European dairy processor Arla Foods had a bumper 2012, with sales and profits up. And its operations in emerging markets played a part in boosting its top and bottom lines. Dean Best spoke with Arla CFO Frederik Lotz about the company’s ambitions in emerging markets as it battles stiff competition for rising dairy consumption in markets like China from its European peers.

In recent years, Europe’s dairy giants have been looking east, investing in markets from the Middle East to China to tap into rising disposable incomes and growing demand for dairy products.

Arla Foods is no exception. The co-operative behind brands including Lurpak butter and Castello cheese has made a series of moves outside its core EU market, including two key investments last year – starting local cheese production in Russia and strengthening its tie-up with Chinese dairy Mengniu.

Europe still accounts for 75-80% of sales but, a fortnight ago, Arla announced higher sales and profits for 2012 and cited its business in emerging markets as a key factor in its performance.

“We had solid growth outside Europe, between 20 and 30% growth rates organically in the Middle East and Russia, and plus-50% growth in China,” CFO Frederik Lotz tells just-food in an interview after the results are published.

Arla, however, believes its businesses in emerging markets are starting to pay their own way. Often, food companies can reel off sky-high growth rates for its businesses in markets like China but, delve a little deeper, and profitability remains hard to find. Lotz, however, says Arla enjoyed improved profits in its emerging markets last year.

“Possibly one of the most important lessons learnt from 2012 is that our ambition to build a global company with a much stronger presence outside Europe is really starting to unfold from an economic perspective,” Lotz says. “Not only did we have solid growth but we have seen a very significant uptick in earnings in these markets. Whereas in the past we have been funding our growth outside Europe with earnings in Europe, these businesses are really becoming self-sustaining and delivering profits at a very attractive level – and that is new.”

However, what is not new is the attractiveness of the world’s emerging markets to Europe’s dairy processors. Dutch group FrieslandCampina has a significant presence in south-east Asia and Africa. The Irish Dairy Board is another European group building businesses in developing economies, with a particular eye on Africa and Russia. More consumers in Beijing, Dubai and Nairobi may be eating dairy products – but Arla faces stiff competition for their custom.

Lotz, however, is unworried. “It’s clear some of our competitors moved earlier than we did. Others haven’t moved at all yet. I would say we are probably somewhere in the middle. What’s new is we have really accelerated and 2012 is a demonstration of that acceleration. You should expect to see more. There are massive opportunities for selling more dairy products outside Europe and there is ample space for a number of big European players,” he says. “As the hundreds of millions of Chinese move into the middle class, they will start purchasing dairy products. We know from experience that, when a certain income level is reached, consumers start adding dairy products to the basket. There’s massive potential, as there is in Africa.”

Perhaps it is the prospect of fierce competition in the east, or the relative freedom in not being publicly-listed (and therefore restricted by stock exchange rules on disclosure) but Lotz is, for a food industry executive, unusually candid about Arla’s ambitions for the emerging markets. The Middle East, Africa, Russia and China are five markets he lists as “priorities” for expansion for Arla. And, while he does not specify which companies Arla could target, he reveals the group will look at “significant” acquisitions as part of its plans.

“The real transformation is still ahead of us because that would involve significant acquisitions, possible mergers and more partnerships outside Europe,” he says. “We’ll pursue any opportunity to develop on our strategy.”

In the short term, Arla is likely to focus on integrating into its businesses the companies it acquired or with which it merged last year, including UK co-op Milk Link. However, Lotz adds: “I would expect that from next year if the opportunities are right, Arla will make its next move on the M&A agenda.”

Arla’s M&A activity in 2012 included its deal with Mengniu, which saw it take a 6% stake in the Chinese dairy and which it hopes will increase its sales by five times in the country by 2016.

However, it was also active in Europe, with mergers with Germany’s Milch-Union Hocheifel and the UK’s Milk Link. Lotz says Arla will continue to look for “bolt on” deals in Europe and points to the “fragmented” nature of Germany’s dairy market. He refuses to be drawn, however, on whether there are still major deals to be had after Arla’s Milk Link merger.

The focus areas for Arla in Europe are likely to be two-fold: being the region in which it generates DKK2.5bn in cost savings to invest back into its business and trying to protect its brands in a market that Lotz says is likely to remain “depressed”.

Arla last year set out plans to save DKK2.5bn by 2017 and said when it published its results two weeks ago the results of its plans will be “more visible” this year. The company is putting the finishing touches to a new dairy in the UK but Lotz says it will look to close other sites to save money. “The continued consolidation of our manufacturing footprint will continue. We have over the last decade closed an average of five plants every year and we would expect to continue that journey as we invest in larger and more automated facilities – and as we continue to acquire and merge with companies who themselves offer new opportunities for further consolidation of that footprint,” Lotz explains. “Most of our dairies are located in the Nordics and the UK so that’s where the accent would take place.”

As Arla battles a challenging European market, where dairy consumption is stagnant and consumers increasingly turn to own label, it is planning to protect its brands through investment in promotions and up its spending on NPD to try to entice shoppers. For all the recent investment in the east and high ambitions for the emerging markets, Arla still has a “core” of six markets that are all in Europe – Sweden, Denmark, Finland, Germany, the UK and the Netherlands.

“We have got a great franchise in each of these core markets but clearly we need to invest in these markets too – and take out costs to improve these businesses,” Lotz says. “[Promotions are] part of the industry and part of how we collaborate with the big retailers in Europe and that will continue. On top of that, you might add innovation. We are doubling our spend on new product development and innovation. That’s a journey we have been on for the last couple of years [and is] an example of where we invest the proceeds of rationalisation.”

This year promises to be another “flat” year in Europe, Lotz says. One of Arla’s global brands, Castello, has struggled in Europe as consumers shy away from more premium products. Lotz says Arla has a “pipeline” of new products planned for Castello this year that it hopes will boost sales. However, Europe is likely to remain challenging, which underlines Arla’s desire to ramp up its businesses in emerging markets.

“We still have a significant over-representation of sales in Europe, close to 75-80% of our sales are in the European region, which helps explain why we must increase our presence outside Europe, given the flat growth that we don’t think will change anytime soon.”