Bega Cheese chief executive Aidan Coleman insists strong demand for infant formula will offset a $130 million revenue hole formed after Coles ditched the dairy company to supply its private label cheeses.
Bega's shares dived 10.5 per cent to close at $6.32 after Coles awarded its new private label cheese contract to Murray Goulburn. The five-year deal will begin next January, and pushed units of Murray Goulburn's listed trust up 2.1 per cent to $2.43.
Murray Goulburn said the contract was worth $130 million in additional sales and would help support its international expansion. The value of Bega's deal with Coles is not known, but it is understood it was worth a similar amount.
Bega said it would divert about $60 million worth of cheese inventory, which normally goes to Coles, into higher value-added products such as infant formula.
Before Coles dumped Bega, the milk processor's share price had surged more than 42 per cent since late October after it launched a partnership with Blackmores to produce infant formula.
"Bega had been rerated on the back of the Blackmores joint venture and was trading on a huge [price/earnings] multiple," Morgans analyst Belinda Moore said.
"This market is unforgiving and you can't have anything go wrong or have announcements that can be viewed as potentially negative."
That Bega/Blackmores branded infant formula hit the market last month and Mr Coleman said sales had so far been encouraging and would offset private label contract losses.
"We have been very encouraged and very pleased with the level of uptake … in fact we even had to reprogram parts of our production at [Bega's infant formula factory in] Tatura to cope with the increase in demand," Mr Coleman said.
"Those nutritional products, by nature with the technology behind them, generate substantially higher margins and value-add, so we can see those compensating for other things we might lose in the meantime."
In the past two years supermarkets have been signing longer private label contract deals with dairy companies. While these contracts are typically low margin, their longer length – ranging from five to 10 years – gives processors a foundation to invest in more higher value-added parts of their business.
Mr Coleman said Bega had prepared for the loss of the Coles business.
This market is unforgiving and you can't have anything go wrong or have announcements that can be viewed as potentially negative.Belinda Moore
"We unquestionably drive our business towards higher value-added products.
"We have a wide rang of long-term contracts so we are always looking at what may or may not occur as a result of any of them leaving.
"We can talk about revenue [but] in this instance it's not really representative of earnings or value. By nature, house brand contracts are relatively low margin."
Bega's revenue rose 4 per cent to $1.1 billion in the year to June 30 after sales of nutritional powder and consumer packed goods surged $72 million.
Greater push into domestic market
Murray Goulburn managing director Gary Helou said the cheese contract, which followed the co-operative securing a 10-year deal with Coles in 2014 to supply the supermarket chain with fresh milk, was part of a greater push into the domestic dairy foods market.
He said becoming a bigger player locally would fuel Murray Goulburn's global expansion, particularly into Asia.
"You need to build critical mass in your domestic market to be able to play a bigger role regionally and internationally," Mr Helou said.
"This long-term deal with Coles gives us that critical mass and allows us to get capacity, efficiency and capability to win bigger and deeper markets."
Murray Goulburn – which listed its non-voting unit trust on the ASX in July – is investing up to $145 million at its cheese factory at Cobram in northern Victoria to improve cutting and wrapping capability, which will help lower production costs.
"[The investment will] deliver world-leading technology for processing and packaging a range of consumer and food service cheese products including block, slices, snacking and shred," Mr Helou said.
"Ultimately these investments are being made to support our drive to deliver sustainably higher and more stable farmgate prices and returns over the long term."
The first stage of Cobram redevelopment is expected to be completed by mid 2016.
Mr Helou said the co-operative was expecting its milk intake from farmers to be down slightly in 2015/16, compared with last year's 5.5 per cent increase to 3.58 billion litres.
Farmers have faced drier weather due to the El Nino weather phenomenon, which has affected milk production.
"It has been quite dry and it's been a challenge for our farmers, but they are lot better these days to deal those climatic issues through supplementary feeding and better buying of raw materials … [so] we don't expect a big reduction in our intake," Mr Helou said.
A Coles spokeswoman said the company would continue to stock Bega branded cheeses.
"We look forward to continuing our good relationship with Bega Cheese and remain committed to stocking branded products produced by Bega Cheese," the spokeswoman said.
"This year we will continue to source Coles Brand cheese from Bega Cheese and stock around 20 Bega branded products in our supermarkets."