Predicting what is going to happen in the SA dairy industry does not require rocket science – some economic knowledge, a bit of industry know how, common sense and insight, is all that is required. Past predictions have to a large extent come true, but farmers have not reacted – let’s hope they do this time.
Some important statistics that dairy farmers need to know are:-
1) The consumption of milk in SA is, in round figures, 3.2 billion litres of milk per annum, (±60% of this is fresh milk and UHT and ±40% is made up of yoghurt, maas, butter, cream and other dairy products). This includes, what is currently a small amount (approx. 3-5% of total volume), of imports and exports – which in the past, have more or less equaled each other.
2) In 1971 there were more than 15 000 small dairy farmers. By 2006 this number had dropped to ±4 000 and now stands at ± 1 450. The total number of cows has increased slightly but the production per cow has, at least, doubled with improved, breading, feeding, technology and overall management – with genetic manipulation, which is likely to come into play in the near future, we will see a substantial increase in production. Bigger better dairy farmers have absorbed their smaller neighbours.
NOTE: The average farmer that the ACD group of consultants deals with in KZN and the Eastern Cape now each milk an average of over 1 000 cows (in 1971 the average herd size was 120 cows)
3) 80% of the milk in SA is currently produced in the Eastern Cape, KZN and the Western Cape. This production follows a seasonal supply curve (less is produced per day in autumn and much more is produced in spring). This seasonal supply in itself creates a problem and the milk price to the farmer tends to be increased in autumn and decreased in spring which has resulted, for the last 10 years at least, with milk price not keeping up with the inflation of production costs (see table1) The movement to seasonal calving has exacerbated the problem.
NOTE: 3.2 billion litres p.a. (per annum) divided by 1450 farmers equals an average production of 2.21 million litres per farmer p.a. (ACD clients are averaging over 5 million litres per farmer p.a. and there are currently a number of big farmers producing more than 10 million litres p.a.). By applying simple arithmetic it is obvious that the capacity of even the reduced number of farmers, to over supply the current SA market, is enormous.
4) The population of SA is almost 58 million people and is exploding at an estimated 1.5% p.a. This means that the population increases by 2 400 new babies a day (births above deaths). The per capita consumption of all milk products in SA is 55 litres per person p.a. which is 150ml per person per day (less than half a cup of milk) – this, by world standards, is very low (some European countries consume over 300 litres per capita per annum (just under a litre per person per day). Unfortunately this growth in the SA population will not resolve the overproduction problem for a long time to come because most of the population growth is in the lower income group. This means that while total consumption will increase, the per capita consumption is likely to decline.
Therefore, if the status quo in SA persists, the projection is that 30% of dairy farmers will not make it financially and will be bought out by their bigger and better compatriots. Table 1 depicts the current and projected status of the average KZN dairy farmer. Because costs of production over the last 10 years have increased by ±6% p.a. and gross milk income has inflated at a lower rate, margins have steadily declined. If this situation continues to prevail it will ultimately drive the smaller farmer out of business. The exit of farmers in the short term, however, will be determined by production inefficiency, high debt servicing and hugely increased education and medical costs. I.e. Smaller producers with little debt will last longer than their compatriots with the above listed problems. However declining margins will ultimately drive smaller producers out of the industry.
The SA milk industry consists of 4 distinct sectors
A. The Primary (farmer producer) Sector
B. The Secondary (the processing and transporting ) Sector
C. The Tertiary (the retailing) Sector
D. The Consumer
Decent co-operation and planning between sectors in SA does not sustainably happen and each sector attempts to put themselves in the best position, if necessary at the expense of the other sectors.
The primary sector (the farmer) has been negatively manipulated by the other sectors for the last 30 years. Clover, one of the 1stand the most influential players in the Secondary Industry was originally formed as a Co-op by farmers to collect, process and market their milk. Different Clover CEO’s (the latest one being Johan Voster) together with former chairmen of Clover and some influential farmers (who were allegedly effectively bribed with an offer Re. preferential shares) changed the Clover structure and, in my opinion, it’s good standing. Clover was changed from a Co-op to a private company and then later was listed on the Johannesburg Stock Exchange with a saleable share price of R17 per share. Clover has recently been split into 2 separate entities, DFSA and Clover. Johan Voster has personally been highly successful and is now the biggest individual shareholder in Clover – I think, however, that he has looked after the interests of Johan Voster and not the interests of the dairy farmer, for some time. The split into DFSA (which has ended up with the potential milk over supply problem together with low return dairy products has resulted in DFSA suppliers currently paying a monthly ‘loss penalty’ per litre. Clover, on the other hand, has diversified into juice, water and high return dairy products such as yogurt etc., has delisted and has organized an advantageous (to Clover) supply agreement of milk with DFSA - all this has been done to make Clover shares more saleable, which is borne out by the current sale negotiation of Clover to an Israeli majority group. It is my understanding that if his negotiation goes ahead, which it probably will, Clover will effectively be sold to an Israeli group that will hold the majority of Clover shares. Clover will carry on with its domestic processing and sales but will also ‘export’ milk into Israel. Exportation sounds sense in the light of over production, but it appears, in order to drive the Clover share price up to R25 per share (which is the price being negotiated with the Israeli group) export milk has been offered at a very low price. If this is so, then exportation, instead of driving the depressed domestic price up to export parity, will, with all probability, further depress it. Clover is currently paying farmers and average of R4.60 per litre in KZN. This price is apparently going to be lowered to R4.40 in winter and then lowered again to R4.20 in spring. Clover has been the most influential “price maker” for milk price payments to farmers in the past – it will be interesting to see if this holds and influences other milk buyers in future.
