Expecting Value – UK Value Investing Blog
6Jul/120

Friday Reading

More on Milk

One of the most interesting sagas I've followed this week - more interesting than what is fast becoming a torrent of woes in financial sector PR - is something which touches consumers in a more obvious and direct way. We've had milk wars galore over the last few years and the prime minister described as 'not knowing the price of a pint of milk'. Of course, there's also been more than a few pieces of typical BBC fare on the subject - just imagine shots of rural idylls and good, honest, hard working farmers contrasted with the all conquering corporate evils of the supermarkets!

On Monday Arla made themselves the last of the 3 main processors to cut the price of milk paid to their suppliers, and unsurpisingly found themselves up against some stiff resistance in the face of suppliers angry at being made to produce at prices they believe damage the long-term prospects of the supply chain. First and foremost for me, then, the story is interesting from an economic point of view. The sort of classical economics most people usually associate with the subject would probably say that, given that producers have been arguing they're being underpaid for years yet are staying in the market, the market is simply behaving efficiently. Their must be some sort of discrepancy between supply and demand somewhere along the line. If milk suppliers truly are being forced to produce at below cost, we have a fairly large indicator that there is rampant oversupply in the market - or that our model of milk production is 'wrong' in one sense of the word or another.

Classical economics in that sense is often described as naive, though, in that it fails to account for so many other factors. Over what timescale the market could be said to be 'efficient' is a common and interesting debate, and there is at least some evidence that the market can make extremely myopic decisions - positive for the short term, detrimental for the long. In that vein, I was more akin to believe that side of the story when the argument popped up that:

“The low price of milk is forcing extremely hard-working farming families into poverty and increasing the dependence on antibiotics used with animals that will have a devastating effect on the industry,”

Hardly a positive if true. Valuhunteruk collated a number of charts on the subject in the context of Dairy Crest which provide a good overview of the business. One of the most interesting there shows the breakdown of where the money in a litre of milk goes - between the retailers, processors and farmers. That certainly raises a lot of questions about who holds the cards in the relationships, is understandably emotive from a public interest point of view, but must also - somewhat unpopularly - suggest that the market is doing a rather good job of squeezing out the best price for consumers.

I'm no more than an interested observer in the story since I know more or less as I suspect the average person does about dairy farming in the UK. I do enjoy watching it, though - something has to give at some point, be it a big drop in the production of milk leading to a smaller, more profitable farming base, supermarkets cutting their margins, or a big increase in the consumption of milk; which the linked graphs suggest is exactly the opposite of what is happening.

Ways to play out any opinions in the equity world seem limited, since Dairy Crest is, as far as I know, the only stock really directly entwined with the dairy sector. To an extent, I also wonder how involved in any outcome the processors can really be - DCG at least are producing at basically no profit, and seem to find themselves between a rock and a hard place in the sense of underpaid suppliers and powerful supermarkets. I wonder if any day of reckoning will really involve them, or whether they will simply continue to eke out meagre returns more influenced by their operations than wider supply chain issues. We shall see.

Next week I hope to get back to looking at a couple more small-mid caps, since my analysis has been something of a non-existence this week with all the performance and other work I've had to do. Back to the real stuff; until then!

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