Operating profits for Lakeland Dairies, Ireland’s third largest milk processor, more than halved (down 54%) to €7.2m last year, as depressed dairy markets and supports for farmgate milk prices weakened the co-op’s performance.

In total, Lakeland supported its milk price to the tune of €16.5m, or 1.5c/litre, in a year that chief executive Michael Hanley described dairy markets as being “unpredictable”. Overall, Lakeland paid an average milk price of 27.5c/l in 2016.

The decline in operating profits saw margins in the Lakeland business narrow 140 basis points to a rather slender 1.2%, with revenues increasing 2% to just over €601m. Earnings (EBITDA) were €18.9m in 2016, while net debt reduced from €50.3m to €48.5m. This gives a net debt to earnings ratio of 2.6 times post the Fane Valley acquisition.

Lakeland invested almost €90m in the business over the last five years and has done so without any share-up requirements or asking for funds from its farmer members. Hanley repeats that this has been the Lakeland strategy where “we would invest outside the farmgate, and let farmers invest inside their farmgate”.

Fane Valley acquisition

Undoubtedly, the biggest story from Lakeland last year was the acquisition of Fane Valley Dairies in May for a total of €13m.

The Fane Valley acquisition brings with it an additional milk supply pool of 240m litres and another processing facility in Banbridge in Northern Ireland. It saw Lakeland process 1.1bn litres of milk in 2016. Lakeland says the Fane Valley acquisition has delivered efficiencies in terms of on-farm milk collections, where milk trucks from both co-ops were previously passing each other on the road.

The acquisition has seen staff numbers for the business increase to 780 employees, while payroll costs have risen to €44m. Total remuneration for Lakeland’s nine key management personnel amounted to €1.86m in 2016.

Fane Valley has also delivered new customers to Lakeland. And while it wasn’t part of the plan at the time, Hanley believes that gaining an enhanced processing footprint in Northern Ireland will be a major asset for the business as the Brexit negotiations unfold.

For now, Lakeland’s strategy for Fane Valley has been to cease production of the relatively small milk powder dryer at its Banbridge facility. The co-op took a restructuring charge of €2.1m in what it terms “the seasonalisation of the operations at the Banbridge site”. He says the site is still being maintained and will be ready to process milk should it be required at a time in the future.

Following the recent €36m investment at its Bailieborough plant, Lakeland plans to maximise milk supply going to this facility for processing, with overflow milk supplies being sent to Lough Egish. All casein production will be maintained at Lakeland’s Killeshandra facility.

The strategy makes sense, considering Lakeland’s Bailieborough facility now has significant additional capacity to produce 160,000t of milk powders and 50,000t of butter per annum.

At Bailieborough, milk drying capacity has almost quadrupled, from 5t/hour in 2010 to 19t/hour today, while capacity for butter production has also quadrupled.

Lakeland’s investment in processing capacity is not unwarranted, given that farmer suppliers have signalled their intentions in a recent survey to increase milk production by a rate of 4% to 5% per annum over the next five years.

The co-op also took a paper loss of €800,000 on its One51 shares, which were valued at almost €5m at year end.

By division

Foodservice

Revenues in Lakeland’s foodservice division, which accounts for 31% of the business, declined 4% to €194m last year, in what Hanley describes as an “intensely competitive market”.

Although sales volumes increased, pricing dynamics in the sector were more difficult.

Due to the competitive nature of foodservice and in a rising global dairy market, which was evident in the second half of 2016, it is more difficult to achieve price increases.

Ingredients

Its ingredients division, which represents 59% of the business, saw revenues increase 9% to €353.6m, as demand from existing customers was able to meet the increased product supply.

The market for casein also improved during the year, allowing the co-op to take advantage of this growth in price.

Hanley says Lakeland has customers in the infant formula and nutritional markets in 80 countries around the world that are ready to take more powder product as Lakeland can supply it.

Agribusiness

Sales in Lakeland’s agribusiness and feed business, which represents 9% of the business, fell 14% last year to €53.3m, reflecting the decline in fertiliser and feed prices as well as reduced spending on feed from dairy farmers due to the weather.

The co-op produced over 160,000t of animal feed last year and sold 20,000t of fertiliser.

Comment

Despite the decline in operating profits, the balance sheet for Lakeland Dairies co-op is in rude health.

The additional processing capacity required has all been financed through profits and bank facilities, without ever having to ask farmers to share up. Hanley is confident when he says all the heavy lifting has now been done and the business is fully invested to handle all the additional milk supply and ready to add value.

Given its location along the border, Lakeland management views the Fane Valley acquisition almost as an insurance policy against potential trade barriers. Given that 600m litres of milk moves from the north to the south each year for processing, a relaxation of tariffs (inward processing relief) on imported milk, which would then be re-exported, would be very welcome in Lakeland’s case, as it accounts for the largest share (around 66%).

However if this does not work, and there are tariffs preventing the movement of milk, Lakeland would have a significant investment (£20m+) in additional processing capacity in Northern Ireland. It does, however, have healthy earnings and its debt-to-profit ratio is not overstretched, which would give it the financial strength to invest.

Fane Valley brings a quality milk pool of decent scale, which adds efficiencies in both milk collection and processing across all sites. In the context of Brexit, the Fane Valley deal gives a level of insurance and offers flexibility where its supply base is split evenly between north and south, albeit that 80% of its milk is processed in the Republic.