Business

Why Bega Cheese is better off without Coles contract

Bega Cheese is better off losing the contract to supply Coles with its no name cheese, say investors and a long-term adviser of the company.

The supermarket chain dumped Bega in favour of Murray Goulburn, which will produce Coles' home brand cheese from January next year.

The change in contract has left a revenue hole of about $130 million at Bega, sending its shares diving 10.5 per cent on Monday. But investors appear to be backing chief executive Aidan Coleman's comments that soaring demand for infant formula will compensate for the contract loss.

Bega's share finished up 2.9 per cent on Tuesday at $6.50, having jumped as high as 5.2 per cent earlier in the session.

​Tobias Yao, an equity analyst at Wilson Asset Management, which is a Bega investor, said the "long-term thesis" for Bega's story was unchanged.

The company said it would redirect milk from Coles' home brand cheese to infant formula, which attracts a much greater margin.

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"The fact that capacity can be redirected into infant formula is definitely positive," Mr Yao said.

Bega already produces Bellamy's infant formula under contract and last October launched a partnership with vitamins maker Blackmores to produce a range of infant nutrition products.

"The Blackmores brand, the Bellamy's brand are very strong brands representing 'brand Australia', which has a growing following in China with a lot of potential," Mr Yao said.

"We think this going to be a multi-year phenomenon. I wouldn't draw parallels to iron ore just yet, but this is something that Australia can get on top of and really benefit from in the long term.

"Murray Goulburn has a different strategy – Bega is more exposed to infant formula, the China play."

Murray Goulburn managing director Gary Helou said the Coles contract would help underpin the co-operative's global expansion, particularly into Asia. "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," he said.

Mr Yao said private labels contracts could help companies, but they could also prove a hindrance as a processor shifts into more value-added products.

Australia's total milk supply has remained flat for the past decade and is tipped to fall slightly this year as farmers face drier conditions stemming from the El Nino weather phenomenon.

"They [private label contracts] are definitely useful for some of these companies during the initial stage because you have all this capacity, you have to sell this capacity to make sure you are earning some income from it," Mr Yao said.

"But as you transition to the high-margin products, you want to invest most of the money where it will give you the most return. It's a natural transition."

Long-term Bega adviser David Williams said the company was better off staying away from no-name deals.

"If it was up to me, I wouldn't have even been bidding to keep this contract going because there is just no margin in the thing for Bega. My attitude would be get out of there as soon as you can, do your own brand," Mr Williams said.

"This no-margin stuff where you are competing against MG, Fonterra and Saputo, is just not going to make any money. For me, it's a nothing thing, in fact it's a bloody good thing because we have now got milk that we can put into branded product – stuff we are doing with Blackmores and other deals."

To illustrate the tight margins, the average price farmers were paid for milk in 2014-15 was 48.5 cents a litre, according to Dairy Australia figures. The raw milk component to produce that 1 kilogram block therefore costs dairy companies about $4.85. This excludes processing, labour and distribution costs, and profit margin.

This compares with Bega being able to tap into Blackmores' pharmacy base of about 25,000 stores to sell infant formula, Mr Williams said.

"Just for first orders, to fill up 25,000 pharmacies would send your business through the roof," he said.

"So what would you want to do, supply 600 Coles stores or 25,000 pharmacies with a high-margin product? I think I'd know what I'd want to do."

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