During the information meetings held for members of Kerry Co-op in recent days, there have been two main themes in questions asked from the floor – is the proposal putting the right value on KDI (Kerry Dairy Ireland), and will the business be able to pay a competitive milk price in the future?

In looking at the second question, there are a couple of factors that we can take into account. KDI right now is structured into four divisions – dairy ingredients, nutritional ingredients, consumer foods and agribusiness.

Of these, consumer foods is by far the most valuable and the greatest source of profit for KDI. Members were told at a recent event that while it uses only 20% of the milk pool, it provides the majority of earnings for KDI.

In fact, Kerry Co-op chair James Tangney told the meeting in Newcastle West that KDI’s consumer foods division alone would be worth €500m. It is fairly immaterial whether he is correct or not, but having such a strong performer within the business is a positive sign for the long-term sustainability of the business.

Many of the concerns surround the costs which KDI will incur as part of the buyout, including interest payments on debt, the dividend to Kerry Group, and the working capital costs, as well as the cost of rebranding and back-office functions.

Interest costs

Looking at interest costs first, the three elements involved are: the payments on the initial purchase debt of approximately €99m, the annual €7.5m dividend to Kerry Group and payments for working capital facilities.

Currently KDI’s working capital facility is provided for under the Kerry Group Treasury function. After the potential takeover, those facilities will be provided directly by banks at commercial interest rates.

While it is impossible to get an accurate number for the cost of future working capital needs, analysis of other co-op annual reports suggest they would be approximately €1m per 500m litres of milk processed (allowing for the reduction in interest rates since 2023).

With a 1.1bn litre pool, that would put working capital costs in the region of €2.2m.

Adding that number to the €7.5m and the approximately €4m that would be paid on the €99m borrowings to fund the balance of the initial €350m purchase, we get annual interest payments of €13.7m, or 1.25c on every litre delivered.

Comparing this cost with historical data for the other co-ops in the country, we can see it is a relatively high number (see Table 1).

Note: in calculating the interest costs for the other processors, we took the average of interest costs for both 2022 and 2023 to allow for fluctuations in borrowing costs across the period.

Kerry Co-op could argue that the payment of the €7.5m dividend to Kerry Group is optional in each year – and removing it from a single year’s calculations would improve the situation – but the payment would eventually have to be made, so not paying it in a single year would only add to future liabilities.

This facility does, however, grant some flexibility to KDI during difficult years.

In addition to the usual capital expenditure undertaken by processors across the country – which Kerry Co-op have earmarked €25m a year for – the new KDI will incur extra costs in its first years for the required rebranding and the development of a new IT system and other back-office functions.

While previous rebranding exercises in the sector in Ireland, such as that for Aurivo and Tirlán, suggest that while the cost could be up to €10m in financial outlay, one of the real problems with rebranding is the amount of man-hours the operation can take, particularly with a company which has established international business relationships.

On the IT and office services sides, the amount of money that would be spent on that runs into the tens of millions, with it again being a major drain on management time.

While the costs could potentially be met from the capital allocation outlined by the Co-op, spending on these necessary items will reduce room to spend on other capital investments in a timely fashion, which could risk further bills in future.

On the man-hours point, it is notable that there are 1,581 employees in KDI. The addition of the extra office functions will see that number rise further. That level of employment is already very high by industry standards, with KDI’s 1.44 employees per million litres of milk processed already the largest in the country (see Table 2).

If efficiencies were required there, the cost of reducing staff numbers could be substantial. Recent experience elsewhere in the industry putting redundancy costs at an average of around €75,000 per person, which would put the cost of reducing staff-to-milk ratio to Dairygold’s level at close more than €40m.

If staff levels are maintained or increased, KDI will continue to run off a higher wage cost base per litre of milk than any other processor in the country.

Comment

Kerry milk suppliers want to control their own processing, and they also want to get a competitive price for their milk. While the proposal to be voted on later this month does go a considerable way towards giving them the first, the jury is still out on where the milk price will land.

There are some flexibilities built into the deal on when payments such as the annual €7.5m dividend are made, which could help relieve pressure when needed. However, KDI in its first years will still have considerable business costs to meet, which arise as a direct result of the change of ownership.

The consumer brands business is obviously the jewel in the crown of KDI and would have to be protected as long as it continues to provide the strong returns it has of recent years.

If there are other parts of the business which are not pulling their weight, then some reorganisation may be required. Such a move would add to costs in the short-term for the business, while providing savings over longer time horizons.

Under details of the deal which were revealed by Kerry Group, KDI has to get agreement in writing from both Kerry Co-op and Kerry Group before it would allow its debt-to-ebitda ratio rise above 2:1.

This possible curtailment on KDI’s ability to borrow money does increase the chances of the milk price becoming the key variable if costs incurred in the business are higher than forecast.

The headwinds facing KDI are not unique, and there are always extra costs to be met when a business changes hands. It will be the number one challenge for the management and board of KDI to meet those costs while also paying suppliers the milk price that they expect.