The Dairy Sector in New Zealand Extending the Boundaries October 2020 www.tdb.co.nz CONFIDENTIAL DRAFT TDB Advisory Limited L5, Wakefield House 90 The Terrace P.O. Box 93 Wellington New Zealand Email: [email protected] Principal contacts for this report: Philip Barry Hannah Pattullo [email protected] [email protected] 021 478 426 022 075 5081 Disclaimer and disclosure: Table of contents This report has been prepared by TDB Advisory Ltd (TDB) with care and diligence. The statements and opinions given by TDB in this report are given in Executive summary ............................................................................................ 3 good faith and in the belief on reasonable grounds that such statements and opinions are correct and not misleading. However, no responsibility is accepted History of dairy in New Zealand ......................................................................... 4 by TDB or any of its officers, employees, subcontractors or agents for errors or Economic significance of the industry ................................................................ 5 omissions arising out of the preparation of this report, or for any consequences of reliance on its content or for discussions arising out of or associated with its Regulatory environment ..................................................................................... 6 preparation. Growing competition in the dairy sector ............................................................. 8 TDB advises a range of companies in the agribusiness sector and its directors Competing corporate strategies ....................................................................... 11 are investors in and are on the boards of a number of dairy companies and other Competing organisational forms ...................................................................... 13 agribusinesses, including suppliers to Fonterra, Miraka, Synlait and Westland. Future challenges ............................................................................................. 15 Share price data in this report is updated to September 30, 2020. In most cases Conclusions ...................................................................................................... 16 financial results and market share data is provided up to the 2019 financial year as that is the latest year for which results for all companies are available. Annex 1: OCD and Synlait ............................................................................... 17 TDB Advisory Ltd The Dairy Sector in New Zealand: Extending the Boundaries 2 CONFIDENTIAL DRAFT • the different companies have focused on and added value for the Executive summary economy at different parts of the “value chain”. Open Country, for example, has been highly successful at manufacturing and exporting base-ingredient cheese and milk powders while, at other end of the The dairy industry has long played a significant role in the New Zealand “value chain”, companies like The a2 Milk Company and Synlait have economy. Currently the sector accounts for around 20% of New Zealand’s developed B2B or high-end brands and distribution channels; and exports and around 3% of GDP. • there is also competition for corporate form, with no single model (eg, The industry is highly exposed to international competition. Several of New co-operative, listed companies or private companies) proving dominant Zealand’s largest and, in some cases, most successful firms operate in the across the sector. sector. These companies include majority farmer-owned co-operative Fonterra, publicly listed companies The a2 Milk Company and Synlait, privately owned Competition for milk at the farmgate has increased gradually over the last two companies Open Country Dairy and Miraka and several overseas-owned decades, with Fonterra’s market share falling from 96% to 81% of the 21 billion processing companies. litres of milk now produced each year. Nationwide, around 74% of farmers now have access to more than one processor to take their milk. The structure and performance of the industry in New Zealand has changed significantly over the last few decades and has been heavily influenced by Looking ahead, there are numerous challenges facing the sector. These government policy. In particular, the Dairy Industry Restructuring Act, 2001 challenges include the international economic ramifications of COVID-19, higher (DIRA) sought to promote a “national champion” for the dairy sector, Fonterra. community expectations for the environment and changing technologies and At the same time, DIRA removed the single-exporter status of the NZ Dairy consumer tastes, with the competitiveness of new artificial products like synthetic Board. This effectively deregulated dairy exporting by permitting dairy milk as yet unknown. processors to sell their products on international markets. The dairy industry will need to adjust and adapt to meet these challenges. But As a national champion, Fonterra has fallen well short of expectations. Industry the openness of the sector to international competition, the range of different leaders projected that Fonterra’s revenue was to grow at 15% p.a. to $30 billion corporate strategies and structures and the ability of the sector to innovate and by 2010 as the company diversified into high-value consumer products. In reality, adapt mean it is likely to be well placed to continue to expand its production revenue has grown by less than 2.5% p.a. and the company has had to write- frontier and to play a major role in the New Zealand economy. down millions of dollars from unsuccessful overseas investments. The deregulation of dairy processing and exporting however has proven successful: • several major new and innovative firms have entered the sector offering different products, with different business models and different corporate strategies. The most successful, The a2 Milk Company, now has a market capitalisation of around $11 billion, almost twice that of Fonterra (approx. $6.4 billion); TDB Advisory Ltd The Dairy Sector in New Zealand: Extending the Boundaries 3 CONFIDENTIAL DRAFT History of dairy in New Zealand Figure 1: Changes in market structure following DIRA Pre - 2001 New Zealand has a long history of dairying. Traditionally, the dairy processing sector was comprised primarily of small co-operatives and some individually or Dairy Domestic market corporately-owned factories. In 1920, 85% of the 600 dairy factories were co- Co-ops Exports operatives. From then on, more efficient transport and economies of scale in Dairy Other wholesalers, retailers, Farmers NZ Dairy Board Consumers processing progressively led to larger factories and the closure of smaller ones. Co-ops traders, partners Co-operatives merged until, by the 1990s, the sector was dominated by the two Dairy largest dairy co-operatives, New Zealand Co-Operative Dairy Group Limited Co-ops NZ Dairy Board had the sole (NZDG) and Kiwi Co-operative Dairies Limited (Kiwi), alongside the sole statutory right to export statutory exporter, the New Zealand Dairy Board (NZDB). Post - 2001 In 2001, an amalgamation of NZDG, Kiwi and NZDB established New Zealand’s largest dairy processor, Fonterra. The amalgamation and establishment of 82% of milk Exports Fonterra was made possible by legislation, the Dairy Industry Restructuring Act, Other wholesalers, retailers, Farmers Consumers 2001 (DIRA) which enabled the merger to bypass the Commerce Commission. traders, partners Compulsory Through the merger, the industry sought to realise efficiencies of scale and shares in Fonterra scope in the collection and processing of farmers’ milk and to compete more Domestic market effectively in international dairy markets. Regulated milk supply 18% of milk Upon its creation, Fonterra collected approximately 96% of New Zealand’s raw Farmers Independent processors milk production. The remaining 4% was collected by Westland Milk Products Exports (Westland) and Tatua Co-operative Dairy Company (Tatua), the only two co- operatives which elected not to participate in the amalgamation. Throughout the 2000’s, new dairy processing companies entered the milk processing and exporting market, including Open Country Dairy (OCD), Synlait, Oceania Dairy www.tdb.co.nz 4 and Miraka. Post DIRA (2001) companies were legally allowed to export New Zealand dairy products for the first time in over fifty years. As is discussed below, at the same Around 95% of New Zealand dairy products is exported. That is, New Zealand time as it created a dominant processor, Fonterra, DIRA also established an produces almost twenty times more dairy products than the domestic market can environment that facilitated innovation, allowing firms like the a2 Milk Company consume. (A2M), Synlait and OCD to enter the market and compete on the international stage. Figure 1 shows the structure of the dairy industry pre and post the Fonterra amalgamation. TDB Advisory Ltd The Dairy Sector in New Zealand: Extending the Boundaries 4 CONFIDENTIAL DRAFT between 2004 and 2020. The value of dairy exports has almost tripled over the Economic significance of the industry period, going from $6.1b to $16.6b p.a. The dairy sector employs around 40,000 workers, with around 27,500 on farm The dairy industry forms a significant part of the New Zealand economy, and a further 13,000 in dairy processing. Employment in the sector has grown accounting for around 3% of GDP. Dairy is New Zealand’s biggest export earner, more than twice as fast as total employment, at an average of 3.7%