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Bega Cheese – Happy Little Vegemites

Your breakfast table might be deemed un-Australian without the yummy products from the good people at Bega Cheese, including the iconic Vegemite spread.

The company’s name belies its ambition to be a strong staple food business beyond its dairying origins. Granted, much of its core products still emanate from raw milk but Bega has made a strategic decision to evolve beyond dairy as part of its future growth.

The food and agriculture industries are not easy territory to conduct business. Large international food manufacturers compete vigorously against local Australian producers using commodity ingredients that are globally priced and subject to currency effects. The supermarkets exert extensive power over suppliers for the scarce and valuable shelf space which is the dominant means of selling product to fickle and fussy consumers. Legislation and regulation play a big part in the daily tussle for sales dollars and did we mention the impact of climatic effects on production?

In that context, Bega Cheese Group has moved on from being primarily a dairy processing business to a more diversified food manufacturer with a vibrant export business to complement its domestic business. As a consequence, brands and marketing are now an important part of the equation.

Export sales of $425 million represented 30% of group sales in 2018.

The shift in Bega’s strategy did not begin with the pursuit of the Vegemite brand in 2017, but it certainly grabbed attention. Being the custodian of such an iconic brand, and especially that it is once again Australian-owned, is a powerful statement from the company about its intentions.

Bega paid $460 million to acquire the Australia and New Zealand grocery and cheese business from Mondelez International in January 2017. The booty included various forms of cheese and peanut butter products and a facility at Port Melbourne, but by far the biggest prize was the Vegemite brand.

As Executive Chairman Barry Irvin said at the time, “this acquisition will be value accretive in its own right, strategically important and company making.”

In November 2017, the Peanut Company of Australia (PCA) was acquired in a very busy period.

Bega currently holds a 9% stake in the listed honey producer, Capilano.

Although the attempt to acquire Murray Goulburn fell short, Bega did get a consolation prize as the ACCC required Saputo to divest the Koroit Dairy manufacturing facility. Bega’s homework on MG gave it an advantage in knowing the value of the asset and subsequently agreed a price of $250 million with Saputo. It came with a guaranteed supply of 300mL of milk each year until 2020 from Saputo which goes some way to filling the 800mL capacity of the asset.

Koroit will add approximately $20 million EBITDA to group earnings in FY19 but will clearly add much more once Bega sources much bigger milk supplies in the surrounding area containing about 2 billion litres of annual milk supply.

Koroit is in a very amenable dairying district with abundant annual rainfall, unlike the drought-affected states of NSW and Queensland that have brought the dairy industry into focus for unfortunate reasons.

But the drought is just one of many important factors that the dairy industry encounters every day.

The dairy industry is about to undergo an interesting change that should see greater fairness for dairy farmers relative to the more powerful processors (including Bega) who are in turn often under pressure from the even more powerful supermarkets.

The ACCC conducted an 18-month review of the dairy industry which was completed in April 2018. The key recommendation from the review was to introduce a mandatory code of conduct to the industry to replace the interim voluntary code under which it currently operates.

It is perhaps the most significant change since the industry was deregulated on 1 January 2000.

The number of dairy farms and farmers has been steadily declining since deregulation, mainly due to the need for increasing scale and efficiency. National milk production has remained steady at around 9.3 billion litres of milk each year for the last 10 years, but the mix of production between states has changed quite a bit.

Even with much larger farms, dairy farmers have been at a disadvantage to the processors who have had the upper hand in negotiating milk supply contracts.

The introduction of the mandatory code of conduct will not necessarily harm the processors but will simply make the process of contracting milk supply more transparent and fairer for the farmers.

This is an important point for Bega as it seeks to source the very large volumes of raw milk it will need to optimise the newly acquired Koroit facility.

There has also been considerable fuss made of the supermarkets’ introduction of $1 per litre private label milk in 2011. The ACCC found during its inquiry that this had no effect on farmgate milk prices. Instead, both the supermarkets and some processors experienced big reductions in profit margins as consumers switched from branded milk to private label.

The major supermarkets account for over half of domestic drinking milk sales and within that figure, private label brands account for about 61% of regular full fat milk and 50% of modified fresh white milk sales (2016-17).

The challenge for Bega is to make the most of its new acquisitions and to consolidate the strong base it has built over a very long period of time.

Bega raised $200 million of fresh equity mainly from institutions who paid $7.20 per share for their contribution while a Share Purchase Plan may collect up to $50 million however the current share price is below $7.10 per share issue price . The funds were used to acquire the Koroit facility.

The pro forma balance sheet remains in good shape with gearing at just 25% and net debt to forecast FY19 EBITDA of 2.2x.

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