In last week’s article, we saw how Ireland’s infant formula exports have quadrupled in value over the last decade to reach €1.3bn last year. Infant formula now accounts for 40% of all Irish dairy exports and has been responsible for more than half (55%) of the growth in dairy exports over the last decade.
And while these figures are impressive, Irish dairy farmers would be right to ask how much of the value in the lucrative infant nutrition market (valued globally at $50bn) is actually returned to the primary producer. The reality is not a lot.
Listen to a discussion of the importance of the infant formula industry for Irish farmers in our podcast below:
In volume terms, the global infant formula market is about 2.3m tonnes in size and growing at 2% per annum. So the market is growing at a rate of 40,000t to 50,000t every year. With Ireland producing close to 250,000t of infant formula a year, our dairy industry now accounts for 11% of the global market even though Ireland only produces 1% of the world’s milk.
However, to better understand the dynamics of infant formula, it is necessary to look at the dominant players in the market. Four companies – Abbott, Danone, Mead Johnson and Wyeth (Nestlé) – account for between 70% and 80% of the global market for infant formula. Of these multinational players, Abbott, Danone and Wyeth (Nestlé) have a manufacturing footprint in Ireland and are supplied with dairy ingredients such as skimmed milk, lactose and whey powders by almost all of the Irish dairy processors.
And while Mead Johnson is not directly based in Ireland, it sources significant volumes of bulk ingredients from Irish processors including Lakeland, Glanbia and Kerry Group for its manufacturing facility in the Netherlands.
In terms of getting a handle on the profitability of infant formula, Mead Johnson is the company that reveals the clearest picture as it is solely focused on manufacturing infant formula. The other companies are involved in multiple areas of the food and nutrition sector that makes deciphering their profit margins more complex.
In 2016, Mead Johnson reported sales of more than $3.7bn and profits (EBIT) of $927m, meaning the business had a very strong profit margin of 25% last year. In fact, over the last five years, Mead Johnson has grown its profits by 33%, where over half of revenues come from Asia.
Operating at this level of profit margin (ie 25%), the infant formula industry in Ireland is making combined profits of €320m based on the €1.3bn in infant formula exports last year.
To put this in context, the combined profits of Ireland’s dairy processors and co-ops was €100m, or 1.5c/l based on a 6.7bn litre milk pool. This equates to an average profit margin of 2% to 3% at primary processing level.
With the infant formula sector generating three times the profits of the primary processors, the question for many in the Irish dairy industry is how farmers can capture more of this lucrative profit margin in the form of a better milk price.
One of the biggest challenges is that while Ireland supplies 11% of the world’s infant formula it doesn’t have a shelf presence in the form of a brand. The infant formula brands are owned by the multinationals, with Ireland supplying the commodity ingredients.
The exception to this is Kerry Group, which has made inroads by partnering with the Chinese dairy giant Beingmate to produce the first Irish infant formula brand called “Green LOVE+”.
In markets such as China, an imported brand will retail for four times the price of infant formula in Europe because they don’t trust the integrity of domestic product.
These infant formula multinationals are here in Ireland to leverage the high-quality, safe and traceable dairy ingredients produced under the Origin Green flag. They are also here to take advantage of our 12.5% corporate tax rate.
So is it time for an Irish infant formula brand to harvest more of the premiums. We’ve seen the success of Kerrygold, which is on track to becoming Ireland’s first ever €1bn indigenous brand.
While it’s a debate worth having, the reality is these global infant formula players control up to 80% of the branded market. An Irish brand could eke out a niche position in some markets but undoubtedly the Nestlés and Danones of this world will aggressively defend their market position and have the deep pockets to do so.
Risk
Such a move also risks losing these players as customers, who buy about 140,000t of ingredients from Irish processors every year.
Assuming Ireland were to win a 1% share of the $50bn infant formula market with a brand, the annual profits based on 25% margins would be €100m (1c/l) a year for the entire industry. It must be remembered that building a brand requires significant investment.
Based on the 17 times’ earnings price paid by Reckitts for Mead Johnson last year, the industry would need to invest at least €2bn to capture a 1% market share. Would the industry and farmers be prepared to fund such an investment?
If not, this leaves the Irish dairy industry in its current position – as a direct supplier of high-quality ingredients to the big players. A decade ago, Irish co-ops were making good premiums supplying lactose, skimmed milk, whey and some other ingredients to the infant formula companies, equivalent to 20% on top of the commodity market price.
However, the premiums available for these ingredients have eroded sharply in the intervening years. Significant global capacity expansion to manufacture infant formula ingredients has seen these ingredients become commoditised and prices have fallen accordingly. Today, these premiums have fallen to as little as 5% on the market price.
For example, 10 years ago, a tonne of whey powder for use in infant formula made €650/t above the commodity market price. Today, the premium has fallen to €150/t.
And while many might argue that this is a result of Irish processors competing with each other on price to win supply contracts, the reality is that the infant formula companies import about 50,000t of ingredients into Ireland.
Next week
In the final instalment of this series, we ask how the industry can leverage a better price for farmers from the infant formula multinationals who are using Ireland’s image as a sustainable, high-quality dairy producer for their own gain.