A tale of two milk prices: Australia and New Zealand
- Australia’s dairy farmers are experiencing record-high opening milk prices this season. However at a 25-30% premium to New Zealand’s farmgate milk price (FMP), this dislocation is driving very different market dynamics and associated lending opportunities.
- For the second time in a month, Fonterra New Zealand (NZ) has lowered the forecast FMP midpoint, now NZ$6.75 per kilogram of milk solids in response to global dairy prices (GDT price index) reaching their lowest level in five years. As a secured lender to agricultural credit, we closely track commodity cycles to deliberately deploy capital into production sectors when there are likely macro tailwinds (i.e. commodity price rebound) over the next 1-3 years.
- For this reason, we have been pulling back from Australian farmgate dairy over the past two years, allowing over $150m of dairy loans to repay, including a $36m loan this week. Our Funds now have our lowest exposure to Australian dairy since 2018 (<3% of the Merricks Capital Partners Fund NAV).
- Conversely, a high milk price environment has real implications for Australian milk processors. Australia’s record milk price has put significant margin pressure on milk processors and created lending opportunities. These businesses are less able to secure bank finance against hard assets due to reduced profitability.
- While we expect Australia’s FMP to correct closer to global norms over the next two years, as domestic processing capacity reduces, a key aspect of our specialised industrial milk processing strategy is to fund businesses that are transitioning away from base commodity milk production to higher grade bio-nutritional products, such as lactoferrin, IgG, IgA and casein protein extraction.
- This week, we extended further funding to one of our capital partners, ProviCo Australia, to fund strategic CAPEX for state-of-the-art equipment at its site in Dennington, VIC.
The price dislocation between Australia’s FMP and GDT is driving material consequences for the industry, with processors that don’t have the balance sheet to weather the globally uncompetitive FMP closing or transacting assets.
Already this season we’ve seen Australian export volumes fall, declining 16% in June 2023 (Dairy Australia), and a 28% increase for imports from New Zealand over the past year (Dairy Australia). The 3bn litres of milk equivalents that Australia exports annually (Dairy Australia) will either continue to reduce as producers of commodity products are squeezed out of the market or we’ll see a rebalancing of the FMP closer to the GDT.
The ACCC is currently conducting a 12-month review of the Australian Dairy Code that regulates the conduct between dairy farmers and milk processors. Based on the current market imbalance, we wouldn’t be surprised if the ACCC sought to realign the governance framework to reduce the impact the current FMP is having on regional manufacturing jobs, export growth, food price inflation and investments in regional communities.
A key macro consideration when examining the NZ dairy landscape is the evolving role that China plays. As NZ’s largest export customer, total dairy export volumes to China have been decreasing steadily with total exports for the year ending 31 March 2023 only 35% compared to 44% the year prior (NZ MPI Situation and Outlook Report). The leading factors driving this structural shift are a slowing population that has reduced the number of babies, there were approximately 5 million fewer babies in 2022 compared to 2018 (Macrotrends), and China’s growing domestic dairy industry. Since 2018, China has increased its domestic production by 30%, or the equivalent to the amount of milk NZ exports annually, positioning China as the 3rd largest global producer.
Our Funds currently have <0.5% of NAV exposure to NZ dairy land. The low milk price environment is reminiscent of the correction that occurred in 2016/17 which led to the substantial increase in new loan opportunities as banks looked for ways to exit dairy farms that breached covenants, and borrowers pushed back on selling properties. In this environment, we can structure bridging finance for recapitalisation or strategic asset sales. We have a strong track record in NZ dairy, having funded over $150m of senior secured loans and delivered investor returns +15% net IRR (after fees and costs).
