheese.

Fonterra is also allowing some farmers to partially supply it on a contract basis meaning they do not have to buy more value shares to increase production. "We will pay variable prices where milk is in danger of going to a competitor," Harris says.

He admits that this is putting pressure on Fonterra's basic premise of paying the same milk price to all of its farmers no matter where they are but says: "We will have to look at everything we can do to protect our supply base in New Zealand moving forward."

 

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