Focus: Saputo looks overseas to offset domestic challenges
Saputo set to complete its deal to buy Aussie dairy WCB - and is eyeing more M&A opportunities
Canadian dairy giant Saputo is expanding apace internationally as it looks to offset domestic challenges with growth overseas. The group is expanding capacity in Argentina, has taken majority ownership of Australia's Warrnambool Cheese and Butter Factory in Australia and is hungry for more international M&A. Katy Askew reports.
Saputo's domestic operations are facing the challenge of a declining dairy market. Overall, Canada's dairy consumption is dropping by about 2% a year. According to the Canadian Dairy Information Centre, per capita consumption of fluid milk declined 3.7% between 2010 and 2013. Cheese presents a bit more of a mixed picture, with specialty cheese consumption edging up, while processed cheese demand is retreating.
However, as CEO Lino Saputo emphasised in a conference call with analysts last week on its third-quarter results, the group is gaining volumes in its home market as a result of aggressive pricing and a focus on differentiation.
"Q3 was marked by continued competitiveness in our respective markets, especially in Canada. The dairy division Canada has therefore continued to implement measures to subside the erosion on volume losses and on profit generation. As such, we now see a stabilisation of EBITDA. But the reality is dairy consumption is declining in Canada. Therefore, our team continues to look for opportunities that bring additional value for our customers and our consumers," he said.
Mr Saputo added: "We're defending our position extremely well. The unfortunate thing, again, is that it comes at the expense of some margin."
During Saputo's third quarter, which lasted until the end of December, revenue generated in Canada rose to C$955.6m, up from C$937.9m in the comparable period of last year. EBITDA from the country stood at C$116.1m, down from C$123.2m last year. While operating margins have now "stabilised", Saputo confirmed they are expected to remain at this depressed level in the market.
The going is tough in the Canadian dairy sector - and the competitive landscape is unlikely to ease in the near future.
According to TD Securities analyst Michael Van Aelst, the difficult nature of operating in the Canadian dairy sector meant the 6% drop in Saputo's third-quarter profits missed market expectations by 5%.
"In the Canadian market, where consumption growth is non-existent, profits fell short of our estimate as Saputo took action to protect volumes, though it did come at the expense of lower margins. Competition has been steadily rising over the past two years and... we do not see the competitive environment getting any easier in the foreseeable future," Van Aelst wrote in a note to investors.
As Saputo grows its share in Canada, its rivals are becoming "much more aggressive" in response, management explained. Pressure on pricing is intense - and seems likely to remain so.
The Canadian dairy industry is also consolidating. Saputo, Agropur and Lactalis's Parmalat process around 75% of the milk produced in Canada. Both Saputo and Agropur have looked to gain market share and volume growth through acquisitions. Last month, Saputo acquired the liquid milk operations of Nova Scotia-based Scotsburn Co-Operative Services. Meanwhile, Agropur went on a veritable shopping spree last year, snapping up the likes of Cook's Dairy, Coast Mountain Dairy and M. Larivee International.
The battle for volumes, already of great consequence in categories like liquid milk where the value-added component is typically low, is given added impetus by the competitive pricing landscape.
In this context, it hardly seems surprising Saputo is eyeing growth in more promising worldwide markets.
In the first quarter of its current financial year, Saputo ceased operations in Europe but, elsewhere, the company is looking to expand its presence in current and new markets.
In the US, Saputo transformed its business through last year's acquisition of former Dean Foods unit Morningstar, which Saputo renamed Saputo Dairy Foods USA. While the company's cheese business is "running at a very good pace", Mr Saputo said that liquid milk margins of the former-Morningstar unit have "typically and historically" been lower.
Saputo is growing liquid milk volumes in the US while also adjusting the product mix by pushing more value-added items by putting "new categories of products" in front of retail customers. "Our expectation, as we move forward, is to focus more on value-added products for the Dairy Foods division," Mr Saputo predicted. "We are looking at value-added categories of products. Sometimes that would be new product development in a way of cheeses. And other times, it would be product development in terms of packaging and packaging formats."
While Saputo aims to develop its margins in the US, the group is looking further afield in its bid to drive sales and profitability.
As part of this drive, the company has ramped up production capacity at its Argentinian subsidiary, which sells products into 40-50 different countries including markets in Latin America, notably Brazil.
The group is also hoping its ten-year ambition to establish a production base in Australia will be realised, if it can push through its acquisition of Warrnambool Cheese and Butter Factory.
Saputo appears to be on the verge of success in the highly-public takeover battle for WCB, with 79% of the group's shareholders now accepting Saputo's offer. If 90% of WCB shareholders take up Saputo's bid by 12 February, the group's offer period will be extended. If not, the business will operate on a separate basis with an independent operating structure to its majority owner, management revealed.
"We think as a subsidy, it could be a very, very good platform for us, and I think we can leverage some of the strength that Saputo has to making Warrnambool a much stronger player in the international markets," Mr Saputo said.
Saputo is upbeat on the broader outlook for global dairy demand.
A significant engine powering the global dairy trade is rising demand in China. But the chief executive is quick to emphasise that China is not the only global growth prospect for Saputo. "We're starting to see a lot of interest from Japan, Taiwan, the Middle East. Russia continues to be a strong platform of net import of dairy products. Brazil is a strong importer of dairy products."
In order to cash in, Saputo is watchful for potential M&A opportunities in countries that offer the infrastructure to support large scale dairy production. In particular, the company is evaluating opportunities in the US, Brazil and - potentially - further acquisitions in Australia or New Zealand.
"We always have three or four files on our desk at any given time. For us, they're all pressing, and they're all exciting.... The runway, still, is very, very long."
With much to play for in the rapidly-evolving global dairy space, it would seem likely then that Saputo's strong balance sheet and acquisitive drive leave it well positioned to capitalise on growing demand in net dairy importing markets. This, in turn, will continue to reduce Saputo's reliance on its domestic operations which face long-term structural challenges.
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