The Oceania dairy debate

Competition between Australian and New Zealand dairy investment managers has gathered pace recently, but there are opportunities in both markets for the right investor.

Investment into both Australia’s and New Zealand’s dairy markets has increased in recent months, as has the rivalry between Australian and New Zealand investment managers as they fight for institutional investors’ attention.

There are several compelling arguments for and against each market. Here are just a few.

The high price of farmland in New Zealand compared with Australia is a frequent criticism but it can be justified when considering the country’s climatic advantage for growing grass, and therefore free cattle feed. These low input costs, the premium milk pricing awarded for grass-fed dairy, the export of 97 percent of all milk produced and secure demand thanks to processor and cooperative Fonterra, can create an appealing return environment, NZ fund managers argue.

Other positives include the availability of cheaper labour in NZ compared to Australia, a free trade agreement (FTA) with China and a stable land profitability ratio, according to the Reinz Dairy Farm Price Index.

Australia may not have an FTA with China, or reliable rainfall in many areas, and the industry overall is much less efficient, but its proponents argue the various shortcomings present opportunities.

“There is enormous potential for growth and improvement because the industry has been advantaged by deregulation recently and there is plenty of untapped capacity in the milk production and processing space,” said Marcus Elgin, executive chairman at AAG Investment Management, the consultancy and asset management firm.

Australia’s reliance on domestic demand from supermarkets keeps the milk price low but it also exposes it to a wider spectrum of milk products. Together with local milk supply competition this produces a less volatile farm gate milk price than in New Zealand where Fonterra buys 90 percent of all milk produced.

In September Fonterra cut the milk price it pays farmers to $5.30 per kg of milk solids, a 37 percent fall from last season’s price. Australian farm gate prices were down between 10 percent and 15 percent by comparison, according to sources.

But, in turn, New Zealand’s greater exposure to the global market, and the overall appealing supply/demand curve in milk, means that its farm gate price has more upside potential.

Despite the very different fundamentals of both markets, Aquila Capital raised some eyebrows last week with the launch of a new NZ dairy investment product because the firm had previously been vocal about the shortcomings of New Zealand’s dairy market while fundraising for its Australian dairy fund.

“It is an odd move by people who have been saying that NZ farms are too expensive to want to take debt against them,” said one industry insider.

But why can’t a fund manager offer both products and opportunity sets to investors?

“We are not pitching our products against each other because they have very different return profiles: the NZ product is strategic, long-term, passive, scalable and tax-efficient with a fixed income DNA, whereas our Australian product is opportunistic, short-term, active, tax-agnostic and suited to private equity investors,” said Detlef Schoen, managing partner of farm investments at Aquila.

Schoen has a point. The two markets are very diverse and present totally different opportunities for investors and fund managers. Each is likely to suit different investment needs.

The New Zealand market could suit a more risk-adverse investor, keen to invest in a more established industry over a longer term. Australia might suit a slightly more adventurous investor keen to make private equity-like improvements to a dairy farm and ride the industry’s overall development.

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