Things were on the up for Australian dairy group Warrnambool Cheese and Butter Factory. In August Warrnambool signed a JV with National Foods that will see it take a share of the Dairy Farmers acquisition and in October the company posted a 154% leap in full-year net profit on higher milk prices. However, in a reversal of fortune that demonstrates the volatile nature of commodity markets, a slump in Australian dairy prices forced Warrnambool to issue a profit warning last week. Dean Best caught up with CEO and MD Neil Kearney to find out more about the company's plans for the future and its push into value-added sectors.

just-food: It's been quite an 18 months for the business, with the rise in dairy prices last year boosting your sales and earnings. How would you characterise the last 18 months in the context of Warrnambool's history?

Neil Kearney: A very buoyant period. The company, through a number of years of working with the supply base to get the most milk in they could, was fortuitously in a good position when commodity prices did move up. We've got pretty flexible production capacity between a cheese and whey stream and the powder and butter stream. It's been good for the business.

j-f: Dairy commodity prices have come off in recent months. How do you see dairy price trends in the months ahead?

Kearney: We're really looking to guidance from some of the internationally-recognised forecasters. None of these forecasters picked any of the soft commodity decline and now most are saying there should be some pick up - I think it's moved from mid-2009 to later 2009, perhaps early 2010. It's hard to do anything other than the consensus of some of those forecasters. [However] the impact of a major dairy manufacturer reducing their milk price is being closely monitored, as well as the volatile market conditions.

j-f: Nevertheless, despite that volatility in commodity prices, Warrnambool has still been very expansive and has made strides with the ventures with National Foods and Friesland Foods and the sales office in Japan.

Neil KearneyKearney: Those deals are an attempt by the business to not be as dependent on the commodity cycle. The Friesland joint venture with the vivinal gos product that it is already making in Holland is very much a high-value food ingredient as compared to a more traditional dairy commodity and is not subject to the same price fluctuation as skimmed milk powder or something like that. That's on track to begin commercial production by the end of the first quarter 2009.

The venture in Japan keeps us in the commodity area but it gives us a little more control over our destiny on exports to Japan, which is a very important dairy market for Australia and allows us to increase the product range we're selling there. We anticipate more value-added product by being able to tailor recipes for end-customers in Japan.

Of course, the joint venture with National Foods, which is still to be finally signed, is a more significant deal than the other two. It potentially gives us good exposure to brands in Australia, with earnings and gross margins much higher than we currently earn.

j-f: Was it that exposure to those brands that really sparked your interest in joining forces with National Foods?

Kearney: Our share of the joint venture will mean that consumer brands will move, in revenue terms, to 30-35% of our business. It's a significant change of profile for the company. The brands within Dairy Farmers are well-known brands in the Australian market. They've performed quite well over recent years, despite an increased retail pressure from own-label products. Having an opportunity to own 50% of that branded business and being able to expand one of our core skills in bulk cheese manufacturing was a great opportunity.

j-f: Warrnambool has only generated a fraction of its business from consumer brands - how much does the venture with National Foods signal a change in focus for the company?

Warrnambool FactoryKearney: It will certainly change our profile but we're not at this stage seeking to internally employ the resources and skills necessary to be a company that can operate in fast-moving consumer goods. One of the attractions with this deal is that we're going with a partner that has a lot of skills in the front end - sales, marketing, distribution to retailers. We're going to focus on the back end, the manufacturing of the product for the joint venture. That was a natural complimentary set of what core skills existed in each business. Whilst we're obviously paying a reasonable price to do that, those skills are in place, where as any decision for us to become a lot more involved in fast-moving consumer goods in our own right requires some refocusing of the business.

j-f: How much has the economic downturn affected consumer demand for dairy in Australia?

Kearney: At the moment, consumer demand in Australia for dairy products has remained pretty firm. It's such a staple, particularly the product areas we are in, in the Australian diet, that it is relatively unaffected by this sort of economic downturn.

j-f: How international is your business and how closely is Warrnambool looking at opening offices in other export markets?

Kearney: We are around 40% Australia and 60% export and within that export Japan is a significant proportion. At this stage, we have not progressed a detailed evaluation of establishing a presence in other markets. It's early days in Japan. The business is going to evaluate, probably over 12 months, possibly longer, how well that works. It is not as important in all international markets as it is in Japan. In the Japanese market because of the tariff structures, because there are number of specific trading conditions that exist, it is necessary to have somebody you can work with there and trading houses have performed that role. There are some other overseas markets where you can quite effectively work from Australia with the end customer or the importer. The same need for a presence doesn't exist. There tends to be a different motivation in Japan where you really do need to have somebody on the ground to work with.

j-f: What commercial applications will the vivinal gos ingredient have?

Kearney: The major application at the moment is in infant formula products but it is also able to be used in yoghurt drinks and yoghurts. It's a prebiotic so it aids probiotics and it has a lot of functional properties that line up well with a lot of healthy dairy products.

j-f: Will the venture be used to serve the whole Asia-Pacific region?

Kearney: Friesland is responsible for the sales and its intention is to focus the factory in Holland very much on the EU and probably North America and the Middle East. From our factory in Australia, the joint venture, sales will be very much focused on Asia-Pacific, particularly the major developing markets for the products in this part of the world. And potentially we'll service South America. That's something that's still being worked through by Friesland and it is in discussions with its customer base.