Dairy Industry – Crisis or Normal Commodity Cycles

By May 25, 2016 News

Opinion piece – Lachlan Polkinghorne ProAdvice

When organisations try to manipulate the supply/demand fundamentals someone generally gets hurt – it is regularly the farmer.  The wool industry has struggled to recover from the impact of the reserve price scheme in the 80s. More recently, Murray Goulburn (MG) have chosen to ignore the low global dairy price that was clearly evident and transparent in the world dairy markets over the last 12 months.

Speculation is rife as to the underlying motivation in the MG camp, and their delayed reaction to a low world milk price:  MG announced they had ‘changed strategy’ to value adding; MG had raised capital on the prediction of a $6/kg milk solids (MS) milk price; Production didn’t fall in other markets; and the $A didn’t keep falling.  Only the board and management really know why, with only the board left!

It is inexcusable to make payments to suppliers for 9 month and then announce ‘actually 10 to 15% of that income payment was a loan’.  Farmers had continued to make spending decision on cow numbers, feed and fertiliser, R&M, capital and personal spending based on a $5.60/kg MS price (that is likely to increase).  This spending will have added to the overall liability build up by the unsuspecting farmers and they also kept the milk churning out – exacerbating the problem.

It was inexcusable as there were clear signs that MG had concerns with ‘what was going on’ during the spring of 2015 but they doggedly marched on with the $6/kg MS rhetoric.  After pushing for new milk supplies in 14/15 MG stated in the spring of 2015 that they would no longer be taking on more suppliers.  The Global Dairy Trade price chart below shows that the world price was at its lowest since the GFC around July 2015 and has stayed low since then.

Milk price chart.jpg

 

Changes to the way companies set opening milk prices?

Regularly, the milk processors generally start the season with a conservative opening milk price. If projections move as expected the processors provide a mid-season step up and if there is an even better outcome than they expected, a further step up is provided.  On the very odd occasion the companies did move early in the season to step the price down, but limited the drop in price to the remainder of the production. In recent years there has been increasing processor demand with higher competition for milk suppliers.  This has been coupled with mergers and acquisitions and businesses capital raising to the market.

The combined impact of this, in my view, has led to a less conservative opening farm gate price which really got out of hand with the 2015/16 opening price.  The following inaction to lower the price early in the season when the global price didn’t recover has then led to the current crisis.

 

Fonterra had to follow suit

Fonterra have a supplier agreement which allows them to match their competitor’s price.  While Fonterra had been making it clear they couldn’t see how the prices could hold up during 15/16 they were also beholden closely to the MG price due to the supply agreement.  Once MG announced the price cut to farmers – back dated – Fonterra were in a very difficult place as to how to match the price.  Unfortunately they seem to have caused a lot of confusion with announcements of the price adjustments changing from day to day.

The whole saga throws a question over management decisions people make from a day to day perspective right through to longer investment decision. Farmers are left to ponder the failure of governance within organisations such as Murray Goulburn.

 

Where to from here?

There are stories of class actions, ASIC investigations and dairy farmers taking their tractors to town to protest.  While it may feel good to achieve retribution and potentially get some compensation, ultimately farmers will be biting the hand that feeds them, if they happen to be successful.  This is because while MG is not strictly a pure Cooperative their structure and milk payments are still very cooperative in nature.  At least the management of MG have fallen on their swords.

As a parallel, it will be interesting to see whether there is genuine change at the board level.   We hope that any review will focus on improving the processes of price setting and to prevent using  claw backs as a tool in the future.

History shows that milk prices can rebound quickly from periods of low price.  However, dairy farmers will need to take heed of MG’s slow reaction mistake.   Even if the immediate response is to ‘batten down the hatches’ to survive, the next step when prices recover is to strategically ensure the business is designed with a cost of production that can survive these periods of low milk prices.