Acct 5910 - Bega Cheese Limited

ACCT5910

Business Analysis and

Valuation                                        

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Bega Cheese Limited[pic 2]

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A well-performing player in a mature Industry[pic 4]

• Performance: Bega Cheese continues to outperform its peers in terms of profitability and financial stability.
• Growth Opportunities: While there is significant growth potential through increasing demand from Asia in the cheese and infant formula segments, domestic market conditions remain challenging.[pic 5]
• Dairy Prices and Supply: Global dairy prices are still volatile. Strong supplier relationships contribute to secure and stable raw material procurement, limiting downside risks.[pic 6]
• Important Alliances: Exclusive contracts with Woolworth´s and a strategic partnership with Blackmores aim to exploit medium-term sales growth opportunities.
• Profitable Investments: Bega continues to benefit from its ownership of Tartura Milk Industries in the milk powder segment.

1. Business Description and Company Information

Bega Cheese Ltd. is a producer, processor and distributor of dairy products listed on the Australian Stock Exchange (ASX: BGA). It was originally founded as a co-operative business of milk farmers in 1899 and has since evolved into an internationally active company, which mainly produces consumer goods in the form of natural and processed cheese, core dairy ingredients such as mozzarella and cheddar, and milk powders for the Australian and international markets. The manufacturing range is complemented by cutting and packaging services for cheese products and licensing agreements for the Bega brand trademarks. Bega is currently the largest player in the Australian cheese industry, holding a 20% market share of the AUD 2.7bn industry. In 2011, Bega increased its presence in the market for milk powder and infant formula products through the acquisition of Tartura Milk Industries, which is now a wholly-owned subsidiary. One of the key strategic pillars of Bega are its long-lasting supplier relationships, which will be discussed later in this report.

2. Competitive Landscape

The Australian cheese manufacturing market is a mature and competitive industry, in which domestic participants compete with each other and with foreign companies. The domestic industry is relatively concentrated with five major companies holding a combined market share of 65.8%. Bega is the largest player with an estimated market share of 20.2%, followed by its closest competitor Warrnambool Cheese and Butter (WCB) with 14% market share. Many of the cheese industry´s key companies such as Bega, WCB and Murray Goulburn simultaneously compete in the milk powder market.  [pic 7]

Australian cheese manufacturing industry players and market shares (Source: IBISWorld)

While the threat of new entrants into both market segments is rather low due to strong existing brands and high initial capital requirements to set up manufacturing sites, the level of existing rivalry is strong. In the cheese market, this is reflected in relatively low profit margins and fierce battles for exclusive supplier contracts with supermarket chains and other large customers. Sometimes, heavy discounts will be implemented to win these long-term contracts. Over the years, the level of consolidation in the industry has increased. One example of this is Bega´s aforementioned acquisition of Tatura Milk Industries (TMI) in 2011. Upcoming substitute products for real cheese such as vegan cheese replacements and a potential change in consumer preference away from dairy products put further pressure on the industry. One can therefore conclude that the overall level of competition in the Australian cheese industry is in the medium to high range.

3. Industry Prospects and Corporate Strategy

3.1. Industry Prospects

The prospects of the Australian dairy industry depend on key factors such as dairy and cheese consumption and milk production output and vary widely between domestic and international markets. Ultimately, medium to long-term shifts in consumer preferences both at home and abroad will define the growth opportunities of dairy producers and processors.

In particular, domestic cheese consumption has recently changed away from cream cheeses and other “standard” cheeses towards specialty cheeses, which have experienced a growth rate of roughly 17% among supermarket cheese sales between 2015 and 2016. Despite challenging conditions, fueled by short-term volatility in raw milk prices, Bega has managed to increase the sales of its block and ingredient cheeses by 2.8% and 1.7% respectively. This stresses the influence of Bega´s diversified revenue streams. It is not only dependent on end-consumer demand, but can also profit from its core ingredient cheese segment, which provides cheese for the manufacturing of a variety of foods by intermediary processors. In summary, we expect Bega´s domestic sales to continue to grow above the flat industry average at about 3 to 4% p.a. in the short term and at about 2% p.a. in the longer run. This growth and its limits are closely linked to the overall dairy consumption and Australia´s expected population growth. However, besides sheer growth expectations, we also anticipate slight improvements in margins through the shift in the company´s product mix towards high quality, value-add products. The detailed inferences and implications of this will be explored in the financial analysis and valuation sections of this report.

International markets, above all Asian markets, will become crucial drivers for demand for various dairy products in the medium to long term. While falling global milk prices put pressure on exporter´s margins, the outstanding quality image of Australian brands and increasing wealth levels in countries such as China and Indonesia provide significant growth opportunities for Australian manufacturers. As eating habits become more globalized, we expect the demand for high quality milk powder and cheese products to enable sales growth rates in international markets to reach up to 10% p.a. over the next 5 years, slowly returning to more moderate numbers of 4-5% p.a. after that. Eventually, we expect this increased demand, primarily from Asia, to drive up even long-term growth rates for Bega to a level of roughly 2.5%. Free trade agreements and the above mentioned superior quality of Australian-made products will offer expansion potential to those companies that position themselves well. However, a strong Australian dollar and potential protectionist measures may restrict export opportunities and must therefore be watched carefully.