Dairy Focus May 2012

    While the fall in the milk price of up to 2 pence per litre earlier this month sent shivers through the UK dairy industry, long term decisions such as whether to expand, contract, cease production or build new dairy units need to be based on the longer term prospects.

    The big questions

    • Is the fall in farmgate milk price a blip or will it be sustained?
    • Is my dairy enterprise competitive internationally in the long-term?
    • Can competiveness be improved?
    • Are there new opportunities to explore?

    Dairy Scorecard

    In order to rationally assess future prospects there are a number of basic farm considerations including:

    • pollution risk;
    • versatility of land;
    • cost of feed source (grass and distillers grain from ethanol manufacture reduce exposure to grain price risk and exchange rate);
    • size of unit (impacting not just on labour but also cost of milk collection). 

    In the short term, the specific contract with the buyer can have a major impact on profitability. However, headline figures may not be sufficient to determine best contract just on farm price. Contract ranking varies with seasonality and payments for milk solids.

    Most on farm structural issues can be dealt with although the solution will often require investment thereby increasing exposure.  There is often a temptation to make “sticking plaster” changes with the result that a problem is dealt with but long-term profitability is not improved.

    In some situations, joint ventures with other producers can lower costs and help supply capital. The return to each party should reflect risk and the level of investment.

    Vertical integration (linkage from producer through processor ultimately to retailer) can increase returns but it is not a panacea. The advantages have to be identified before putting arrangements in place.

    The advantages may be as simple as undervalued capital or shared promotion costs. The most satisfying supply chain joint ventures are where communication is improved so that the highest return overall is produced with an equitable division of the return between the participants. Inevitably, this will involve innovation in terms of products or business structures.

    There are also new grant schemes available that can help deal with some of the problems facing the sector.

    Key points

    • Farmgate milk price cuts of up to 2ppl on the back of weak commodity markets, further price cuts may follow in the summer
    • UK milk production has increased following a period of decline and the rate of increase in US, Australia and NZ has quickened
    • Weaker sterling could expose UK markets to imports especially from Ireland
    • Good profits are made when the cost of production is low.
    • UK market has some protection by virtue of the fact 50% of milk sales are liquid
    • Retailers have set up their own direct supply groups to secure supplies
    • Devolved regions are more exposed to CAP reform than England but may opt for coupled payments to avoid a producer exodus
    • Dairy farmer confidence will be eroded by falling milk prices which may slow reinvestment and expansion
    • Tenants face additional pressure from higher rents and low capital reserves 
    • Milk contracts are a key determinant of enterprise profitability

    For more information, read our full Dairy Focus factsheet.

     
     

    Key contacts

    Ashley Lilley

    Ashley Lilley

    Director
    Food & Farming

    Savills Cheltenham

    +44 (0) 1242 548 012

    +44 (0) 1242 548 012