Consolidation is rife in the Australian dairy industry, with the four largest domestic players jockeying for the dominant position through M&A activity - but where will it all end? just-food.com's David Robertson provides a comprehensive overview of this important market and suggests that the push for dominance within Australia could be just the first step in a bid for global power.

The four major dairy processors in Australia admit that consolidation is necessary in the A$7bn (US$3.8bn) a year market to take out excess capacity and improve economies of scale in an industry with very tight margins. And as a result, the country's dairy processors are jockeying for position as the industry moves towards a period of consolidation that might be global in significance.

National Foods, the only listed processor, Dairy Farm, Bonlac and Pauls, which is owned by Italian dairy company Parmalat, have all talked on and off over the last three years about mergers, takeovers and joint ventures. However, Dairy Farm rebuffed a formal offer worth A$793m from National Foods at the start of last year. All other overtures have been similarly unsuccessful as each company struggles to make sure it is not manipulated out of existence.

Significant shift

But the playing field shifted significantly last month when Dairy Farm raised A$80m from backers to buy a 7.7% stake in National Foods. Analysts believe that the company is unlikely to be able to raise the A$900m (or more) necessary to buy out its rival, which raises an obvious question: Other than giving National Food executives something to worry about, why bother?

Some analysts are now suggesting that the answer may lie across the turbulent sea to Australia's southwest. But first, how has the dairy industry in Australia wobbled into the game of brinkmanship it now finds itself playing?

Dairy deregulation

The Australian dairy market was heavily regulated until the end of the 1990s but with deregulation came price competition and in 2000-2001 milk prices fell to their lowest level in a decade. This was in large part due to the country's largest supermarket chain Woolworths, which used the competition to get a price for its own-brand milk that was below the processing cost. The milk companies were killing each other for business that was unprofitable (dairy companies need the large volumes from supermarket milk sales to drive the rest of their capital-intensive business) and not surprisingly profits collapsed.

National Foods has aggressively been seeking a way out of these low-cost, high-volume milk sales and is expanding its cheese, butter and yoghurt ranges. Earlier this year, it bought the King Island Dairy group (which specialises in luxury cheese products) and it has also bought distribution rights in China for the Yoplait yoghurt licence. Analysts also expect the company will take up its opportunity to buy Yoplait licences in Indonesia and the Philippines.

National Foods is also considering buying New Zealand Dairy Foods (NZDF), which has 60% of the yoghurt market in NZ, but has been blocked so far by competition authorities, who have expressed concern that the deal would give National Foods 80% of that market.

A price rise of between 10 and 15% for milk is expected to allow the milk companies to improve margins this year and National Foods should hit analyst forecasts of about A$51-52m profit.

Too many processors?

Expert Analysis

The Global Market for Dairy Products
Comprehensive analysis of trends in the market, including: milk, cream, butter, cheese, yoghurt and chilled desserts, fromage frais/quark, chilled desserts and chilled snacks. Sales are analysed at world/regional level and in over 50 individual countries for 1996-2000, with forecasts to 2005. Dairy products developments are also examined at a key player level for : Arla Foods AMBA, Dean Foods Co, Groupe Danone, Groupe Lactalis Meiji Dairies Corp, Nestlé SA, New Zealand Dairy Board, Novartis AG, Parmalat SpA, Philip Morris Cos Inc, Snow Brand Milk Products Co Ltd, Suiza Foods Corp, Union Sodiaal

 
But even with National Foods looking for new markets and prices rising there is still, analysts believe, at least one too many processors in Australia. And this is where it gets complicated.

National Foods' largest shareholder, with an 18.2% stake, is the Kiwi dairy powerhouse Fonterra. (Incidentally, National Foods is trying to buy NZDF from Fonterra, which is being forced to give up the yoghurt operation to meet competition requirements). Fonterra also has a 25% stake in Bonlac and an 80% holding in a West Australia processor called Peters & Brownes. Fonterra has also held discussions with Dairy Farmers about a strategic alliance, and analysts and food industry consultants are rapidly coming to the conclusion that the Australian dairy industry is about to be swallowed by the New Zealanders. The Dairy Farm stake in National Foods could be the prelude to some sort of "takedown".

Fonterra clearly has big plans to use the renowned New Zealand dairy industry to expand globally. It signed an agreement with Swiss food behemoth Nestlé last month to carve up the dairy industry in the US and South America. Dairy Partners America will be a joint venture to create yoghurts, desserts and milk with a first year sales forecast of US$1.4bn.

So while the manoeuvring of the Australian companies has the look of desperate survival about it, many analysts feel that it is only a matter of time before Fonterra controls dairy throughout Australasia. It is then in a position to expand into the US, South America and Asia, as well as its traditional Commonwealth markets. The Australian industry increasingly looks like it could be just the first target in this global strategy.

By David Robertson, just-food.com correspondent