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«David Alvis A 2008 Oxford Farming Conference / Nuffield Farming Scholarship Trust award Thanks and acknowledgements I would first and foremost like ...»

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Aerated Slurry storage lagoon at Vreba-Hoff dairy Willy van Bakel is reported to have severed ties with the Van Bakel’s dairy farming interests in the Netherlands to protect the family’s assets from the potential consequences of any future failure in their US business Vreba-Hoff recognised and took advantage of an opportunity offered by the historically huge disparity in asset values on either side of the Atlantic. The asset arbitrage model was an ingenious one that allowed the van Bakel & Vander Hoff families to leverage the value of their collective experience and knowledge of the dairy industry to their considerable benefit It would be a disappointing end for an ingenious and enterprising business if it were to fold, but equally it underlines the fact that the US milk market is as unforgiving in a downturn as it is lucrative in a boom and however entrepreneurial the venture, adequate risk management is an essential element of any large dairy business, especially when the business model relies so heavily on leveraged finance.

Personal reflections on my study An interesting aspect of my travels in the Midwest in the autumn of 2008, was watching the world’s financial markets unravelling in real time. 24hr news is often criticised for desensitising the viewer to significant events but in this case it served to focus my mind on what was happening in the wider economy and how that related to agriculture.

It also provided the opportunity to get a greater insight into the financial strategies and risk management processes employed by the businesses I visited. I was warned by a previous Nuffield scholar that Americans, as a generalisation, are happy to discuss their businesses with you until you start asking specific questions about financial numbers. However given the rollercoaster ride that the US dairy industry had experienced in the previous 10 years and the financial storm that was beginning to blow through the whole economy, finance and particularly risk management were subjects that many of my hosts were surprisingly willing to discuss.

Financial structures varied widely from business to business and there was little clear evidence of a uniquely superior business model. The range of different financial structures reflected the evolutionary process of the individual business, but one characteristic, common to all successful large scale dairy businesses and the Achilles-heel of those that were struggling was their ability or lack of it to manage risk.

Risk Management

Effective risk management is without doubt the single most significant differentiating factor between successful large scale dairy businesses and the rest. Technical efficiency is assumed for dairies of this scale and whilst essential is no guarantee of business success.

All the farms I visited were, from a technical performance standpoint, streets ahead of the average dairy farm in the UK. This is perhaps an unfair comparison as they were certainly not average US producers as one is naturally inclined to seek out examples of best practice for a Nuffield study, but one thing that became clear to me very quickly is that price volatility makes the US milk market a brutal environment where sub optimal performance is rapidly and harshly exposed and even the best operators have little room for manoeuvre at the bottom of the cycle.

And I mean risk management in its broadest sense. It goes far beyond mastering the use of financial instruments to hedge your position against market movement and lock in margins, although this was key for many of the businesses I visited, not least Jim Ostrom, who as a result of an extremely disciplined approach to margin hedging was able to secure significant debt finance to grow his business through the worst of the financial crisis.

Building and maintaining relationships with partners and suppliers, both upstream and downstream is fundamental to mitigating commercial and market risk.

Kenn Buelow has developed a highly successful, mutually reinforcing network of supplier relationships with local farmers and other businesses that reduce both market and environmental risks to his business.

His forage pricing matrix captures the value of the manure stream and secures an outlet for that manure, provides a stable & lucrative market for his suppliers and secures a supply of quality forage without having to invest in land, machinery and working capital to finance the growing costs.

Mike McCloskey and Tim den Dulk at Fair Oaks have, by building and managing a lean, efficient co-operative marketing infrastructure for their milk, been able to manage the interface with the customer, driving out supply chain costs and improving responsiveness, two factors that generate a premium value for their milk and reduce market price volatility.

Their major investment in manure handling and Anaerobic digestion infrastructure as part of an environmental management policy has helped to mitigate many of the environmental and reputational risks that threaten large scale dairy farming whilst at the same time reducing their exposure to increasingly volatile fertiliser and energy markets; and as net sellers of energy derived from waste, they are set to profit from future rises in energy costs.

And by developing the truly remarkable visitor centre and associated activities, they have turned a potentially huge corporate reputation risk into a source of positive PR and wealth generation External Capital When I set out on my Nuffield study I made an assumption that was quickly proved wrong;





that the growth in large scale dairying in the US over the last 20 years had to be driven by large scale external capital investment.

The reality is that external investors are active in this market, exemplified by the private investment fund behind Kenn Buelow at Holsum dairies and the real estate fund investor in Fair Oaks Farms; but these are often relatively small players in financial market terms and their origins are often rooted in agriculture. In the case of Fair Oaks, the source of much of the fund’s capital was from the sale, for development, of farmland in California; a not uncommon source of funding for many large US dairy businesses.

The Vreba Hoff model created value by exploiting the differential in asset values between Europe and the USA, allowing relatively small Dutch dairy farmers to quickly achieve the critical mass necessary to survive in the harsh commercial environment of US dairying. How they adapted to the cultural and operational challenges that came with such a transition was a separate issue and one that in some cases destroyed much of the value that had been created.

Vreba Hoff’s transition to a true external capital funding model, whilst a logical progression, appears to have been, temporarily at least, undermined by the sharp fall in dairy prices in late 2008 & 2009 and the businesses (in)ability to manage risk in its existing activities The age of the large institutional investor in dairying would still appear to be some way off.

