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Bega Cheese: Targeting Higher Value-Added Products

Summary

Leading dairy products manufacturer in Australia with strong export position.

On track to decrease its exposure to dairy product commodities like milk powder in favor of higher value-added products.

Geographic position and authentic Australian dairy brand favorable for emerging market exports.

Underlying growth rates in higher-value products masked somewhat by weakness in commodity products.

Attractiveness already discounted in share price; stock is not a bargain at this price.

(Editor’s note: The stock trades with much higher liquidity on the Australian Stock Exchange under the ticker BGA).

Bega Cheese (OTC:BEGAF) (OTC:BGCHY) is an Australian manufacturer of milk, cheese and other dairy products. Australian and New Zealand dairy companies have become quite desirable assets due to their relative proximity to Asian emerging markets (primarily China), where long-term demand opportunities for high-quality protein-based products is favorable. I have been looking at other dairy-based industries lately because the global milk-markets are displaying dynamic changes that may result in investing opportunities.

One dairy company I looked at earlier was UK-based Dairy Crest (OTC:DRCSF), which I wrote about last June when it was selling for 520p while it currently sells for 650p (for a 24% return in barely 5 months). My main thesis then was that lower milk prices would benefit the gross margin of its consumer business, especially after the sale of its milk business was to get regulatory approval (which has happened). Let's take a look at how similar milk-market dynamics will impact Bega Cheese.

While it may seem logical to assume that milk market dynamics are driven primarily by regional changes in demand and supply, this is not the case even though fresh milk is a highly perishable product. Milk markets are connected globally because there is a wide variety of dairy products with much longer shelf life that can be produced by processing fresh milk in a number of ways.

The most important ones are sterilized milk, condensed milk, milk powder, whey powder and several kinds of cheese. With the growth in milk production in the EU and the US currently unmet by demand in those markets, I expect more milk will be processed into aforementioned products, which may lead to even lower prices globally. This can then also depress local fresh milk prices in other markets because more expensive milk markets may see lower conversion of milk to other products.

Recent performance

During FY15, Bega Cheese managed to navigate the downturn of the global milk market quite successfully. Sales were up by +4.04% in a highly negative pricing environment due to higher production volumes. The negative price developments in dairy products globally resulted from increased output from the EU and the US that coincided with a slowdown in demand for dairy imports from emerging markets.

The Russian boycott of certain dairy products from the EU (and some other countries) was an important factor in the disruption to the global market, while demand from China has been weak in most categories this year. The policy changes in the EU however will continue to contribute to supply side changes as milk farmers in EU member states have been ramping up production in anticipation of the abolishment of milk quotas (especially in Ireland, the Netherlands and Poland).

I described the background of the EU changes in my article on Dairy Crest, so I will not go into them as extensively again, but I believe milk production in the EU will grow as a result of these policy changes. I also believe this production increase...


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