Not for years have Britain's leading dairy firms been so chirpy. After suffering the pains of retrenchment and restructuring, the market has turned in their favour and profits are looking up. Even so, analysts worry about the new chirpiness in dairy boardrooms.
Much of the about-turn in financial fortunes has been due to changed market circumstances which may not be long-lasting. Also, plans of the Milk Marque dairy farmers' co-operative to expand into processing could pose potential threats to the profitability of dairy firms.
Strong improvement in dairy profitability has been reported in the interim financial results from the quartet of British companies in the sector. Dairy Crest, the farmer-controlled company de-merged from the old Milk Marketing Board, lifted consumer foods profits by 14 per cent to £14.7 million on sales up on barely changed turnover of £224 million. Unigate increased its fresh foods profits by £5 million to £31.5 million on the back of higher profits earned on spreads, yoghurt and cheese. Dairy profits rose 11 per cent to £19.5 million.
Northern Foods lifted its dairy profits by 26 per cent to £27 million even though sales declined 7 per cent to £374 million reflecting further price deflation. Mr Robert Wiseman, the leading Scottish dairy concern, increased its operating profits by 38 per cent to £8.75 million on turnover increased by a similar amount to £125 million, partly due to first-time contributions from acquired businesses.
Avonmore/Waterford, which has extensive dairy businesses in the north-west and midlands of England, does not give a breakdown of the contribution from this part of the business, but industry analysts believe that Avonmore/Waterford's results from its British dairy business should at least be in line with the British companies. Most attention, however, will be on how the Irish group rationalises its British dairy business after the merger.
Much of the improvement in financial returns in the dairy industry has been due to the benign trading environment brought about through the combination of sterling strength and weakening of Milk Marque's pricing influence.
Raw milk prices have fallen significantly. Indications are that Milk Marque's realised prices in the current year to next March will have fallen by around 15 per cent compared with 1996-97.
Crucially, say dairy sector analysts Mr Alan Erskine and Mr John Parker at NatWest Markets, it is "extremely unlikely that dairy processors will see anything like this scale of decline in the price of their finished goods". Their analysis of trends in different parts of the sector spells out the potential for gross margin improvements.
None of the dairy companies has reduced the price of milk delivered to household doorsteps, while cream prices having weakened in the second half of 1996, are now firming.
This is only partly the result of sterling "coming off the boil". Demand for cream and butter in Europe is buoyant at present.
The market for skimmed milk powder remains relatively weak with the product trading at or around intervention levels. With the intervention price being ECU-denominated, however, any weakness in sterling will lead to some modest price increases.
It is, however, in the supermarket area that battle lines are being drawn between the various British-based dairy processors. Northern Foods chairman, Mr Chris Haskins, has publicly opted to pass on the falling raw milk prices to the supermarkets to put pressure on some of the "loose cannons" in the industry which has little choice but to follow suit.
In reality, the NatWest analysts suspect Northern's actions have not matched its public rhetoric and some expansion in gross margin may have been eked out. Immediately ahead, the NatWest analysts agree with the companies that the benign trading environment should continue for some months.
Further on, the benign combination of sterling strength and Milk Marque weakness is unlikely to continue to the same degree, leading to marked slowing in dairy profits growth. Another factor of growing concern is Milk Marque's move into processing in response to its inability to clear all its milk through sales to the dairy industry at its minimum prices.
Increasingly, companies are using direct purchases from farmers at a premium over Milk Marque prices to meet most of their requirements and only making "top-up" purchases from Milk Marque. This led to the bizarre "coals to Newcastle" situation where Milk Marque has exported surplus milk to Ireland to be processed on its behalf. Most of the dairy companies, including Avonmore Waterford, now source over one-third of their milk supplies directly from farmers.
In the autumn just gone, Milk Marque alarmed dairy firms by moving directly into processing through the acquisition of Aeon Valley Cheese in South Wales as the base for developing a processing business to take around 15 per cent of its milk.
The Milk Marque processing move has caused consternation among dairy companies. The Dairy Industries Federation, which takes in most of the major processors including Avonmore/Waterford, has called on the Office of Fair Trading to refer the Aeron Valley acquisition to the Monopolies Commission and has urged the European Commission to prevent Milk Marque from expanding further into processing.
Official intervention is unlikely to be quick. Dairy companies therefore have reason to worry that Milk Marque will rapidly expand its processing capabilities at a time when the trading environment becomes less benign. In such a situation, the ability of the dairy companies to operate with the minimum cost will be crucial.
Most in the industry believe that of the six or seven sizeable dairy processors in Britain, at least two are likely to withdraw from the market. The Danish group, MD Foods, is thought to be becoming increasingly disenchanted with its British business.
If there is a shake-out in the British dairy industry, Avonmore/Waterford will be hoping to expand its market share. The Irish company currently has 15 per cent of the British national milk pool and an estimated 10 per cent of the trade with the major multiples.
