By Gareth Morgan*
Resorting to stuffing their cows with palm kernel in response to the drought-induced shortage of pasture, is just the latest instance of a New Zealand dairy industry that continues to take more and more risk in order to keep the meagre money train rolling.
When cows eat palm kernel, and other grain foods for that matter, it changes the fat content of the milk.
The Omega 3 you find in milk from grass fed cows disappears, and in its place appears the less healthy palmitic fatty acid and even trans fats.
We know artificial trans fats are bad – real bad – the stuff that boosts our risk of heart attacks. This is why cheap margarine is such a curse and more a less the choice nowadays only of the budgetary challenged – few in their right mind with free choice would feed that crap to their families.
We don’t yet know if the trans fats from cows are as bad as the margarine version, but in many European countries all trans fats are banned.
I’ve written a bit on this lately – our dairy industry, which is really important, has become so unhinged from sustainable economic reality that its decisions are increasingly being driven by short term opportunism that is putting the future of the industry, and the country for that matter at risk.
The pressure that has driven us to such extremes is best summarised as the price of land, which has become totally unrelated to the financial earnings of farmers.
With a pitiful rate of income return on such an expensive asset being the norm, there has never much of a cash cushion for farmers to weather stormy economic climes.
As we all know the raison d’être for dairy farming certainly isn’t income, for decades now it’s been the appreciation in land values. Can this just continue forever?
The answer to that is no, it can only continue so long as expectations of greater income some time down the track are fulfilled. Otherwise, as we’ve seen in plenty of other instances the speculative fervour, once shown to be unjustified, leads to a crashing of the asset prices. Housing markets around the world are a great recent example.
Back to dairying.
With growth in the world’s appetite for protein we know demand conditions for the product are favourable.
But so are they for meat and from that example we know how it doesn’t necessarily follow that the value of meat-producing assets are guaranteed to appreciate. But of course so far for dairying they have, and understandably the longer that has gone on the more the conventional view is that it will continue.
Farmers gear up and buy more land, invest more in intensifying their farming, including feeding not just pasture, but grain to livestock.
The New Zealand dairy industry remains a volume game, kgs of milksolids are the holy grail of dairying success.
Anything the farmer can do with his payout cheque or Fonterra dividend to raise production he will – some beyond the point of rationality – pursuing the nirvana of greatest kgs of milksolids per cow and per hectare.
The rationale is simple – other farmers price the value of the asset on the basis of kgs of production, virtually irrespective of the costs of production. So long as that is the buyers’ rationale the industry will continue to grossly over-invest on-farm. And it will until farm prices reflect profitability not revenue.
But the risks are rising – the 2008 episode with melamine and the 2013 DCD scare are examples of the types of risk that food safety concerns can deliver, trans fats are another.
For New Zealand, the more dependent we are on milk volumes the more vulnerable we become to risks around the quality (eg: from contaminants) and the quantity (eg: from drought or an outbreak of cow disease similar to what PSA has done to kiwifruit) of that volume.
It’s a simple problem of having too many eggs in one basket.
If you combine this with the wafer thin buffer of income farmers get from investing in such an expensive asset (land) then it doesn’t take much of a stress test on the industry to catapult it into a major shock.
Now any business has risk, it’s part of the game. But what we’re discussing here is the extent of the risk and whether in the case of New Zealand dairying the risks are steady to declining or growing.
As a firm matures the norm is that risk declines – mainly achieved from diversification of income streams. Therein is the test our dairy industry is failing.
There is little diversification of income sources, it remains predominantly from the volume of milksolids. And we know the rate of return on asset values is woefully inadequate already, meaning the cushion for shocks is getting less not greater.
What to do?
The industry faces a challenge – it’s faced it for over 30 years and has only played around the periphery in trying to address it.
Instead of all the dividends being re-invested pretty much on-farm in pursuit of volume, it needs more to be coming from those areas of the supply chain that provide markedly higher margins.
They include delivery of consumer products in international markets, transfers of on-farm technology and IP to other countries. Now there is a little of this occurring but it is pitiful in relation to the industry’s main act – it simply is not effective diversification.
Until that does occur we continue to raise our bets on the one nag – kgs of milksolids coming off NZ farms.
And we know that is way past the profit-maximising point, and without relying on further appreciation of land prices dairying is high risk, low return.
The relevant question is not how long this can continue – because that is unknown. It is how many of the investors in the sector accept the argument and are moving to protect their personal investment stake?
And on that front you’d have to say, bugger all.
Gareth Morgan is a businessman, economist, investment manager, motor cycle adventurer, public commentator and philanthropist. This opinion piece was first published on his new blog garethsworld.com and is reprinted here with permission.