In a 52-page analysis on the two firms by investment banker Panmure Gordon, analysts Graham Jones and Damian McNeela argue that a period of relative stability in supermarket milk supply could be about to end, as Arla builds a 1bn litre 'super dairy' and Asda, Sainsbury’s and Morrisons review their milk supply arrangements.
They add: “In our opinion Wiseman is best placed to benefit, while Dairy Crest looks the most vulnerable to any potential changes in these supply contracts.”
While Arla’s new dairy would not add much net capacity to the trade (it is expected to close three older less efficient dairies), it would however lower the cost structure of the industry – and as such present a greater risk toDairy Crest given its lower operating profitability compared with Wiseman, they argue.
Wiseman, meanwhile, was “likely to build additional capacity if it were successful in gaining significant incremental volumes, allowing it to further improve its cost position”, they claimed.
The cost of constructing a new dairy of a similar size to Wiseman’s new 500m-litre Bridgwater dairy in Somerset would be around £100m, which it would be able to finance through debt without placing its balance sheet under undue pressure, they add.
“The outcome of any potential reviews though is unlikely to be known until the second half of 2011 and consequently there is likely to be a degree of uncertainty surrounding the growth profile of Wiseman’s milk volumes and any subsequent requirement to build additional capacity.”
Supermarket supply contracts
Recent data suggested retailers that paid a premium for their milk via dedicated milk pools had lost market share to discounters over the past two years, they added.
“If this trend continues, it is likely that retailers could address current supply arrangements and there is some evidence to suggest that this process has already begun.”
As Wiseman does not currently supply Asda or Morrisons, any review by these two represented “a significant opportunity [for Wiseman] to gain additional market share”, they added.
Asda, which has a sole supply arrangement with Arla for its liquid milk, is also rumoured to be considering diversifying its supply base over the next 12–18 months, they claimed.
“Given Wiseman’s lower cost structure we would expect it to be able to compete more effectively than Dairy Crest in a tender process.”
Wiseman was also in a good position to demonstrate its customer service levels to Asda through its distribution to Netto following Asda’s acquisition of Netto’s UK business in May.
Meanwhile, Sainsbury’s recent decision to switch 5% of its milk volumes from Dairy Crest to Arla suggested Dairy Crest was “at a higher risk of losing any further volumes than Wiseman”, they claimed.
Finally, if Tesco were to tender its business, both Wiseman and Arla would “vigorously defend their volumes.Given that we believe Dairy Crest’s operating costs to be higher and with arguably less scope to reduce costs than peers we would expect Arla and Wiseman to retain this business.”
Dairy Crest: not a passive observer
However, Shore Capital analyst Clive Black said we “shouldn’t just take it for granted that Dairy Crest will lose out when Arla builds its new dairy”.
He added: “Dairy Crest won’t just lie down and get rogered, it’s investing £75m in its dairies. It’s not as weak as some people think. It’s also got a strong stable of brands. In fact Arla probably has the most to think about.”
All eyes were now on Wiseman, he said. “If Wiseman builds a 250m-litre or 500m-litre dairy, that really will add incremental capacity to the market, and I would be surprised if there is not some kind of announcement from them between now and the end of next year.”