Dairy farming: It'll be survival of the fittest

Dairy cows make their way to a milking shed at a farm that supplies to Fonterra. Photo / Brendon O'Hagan

Bank analyst has confidence in the sector’s ability to adapt but says that some of those ill-prepared for the downturn will go to the wall, writes Jamie Gray.

The dairy sector may be in for a period of adjustment of an order not seen since the 1980s, when farmers were hit with high interest rates, a high New Zealand dollar, and the removal of subsidies, says Rabobank NZ's head of country banking Hayley Moynihan.

As dairy farmers prepare to enter what may be their third season in a row of negative returns, Moynihan said there will be casualties, but she has confidence in the sector's ability to cope.

Fonterra this week cut its farmgate milk price forecast to $3.90 a kg of milksolids from its previous forecast of $4.15 a kg, citing overproduction in Europe as the main reason for weak prices.

The co-op has said prices may remain low for the next six to 12 months.

Last season's milk price came to $4.40 a kg and some forecasters now expect the coming season's milk price to remain well below the average break-even point of $5.25 a kg.

"In a market downturn, there will be casualties," Moynihan said. "This type of adjustment, while it does place the sector in good stead competitively, is very painful for those going through that adjustment and unfortunately, not all farm businesses will survive," she said.

Moynihan said the sector had adapted to new conditions in the past and would continue to do so.

"It is accustomed to doing this and it has done so in the past, but this is a significant adjustment that will require something along the lines of the changes that we saw in the 1980s when New Zealand farming really changed in terms of policy settings and support being removed at that time," she said.

"The adjustment this time - driven by different factors - may well be of a significant magnitude for those dairy farmers."

Moynihan said New Zealand dairy farmers were "definitely under stress" due to the current low milk price.

"They are coping with that in a number of different ways - mostly through cost reduction and looking for more efficient ways of producing milk," she said.

"That's going to have ongoing ramifications for the sector, some of which will be positive for those who survive and manage through what will be a prolonged downturn."

This type of adjustment, while it does place the sector in good stead competitively, is very painful for those going through that adjustment and unfortunately, not all farm businesses will survive.

Rabobank had been picking an improvement in dairy prices to occur mid-way through this year, but unexpectedly strong production growth in the European Union (EU) now means the bank does not expect to see improvements until late this year or early next year.

The EU did away with production quotas last year and still subsidises the market when prices reach certain trigger points. But Moynihan said the main problem was the European dairy companies themselves.

As it stands, EU farmers have had a favourable winter and have yet to feel the full brunt of lower prices.

"Milk companies in Europe have chosen to support milk prices through other product returns and through leveraging their capital base, therefore farms are producing more milk and that milk is far outweighing any production declines that we are seeing in New Zealand and elsewhere," she said.

She said EU dairy companies would eventually lose their appetite for shielding their farmers from the rigors of the global marketplace.

In New Zealand, milk production is expected to decline but - thanks to generally good growing conditions over summer - local production in the current season will not decline by as much as many had expected.

The EU still intervenes to provide price support for skim milk powder and butter. For skim milk powder, the cap for purchases is set at 109,100 tonnes and the EU is about halfway there. Stockpiled product will inevitably lead to a delay in any recovery on the world scene, Moynihan said.

Moynihan has for some years commented on the need for New Zealand to remain a low cost, pre-dominantly grass-fed, producer.

Hayley Moynihan, Rabobank NZ.

That has largely fallen on deaf ears as production - and costs - have ramped up through a raft of measures, including use of supplementary feeds, off-farm grazing and higher stocking rates per hectare.

"The industry was growing at such a pace in terms of lifting production and in terms of the number of new farms - particularly over the last decade," Moynihan said.

"With that growth inevitably comes a period of consolidation. "What this particular downturn will do is refocus our energy on competitiveness inside the farm gate because we are still a long way from our markets and there is a lot of competition out there. That's where the core focus needs to be," she said.

"It is still a good industry but we did lose sight of the fact that we needed to be very competitive so that we can get through these periods that we are experiencing now."

In 2008-9 farmers geared up in terms of their production costs to capture higher milk prices, on average.

"What I think this particular downturn is going to cause is a re-assessment of what the New Zealand farming system looks like," she said.

Those with low farm expenses and high debt will tend to be OK, along with those with low debt and high farm expenses. It is really that top quadrant that is going to find it stressful.

Resilience and the ability to survive downturns was imbedded in the grass-fed farming system, Moynihan said. "I think that we will see a change - not necessarily back to the way we were - but a change to cope with what will inevitably happen as a result of this downturn. That's going to be quite a shift and that's where it will be quite painful."

Moynihan said she expected farmers to take a "more holistic" approach to land use, moving away from dairy as the first port of call.

In terms of the people who were going to find the situation difficult - those with high debt and high production costs - it would be a relatively small percentage.

"Those with low farm expenses and high debt will tend to be OK, along with those with low debt and high farm expenses. It is really that top quadrant that is going to find it stressful," she said.

With her banker's hat on, Moynihan said one of the strengths of the New Zealand industry was the support that it had from the financial community. Because agriculture, and dairy in particular, had been such a big part of New Zealand economy generally, finance was generally readily available.

"And that's not something we see in other parts of the world," she said.

"Even though dairy is experiencing a severe downturn now, I would still expect that that support would continue," she said. "I would expect that banks will work with farmers during this period. Some of those conversations will invariably be quite tough - there is no getting away from that - but I think it will be quite different from what you would expect in other countries and other industries going through this type of downturn," she said. "And of course, low interest rates will help."