The milk pricing structure to farmers has not encouraged the production of high solids (quality milk). In the future more emphasis will be put on high solids (7.5 – 8%) and low solids milk is likely to become difficult to sell.
a) It has been, and still is, my opinion that every cent made on Clover share deals by farmers involved has been lost by these same Clover farmers as a result of the poor milk price they have received.
b) Clover is not the only milk Co-op to be transformed to a company. Some years ago the Towerkop Co-Op was bought and changed into a company by Parmalat and other similar deals have taken place.
Therefore, what can SA Dairy Farmers do to improve their position?
Five possible alternatives come to mind:-
1) Retain the status quo and let the milk price paid to farmers be determined by domestic supply and demand.
If the oversupply and seasonal production continues, the result will be a fluctuating and depressed price. The problem will only be resolved when sufficient farmers are driven out of the industry and seasonal production is evened out. This is not really a solution but is the most likely scenario to occur.
a. The increases in dairy land prices have largely compensated for the poor milk returns. Estimates are (see table 1) that dairy land prices, over the last 20 years, have increased by more than 15% p.a. compounded. This, in many ways, does not make sense, as over the same period the average dairy farmer has made a poor return on capital. However, some of the bigger more efficient farmers, through their size, efficiency and ability have made a good or acceptable return on capital and as dairy land is finite in extent, have been prepared to pay high and increasing prices for land in order to ensure expansion. In so doing they are adding to the overproduction problem and disregarding the political threat of expropriation without compensation.
b. No Import tariff has been imposed by the SA authorities on dumped or imported products in a number of industry (textile, broiler, sugar cane, glass, milk etc.). The SA milk industry has, in the past, been largely protected by the perishability of the product and the value of the Rand. With improved technology i.e. UHT etc., perishability is no longer a significant factor and the value of the Rand does not play a big role when product is dumped. In many SA industries importation and dumping started in a small way and then accelerated with devastating consequences – this problem, if it grows significantly in the milk industry, could affect both volume and price of milk. The MPO has for many years attempted to get the government to impose tariffs on imported milk products and has unfortunately, to my knowledge, not succeeded.
2) Farmers to create a profitable export market for milk products.
If sufficient product is to be exported this would be a highly desirable solution as overproduction would no longer be a problem and the domestic milk price would be driven up to import parity. It is very unlikely to be organized and driven by farmers. Sub Saharan Africa currently consumes less than 50 litres per capita p.a. – the total population of Sub Saharan Africa is currently 1.2 billion and this is projected to increase, at the fastest rate in the world, to over 2 billion people at the end of the century. Even with a low per capita consumption p.a., this would create a market of more than 80 billion litres of milk p.a. Servicing the market, the logistics of distributing into the many different African countries, the red tape involved and the collection of payments, are all very off putting, however, if SA does not do something soon someone else will take advantage of this potential market, e.g., Fonterra for New Zealand milk once China (to which NZ are mainly exporting) is self-sufficient. Milk production in the number of Sub Saharan countries is being encouraged and investors have already responded.
3) SA Dairy Farmers to Vertically integrate within the Milk Industry
I.e. process part or all their own product into saleable commodities, transport their own product and possibly mix and even pellet their own meal. All of these integrations have their own set of challenges and that is why most dairy farmers have chosen to horizontally expand rather than vertically integrate.
4) SA Dairy farmers to reduce milk production and expand into other Agricultural enterprises.
The SA Sugar Cane industry, which has been a highly profitable and well organized industry for more than 100 years, has recently run into over production problems as a result of decreased sugar demand and the dumping of imported product. The cane industry recognized the growing problem early and many cane farmers have already reduced their cane area and diversified into other enterprises e.g. Macadamia nuts, Avo’s etc. I do not know of a single dairy farmer that is sufficiently aware of the potential SA oversupply problem that has done anything about it.
5) SA Dairy Farmers to reduce production and diversify into other industries (possibly even offshore).
Jeff Every, a ACD consultant in the Eastern Cape, some years ago, advocated that in order to hedge against the future in SA, at least 30% of total assets should be held offshore. He has achieved this goal with the majority of his clients – in KZN very little has been done in this regard.
Summary & Conclusion
As stated, the status quo will result in fluctuating and depressed prices and is likely to result in the number of farmers declining by at least 30% over the next few years. SA dairy farmers currently have the potential to, and probably will, considerably oversupply the domestic demand for milk. They are also unlikely to rectify their seasonally skewed supply curve. Like the sugar cane farmers they need to reassess their position and react accordingly – possible alternatives are listed above and there must be many more. I look forward to serious readers of this article putting forward other alternatives to consider, please send these to email@example.com. The weather (particularly with global warming) and political interference, are two factors that could have a major effect on the projected scenarios.
If dairy farmers do not react (and I suspect they will not for some time to come) milk prices to the farmer will fluctuate and will stay depressed overall and the industry from a farmer point of view will remain fragile.