Consolidation is something that has been heralded as the panacea for the dairy industry.

The narrative goes that fewer co-ops can achieve greater efficiencies through larger milk pools, which deliver higher prices. Sounds simple.

In practice, it is a whole lot more complicated.

Consolidation

Since the formation of dairy co-ops, there has been consolidation.

We are now down to around 23 processors and the latest consolidation was approved this week when the competition authorities approved the Lakeland-LacPatrick merger.

Interestingly, these co-ops themselves were formed through mergers - Lakeland through the merger of Killashandra Co-op and Lough Egish Co-op in 1990; and LacPatrick through the merger of Town of Monaghan Co-op and Ballyrashane Co-op only four years ago.

It will have over 3,200 milk suppliers and have sales in excess of €1bn

Lakeland, the name of the newly formed entity, now has a combined milk pool of close to 1.8bn litres, making it the second-largest buyer of milk on the island of Ireland (after Glanbia). It will have over 3,200 milk suppliers and have sales in excess of €1bn.

It also makes the new co-op (taking over from Dale Farm) the largest buyer of milk in Northern Ireland. Lakeland will have a pool of around 1.2bn litres of milk in the North - approximately half of all milk produced there.

Divergence

So, with two thirds of the milk now coming from Northern Ireland, if competition increases for milk in the North, it could see a divergence in milk prices between North and south (within the same co-op) to retain supply in the North. Afterall, Dale Farm has not been shy about seeking to grow its milk supply base.

Lakeland itself has grown significantly since 1990 and evolved into a regional dairy powerhouse in the northern half of the island via a steady process of merger and acquisition.

It purchased the Bailieboro side for €33m from Kerry Group in 2002 and then moved quickly a year later to buy Pritchit’s food service business for a further €18m.

Expanding capacity

Over the next 10 years, Lakeland focused its investments and capital on expanding capacity within its own business and improving existing facilities in the lead-up to the ending of milk quotas.

In 2015, Lakeland ended up acquiring the dairy business of Fane Valley in a €13m deal.

The Fane Valley acquisition brought with it an additional milk pool of 240m litres and another processing facility in Banbridge, Northern Ireland.

Does it make sense for the new entity to retain this business or should it look at its options

This helped grow Lakeland’s overall milk processing pool to 1.2bn litres last year, with half coming from farmers in Northern Ireland and the other half coming from suppliers in the Republic of Ireland.

This merger brings Lakeland into the liquid milk business for the first time and adds a butter, yogurt and desserts business, sold under the well-known Champion and Ballyrashane brands.

While liquid milk can be used as a hedge, it forms a small part of the overall milk pool.

Given the low-margin ultra-competitive liquid milk market, it could be asked does it make sense for the new entity to retain this business or should it look at its options?

Powder business

It also brings a significant powder business, and textured butter and Regato cheese capabilities. It has three sites at Monaghan town, Ballyrashane and Artigarvan.

The Artigarvan site contains three dryers capable of drying a total of 12t/ hour, including a new €40m state-of-the-art dyer commissioned in 2017.

This site produces mainly whole and skimmed milk powders and is located close to a significant milk pool to fill it.

These sites build on Lakeland’s own sites at Bailieboro, Killeshandra, Lough Egish, Newtownards and Banbridge.

Brexit

The other issue worth exploring is around Brexit. Some 600m litres of milk goes from north to south each year for processing.

With a drier in Artigarvan that needs filling, this means there is little need for any Northern Ireland milk to go south at all.

Under the rules of the new society, the existing representative structures on both sides (including electoral areas and council) will be kept in place for a period of 12 months.

After this, a transitional board will be established. This will be made up of 15 Lakeland board members and eight LacPatrick board members.

The transitional board will elect a chair (from the Lakeland directors) at its first board meeting and there will be two vice-chairs (one from LacPatrick and one from Lakeland).

Comment

No doubt, the combined business will have a diverse portfolio of complimentary products which should offer greater insulation in times of downturn in global dairy markets.

It also provides significant scope to optimise capacity utilisation, based on the relative returns available across a range of products or markets.

Furthermore, it Brexit-proofs the business with four processing sites located in Northern Ireland and four in the south.

According Lakeland CEO Michael Hanley: “This level of scale provides greater firepower and influence when operating in an evermore competitive marketplace.”

Costs will have to be taken out to ensure competitive milk prices for its dairy farmers into the future

But scale for scale's sake is never a good reason to buy or merge a business.

The benefits must arise from synergies between the combined entities.

Efficiency and productivity gains will need to be achieved - be it in collecting, processing or marketing the milk.

It also means that costs will have to be taken out to ensure competitive milk prices for its dairy farmers into the future.

Hanley’s job will be to quickly turn the loss-making LacPatrick business around, while also demonstrating to milk suppliers how this deal will add to the bottom line of the co-op and ultimately improve milk prices in the future following this merger.

In a quota-free environment, volatility in prices appears to be the norm now rather than the exception.

These swings are difficult for smaller entities to ride out. The greater financial firepower of the combined entity should help.

With scale created, the focus must now turn to creating value for farmers in terms of delivering an improved milk price over the longer term.

Ultimately, costs need to be driven out, efficiencies increased, and synergies gained.

That is the only way Hanley can deliver to his farmers on his promise of “positive profit and milk price growth” into the future.