A problem with an active imagination is that issues of the the day trigger a stream of images and metaphors. It becomes a bit like that song in your head that won't go away. When I think about Warrnambool Cheese and Butter and Murray Goulburn the image that won't go away is the Goddess of Justice. Now in no way do I presume to be wearing the flowing robes. It is the WCB shareholders that are in that are holding the scales and the sword, and my guess is they are almost certainly wearing the blindfold as well.
So what is it that makes WCB so important, and especially to Murray Goulburn and the Australian dairy industry. The answer lies in their growth and success against the background of a declining milk pool.
- WCB has paid the market price or more for milk
- They have grown their milk supply and production capacity
- They have been routinely profitable
- They have had successful partnerships with overseas and local manufacturers
- They have (until recently at least) enjoyed good relationships and strong support from their milk suppliers
When I last checked WCB was processing close to 900m litres of milk. They are one of the few companies that can boast significant increases in the past 10 years and are now a substantial force in the western district of Victoria, one of the few regions of Australia where the supply base has been growing.
WCB's underlying financial performance and management capability has allowed them to list on the stock exchange and disconnect their capital base from the traditional co-operative structure. It was a big thing for the Australian dairy industry - a dairy industry asset that we could all share in and a public financial barometer of the Australian export dairy industry. Students of the history of WCB would know that this listing was not exactly driven by the public interest but it hasn't been a bad thing with both shareholders and farmers continuing to prosper.
It was all going swimmingly well until Management and Board got just a bit ahead of themselves and forgot that the foundation of their success is their milk supply. The informal contracts between farm suppliers and processors, and the surplus factory capacity in Victoria, allows milk suppliers to switch factories quickly and easily and, with one stroke of management genius, they did, in droves. But never mind that. The old guard were put back in control and WCB is back on track onwards and upwards to a brighter future.
And then along came Jones, slow walking Jones, slow talking Jones, and Jones (AKA Murray Goulburn) are getting just a bit tired of being the draft horse of the Australian dairy industry. All of those milk suppliers who ran for cover to MG when WCB dropped the price, and then promptly ran back when WCB promised to pay and not do it again - they will have stirred the giant somewhat. I can imagine some strong words traded between MG's hard working, long suffering, loyal co-operative suppliers and their hard working, long suffering, Management and Board.
Perhaps it is the recent history that has stirred the slumbering giant, perhaps financial imperative, or perhaps threat of another foreign invader at the door of the Australian dairy industry. Irrespective, MG has been driven to action and they have taken a more direct and aggressive approach than ever before - going more than once to the table with an offer and, when rejected more than once, committing their precious capital to a hostile purchase of the maximum shareholding allowable.
There are lot's of reasons why WCB is strategically important to MG and clearly the opportunity is serious enough for MG to drive the share price to double the value of a year ago. But what does this all mean for WCB shareholders and their milk suppliers, and why is it so important for the industry in general. Well, in my humble opinion, it is the last ditch stand between farmer co-operative influence over the Australian dairy industry and big foreign capital ownership.
In the past 10 - 12 years the battle for the hearts and minds of dairy farmers and their co-operative assets has been won by overseas capital and their cash. The list of dairy co-operatives lost to private capital is compelling:
- Bonlac - taken over by Fonterra NZ
- Dairy Farmers processing and retail brands acquired by National Foods / Kirin
- Warrnambool - Publically listed and exposed to purchase by the highest bidder
Other major dairy assets that have gone to overseas capital are:
- Peter's and Brownes WA to Kiwi / Fonterra
- Roll up of domestic milk businesses by Parmalat
- Roll up of domestic milk and cheese businesses by National Foods who have subsequently been bought by San Miguel and then on-sold to Kirin
To add to this list - Tatura has failed as a co-operative. Control of the company and the assets is still in the hands of Australian farmers but it has been taken away from those that supply the milk. There is also an argument that sale of downstream brands and marketing to overseas interests makes co-ops captive to those interests and not truly independent.
There has been a massive change in the structure and ownership of the Australian dairy industry. Murray Goulburn is the only dairy co-operative of any scale that has been able to survive the ravages of economic crises and resist the lure of overseas capital (and the strings attached).
So what? Perhaps the overseas capitalists are better at running these businesses anyway. Maybe so, but for me the balance of the argument rests on three simple and indelible facts:
1) The asset base of the farms that supply a milk processing factory is 4 - 5 times the asset base of the factory itself.
By way of example, WCB has a Total Asset base of about $240 million, and Equity of about $100m and a Market Capitalisation of about $170m. The 900 million litres of milk going into WCB will be coming from farms with and asset base of somewhere between $800 million and $1 billion. Add to this huge amount of investment going into businesses that supply and support the farms and you have a very big iceberg with WCB just the little bit that sticks out of the water.
2) The defining difference between a co-operative and a private or publically listed milk processor is about who Management and the Board are working for.
- The primary interest and responsibility of Management and the Board of a farmer co-operative is to maximise the returns and long term wealth of the farmer co-operative owners.
- The primary interest and responsibility of Management and the Board of a private or publically listed business is to maximise the returns and long term wealth of shareholders
So in our example of WCB, a co-operative Manager and Director would have a direct responsibility for more than a $ billion of assets and the associated businesses and community linked to this. The primary responsibility of Management and the Board of WCB as it stands today, and as it certainly will be if taken out by overseas interests, is to the shareholders that own the $100m of equity on the WCB balance sheet.
3) Milk price is the most important determinant of the profitability of dairy ingredient business
This is what Management and Boards think about all the time. In the case of a co-operative - how can I pay as much as possible? In the case of a private business - how can I pay as little as possible?
Our WCB case study is a fascinating example of this dilemma for Management and Board. In the 08/09 season WCB opened strongly - ahead of the rest - a bold statement to the milk suppliers and the market. When the world crashed in late 2008 they followed the MG milk price down but because of their strong opening price were still well ahead on average (about 4 cents per litre). It was a mistake. They got the numbers wrong. And when they tried to correct this later in the season it was too late - the business was almost destroyed by the flight of milk suppliers to other processors. The pricing decision was reversed and suppliers returned and the loser was the WCB shareholders. The loss incurred by WCB in 08/09 was equivalent to the price premium they paid for milk - and that mistake cost the CEO and the Chairman their jobs.
Make no mistake about this final issue - Murray Goulburn sets the milk price in Victoria and the benchmark for the rest of Australia. Every other trader and major processor is trying to work out exactly how much more they need to pay to maintain their short term and long term milk supply. The responsibility to their shareholders is to get this right and not pay one cent more.
For the dairy farmers in Victoria, and indirectly throughout Australia, the fate of their milk price, the farm profitability, and their livelihood is in the hands of Murray Goulburn. If MG cannot maintain a dominant position in the milk supply market, and run an effective and competitive export business, then control will shift to the owners of the processing capital. It won't be a complete disaster if this happens but things will be never be the same again.
So choose wisely and well Warrnambool Shareholders, the fate of the Victorian, and Australian Export dairy industry may well be in your hands. And while you think about this, hold the image of the Goddess of Justice in your head. The birthday party with pinata and the game of pin the tail on the donkey just isn't going to cut it with the next generation of Australian dairy farmers.