Loan portfolio positioned for lower commodity prices: Milk sector a case in point

• The new season farmgate milk price announced this week was 15% lower than last year’s average as major dairy processors responded to higher domestic input costs relative to the lower global milk price (source: Fonterra Australia).
• With 10 Australian processing factories having closed in the past 18 months, the industry challenges of a milk price 20-30% higher than the global index has taken its toll (ABC News).
• We have reduced our loan exposure to farmgate dairy (from 9% to <1% across the Merricks Capital Partners Fund and the Merricks Capital Agriculture Credit Fund) as the sector has been well-banked over the past two years, with interest coverage increased due to the higher milk price environment.
• At the same time, we increased our portfolio weightings to downstream dairy processing assets (5% & 12% total allocations in the Funds respectively), financing a milk processing business in Warrnambool, owned by ProviCo Australia, and a dairy & non-dairy beverage packaging factory, Purearth.
• In a high milk price environment, these businesses were asset-rich but suffering margin contraction with elevated input prices. As Australia’s milk price once again trades closer to the global index, we expect export competitiveness to be significantly improved and anticipate the return of bank capital to downstream assets as profitability improves.
• We also expect a lower milk price to drive lending opportunities at a farmgate level, similar to what we saw in 2018-2021. We currently have one dairy loan in due diligence – a $37m facility to a NSW farmer that will have a starting LVR of 45% and peak LVR of 51% against farmland.

Source: Merricks Capital, GDT, ABARES