Jim Ostrom alluded to the fact that a number of funds were watching the industry with interest and will almost certainly drive the next major wave of rationalisation in the dairy sector, in a similar way to how the pig and poultry industry has evolved.

Dairy farming has always been viewed as a more complex and thus more fundamentally risky business than monogastric production, where management is generally simpler, less land constrained and thus easier to scale up than dairy. Therefore it has taken longer for the dairy industry to develop the requisite and often technology driven management solutions to the challenges of scale.

That said the recent $100million+ investment by Kohlberg Kravis & Roberts, a largeUS based venture capital house, in Mengniu Modern Dairy a large scale, vertically integrated dairy farming and milk processing business in China, has perhaps signalled the dawn of true corporate investment in dairy farming.

Likewise there have been a number of significant institution backed dairy ventures in South America and in parts of United States often led by New Zealand based consortia, lured by the relatively benign climate and abundance of cheap land. Such an environment suits the low cost New Zealand grazing based model but their relative geographical isolation and seasonal production profile, means that such systems are often constrained to supplying increasingly volatile world dairy commodity markets.

As major producers such as the US and EU with large internal markets that effectively act as a buffer against world market volatility, increase production, those producers more exposed to the global market are likely to see even more volatility in the future and as such their business models will become increasingly dependent on appreciation of the underlying land value.

Just last month (February 2010) New Zealand Farming Systems, Uruguay a New Zealand backed dairy venture was forced to sell off 2,500 hectares of land to service its mounting debts. This follows previous substantial land disposals in June and October 2009. Whilst the disposals realised a significant profit over purchase cost it somewhat calls into question the long term sustainability and thus attractiveness to investors of such a model and whether such a venture is principally a dairy farming business or merely a property speculator, using dairy farming as a rather risky means of maintaining the productive capacity of its asset base.

Application to the UK market.

With domestic ‘per capita’ consumption stable and the UK population set to increase by 10 million over the next 20 years, the prospects for the UK dairy market provides a relatively stable long-term investment environment.

This is further reinforced by the recent resilience of the UK milk market during what was a blood-bath for many producers globally, not least in the US. While prices here fell from their 2008 highs, they didn’t fall nearly so far and so fast as elsewhere in Europe and beyond which suggests to me that our market with its large and growing domestic consumer base is actually a lot less volatile and offers more long term sustainable growth opportunities with lower risk than many other countries.

The key for new entrants will be developing an appropriate business model for the market sector they seek to supply and ensuring that adequate risk management procedures are in place.

Jim Ostrom provided a great example of how to manage sustained growth in such an environment, combining scale, technical performance and a disciplined approach to managing risk and market volatility.

The importance of the liquid market in the UK and the cost to the industry of balancing seasonal milk supply against essentially flat year, round demand would seem to favour the establishment of large scale production units, supplying on a level profile close to centres of population. Arla’ s announcement in 2009 that it plans to build the largest liquid milk processing plant in the world on the outskirts of London would tend to support this and is a further vote of confidence in the future of the UK milk market.

Developing the supply chains necessary to feed such a facility efficiently presents both a challenge and an opportunity for the industry, but one that my Nuffield experience and particularly the lessons learned from Fair Oaks has shown to be eminently achievable and sustainable.

Another positive development in the UK in the past 12 months is the introduction of government guaranteed ‘Feed-in-tariffs’ for small and medium scale renewable energy projects (up to 5MW capacity). This effectively underwrites the price producers receive for up to a 20 year period, essentially the life of the asset and provides a stable and potentially securitisable income stream.

The potential introduction of feed in tariffs for renewable heat in 2011 will further add to the revenue generating potential of on farm AD, provided that a suitable use for the recovered heat can be found.

This may require a degree of imagination and lateral thought, but there are many potential applications for heat recovered from AD/CHP which have the potential to significant improve the long term sustainability of integrated Dairy / AD models both commercially and from an environmental and consumer acceptability viewpoint.

Consumer acceptance of large scale dairying will be one of the more challenging issues to address. The recent media furore surrounding a proposed 8,000 cow unit at Nocton in Lincolnshire, shows how the media and single issue pressure groups will attempt to undermine in the eyes of the consuming public what is essentially a robust and sustainable business model, through often blatant misinformation and the use of inappropriately emotive language and imagery.

Effective stakeholder management is the key to ensuring success in this potentially hostile environment. Fair Oaks Farms and Holsum dairies provide excellent examples of how large scale dairy businesses, can exist in harmony with their environment, and contribute significantly to the local economy.

The Educational and PR value of the Fair Oaks Farms visitor centre is fundamental to their gaining and maintaining consumer acceptance, operating in an industry sector that is under increasing public scrutiny on animal welfare and environmental grounds. By actively engaging the public and presenting a clear, positive and professionally managed message, they have been able to win back a lot of ground ceded by the industry in previous years to the better managed PR machine of the animal welfare and environmental lobbies.

Kenn Buelow at Holsum dairies also provides an excellent model of best practise. By engaging fully with neighbouring farmers, he has created a mutually reinforcing business model that generates value and mitigates risk for all parties involved. His approach is one of co-operation allowing his business to focus on its core strengths whilst exploiting, to their mutual benefit, the potential of relationships with neighbouring crop growers and other local businesses.

Combined with excellent levels of technical performance, environmental management and disciplined financial control, Kenn has built a truly sustainable model of large scale dairying and of all the businesses I visited is the one that I feel could be replicated most successfully in the UK.



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