Tirlán cost cutting: a sign of things to come for the industry?

When Tirlán announced a cost reduction programme last week, including a voluntary redundancy package which is expected to see 150 job losses, the co-op said it was “proactively” managing its cost base.

The company said that costs of energy, interest rates, wages and environmental compliance are all rising, while milk supply volumes are in decline. It sought to reassure farmers by saying that milk processing capabilities will remain unchanged and that the co-op will retain the ability to increase capacity if there are changes in milk supply dynamics.

Incoming CEO of Tirlán Sean Molloy told the Irish Farmers Journal that the processor is in a “very strong financial position” and is making these decisions “from a position of strength”.

He also said that while declining milk volumes was a factor in the scale of the measures announced, the business would have engaged in this programme anyway.

Milk supplied to Tirlán is 8% lower than it was last year.

Looking across the dairy sector, there is nothing to suggest that we won’t see more cost-cutting measures.

While overall net debt levels at the six largest dairy co-operatives in the country dropped significantly in 2023 (see Figure 1), interest payments almost doubled from €32m in 2022 to €63m last year (see Figure 2).

This is direct impact of the rise in European borrowing costs during 2023. With those borrowing costs remaining high this year, the pressure from debt burdens will remain elevated, even if the level of borrowing continues to fall.

Certainly, in the immediate term, there are no extra cost savings to be made there. The €63m in interest payments last year are the equivalent of 1c/l on milk supplied.

On energy, there are also probably few savings to be made for the industry in the short term. With the amount of energy used directly correlated with the amount of milk processed, the drop in milk supplies will lead to a fall in energy usage. However, it is the cost of energy per litre of milk processed which matters for the bottom line.

Like with interest rates, processors are price takers when it comes to energy. In the longer term, developments around alternative sources such as solar and anaerobic digestion should increase control of this cost.

So, for the industry, the only places where co-ops can make savings are in the prices they have the power to set themselves.

These are, fundamentally, how much they pay their employees and how much they pay their suppliers.

Tirlán, with its 150 redundancies, and Lakeland with 78 redundancies last year, and more planned, have already made moves in that direction. Processors can also put workers on shorter hours, and cut overtime, as Dairygold have already done this year.

Over the longer term, reductions in wage bills can be achieved by increasing automation, reducing complexity in processing, and consolidating operations in key sites, as alluded to by Lakeland CEO Colin Kelly in recent days (see page 7).

As the dairy sector is a very-low margin industry, it is unlikely that a large number of job cuts can be made without significantly affecting processing capacity in the industry. For now, the co-ops seem to be trimming what they can while maintaining capacity.

If milk supply recovers over the medium term, then the level of job losses may be contained. However, the risks to that scenario are high with the derogation decision, the weather and the age profile of farmers all likely to play a hand in what the outcome there is.

The outlook for global demand is a key factor for co-ops when making strategic decisions. The changing market dynamics point to the possibility of greater demand in Europe, with opportunities in Asia becoming more scarce.

A report from Rabobank recently suggested that China, for years a key market for Irish dairy powders, is rapidly becoming more self-sufficient in its dairy needs. China’s imports of whole milk powder dropped by 140,000t in 2023 to 430,000t. That drop is equivalent of 6% of New Zealand’s annual production of just over 20bn litres.

As Rabobank say, that milk will now have to find new markets in the region. Already at a disadvantage due to geographical distance, it seems the Irish dairy success story in China may be finally coming to an end.

On the other hand, Rabobank also says that dairy production in northwestern Europe is set to move into a period of structural decline, with output dropping by between 13% and 20% over the coming years.

If Ireland can buck this trend, then the industry here may well remain robust over the medium to longer term.

However, there are some timing mismatches that have to be taken into account.

The plunge in Chinese demand is already well underway, while the decline in output from northwestern Europe has yet to begin.

In fact, milk production for the first four months of this year from top European countries is the highest it has ever been (see Figure 3).

This means, in effect, that global demand has already been hit by the shrinking Chinese import market, while European production has yet to peak.

Presuming that the Rabobank analysis is correct, then co-ops here have to play a waiting game where they try to manage costs while maintaining productive capacity in the hope that they will be able to take advantage of a drop off in European output.

This also assumes that Irish milk output manages to hold up over the coming years, which is far from guaranteed.

How well the processors can play that waiting game, comes down to how financially strong they are.

As we already said, co-ops have few options when it comes to reducing costs. They have some room on the wages side and we already see moves in that direction.

They also have control over their single largest input cost – what they pay for milk. Therefore, to get an idea of which of the co-ops is under the most cost pressure, we can just look at what they are paying for the milk they are processing.

Looking at the latest Irish Farmers Journal milk league to the end of April, Lakeland is well placed, with Tirlán in a steady mid-table position. However, one co-op is rapidly starting to stand out as it falls behind in what it is paying its suppliers.

Tipperary Co-op has been bottom of the milk league every month of this year. A farmer supplying 500,000l per year at national average milk solids would have been paid €60,050 for their milk in the first four months of the year, more than €1,500 less than the next lowest co-op, and over €3,300 less than the best payer.

Tipperary’s problems have been exacerbated by the timing of its €32.7m investment in a new dryer, which opened in late 2021.

There was another €10m investment in upgrading its older dryer, completed in mid-2023, leaving the co-op with the capacity to process over 600m litres of milk annually. The co-op almost perfecting picked the top of the dairy market to launch its new capacity.

Also, worryingly for the co-op, it refinanced its debts in August of last year, again picking the top of the market, but this time for the most expensive interest rates have been for many years.

Tipperary’s problems are not helped by the fact that less than 70% of the milk it processes comes from its own suppliers.

If, as seems likely, the milk from other processors dries up, it will have in the region of 180m litres of its own supply this year, meaning its processing facility will be running at less than 30% capacity. In the Irish industry the grass-based dairy system means most co-ops run at about 60% capacity on average across the year, so it seems that the inefficiency in Tipperary is particularly pronounced.

These problems will be further worsened by the outlook for processing. There is only so much patience that dairy farmers will have with being the worst paid in the country.

There is a chance that Tipperary will find itself in a position where the drop in prices will be seen as weakness in the co-op, which will lead to further drops in milk supplied, which will increase the inefficiency of the processors operations which, in turn, will force it to pay even less for milk. The board of the co-op recently replaced John Daly as CEO with John Hunter, who was appointed on an interim basis. More than any other co-op CEO in the country, he will have the hardest task of navigating the wait for global markets to turn, or supply to rebound.

Dairy processors are caught in a tight squeeze at the moment. The decade of expansion could have lead to a slow consolidation as milk supply peaked and global markets recovered from the volatility of the past few years.

However, the change in Irish milk supply has been much more rapid than expected. Every co-op CEO we talked to last year admitted that the years of rapid expansion were over, but that future supplies would be flat.

A combination of bad weather and uncertainty over policy have seen them come in well below those optimistic projections.

This, in turn, means that pace of the consolidation and cost-cutting has to be increased, as Molloy alluded to.

For dairy farmers, watching processors effectively manage their costs should be good news. A more efficient processor will be able to pay more for milk. But a very rapid change can lead to bigger problems as it increases the potential for disorderly drops in processor capacity.