Tirlán’s investment dilemma

The dairy processing business is one of very thin margins. Fortunately for most processors, they have control over the price they pay for milk, their biggest input cost. That means they can generally maintain the margin fairly well irrespective of how global dairy markets are performing.

Tirlán, which reported results this week, showed that control in action. The co-op reported a €530m drop in revenue to €2.53bn during the year, and yet its profit after tax only dropped €2.3m to €42.3m.

This, in many ways, is fundamental to how co-operatives are supposed to work. The business keeps between 1.5%-2% as profit and pays everything else back to its members.

While Tirlán did report an €8m jump in interest expense during the year – reflecting the higher bank lending rates – that number was significantly lower than it otherwise might have been. This is because Tirlán managed to raise €250m of borrowing through a five-year bond in early 2022 that has a fixed rate at under 2%. The decision to lock in that rate when it was available has proven to be a good bit of business for the processor.

The reason it was able to borrow at that low level was because it was able to offer just over 15m shares in Glanbia as collateral. Glanbia’s share price has risen considerably since that bond was issued, leaving Tirlán in a very comfortable position with the bond.

In fact, net debt at the processor is now at the same level as it was a decade ago in 2014. Net debt to EBITDA is at a ratio of 1.3 times, which, if anything, is a little low.

Add to this the separate fund of €210m which Tirlán has in place – again held as shares in Glanbia – which it can use for investments, and Tirlán looks like a company that is very ready and able to make some major acquisitions.

All things being equal, the company could probably manage a €400m-€500m investment without significantly loading risk on the balance sheet. Add to this the need for it to diversify – both in the business it is doing in order to earn higher margins, and in the piggy bank it has, which is entirely exposed to the price of Glanbia shares.

The problem Tirlán may face with its diversification drive is that it may be tempted to invest significantly in a whey business. The new cheese plant will produce a lot of whey as a by-product of the production process, which will need to find a home. From a business sense, maximising the return on that certainly would be a good idea.

However, from a diversification perspective, the logic of a major investment or acquisition in whey – or downstream sports nutrition – may be a little thinner.

While the majority of Tirlán business is processing milk, a very significant proportion of the value of the group is tied to its shareholding in Glanbia. That company is already a major global player in the sports nutrition business through its Optimum Nutrition brand. Through its almost 30% shareholding, Tirlán gets the benefit from that brand, without having to do anything at all.

Making an investment in that area itself could actually end up concentrating risk on Tirlán balance sheet, rather than do anything to diversify the co-op’s earnings.

To be clear, Tirlán’s possible headache in trying to successfully diversify its business is very much a product of the good health of the co-op’s balance sheet. I’m sure many other processors in the country would love to have the problem of trying to decide what to do with all the money they have available for investment.

That being said, the world of mergers and acquisitions is littered with badly timed or badly executed takeovers which end up doing significant damage to the parent company. Tirlán is right to take its time, but by not diversifying away from both dairying (its core business) and sports nutrition (through its Glanbia holding), it is missing the opportunity to provide a third leg for its future earnings potential.

The largest recent significant investment by Tirlán has been the construction, in conjunction with Royal A-Ware, of the new €200m continental cheese plant in Co Kilkenny. Tirlán CEO Jim Bergin told the Irish Farmers Journal late last year that the plant would run at close to capacity in 2024. He clarified those comments this week, saying that it is still in the commissioning phase. While milk is being supplied to the plant and cheese is being produced and exported to the Netherlands, where it is being sold, the plant will not come close to taking its full milk allocation this year. He confirmed that Tirlán is contracted to produce 50,000t of cheese from the plant, which means it will consume over almost 500m litres of the co-op’s milk pool when it is fully operational.

CEO-designate Seán Molloy said that the logic that existed five or six years ago when the decision was made to invest in the plant with a partner still stands.

“We wanted to diversify our product offering, we wanted to remove a huge exposure we have, and we as a country has, to the UK market, and we wanted a route to market for the new products.”

He added that the tie-up with Royal A-Ware gave them that route to market as that company has an existing customer base.

“Finally, we wanted, as we see this as the future, to get a whey pool from that plant and continue to develop it.”

He said that Tirlán still has the exact same ambitions now.

“What has changed since is maybe the expectation for growth has tempered somewhat, but the value proposition remains the same.”

The results of Tirlán’s 2023 survey of its farmer suppliers showed that there is still ambition to invest in dairying, with one in three respondents saying they intend to spend money on milking facilities in the future.

However, three quarters of suppliers saw environmental issues as placing a limit on milk production, with 71% citing land availability and 55% saying shortages of labour would be an issue.

The average age of suppliers was 52, which is young when compared to other farming enterprises. While the average number of cows per farm was at 123, Molloy did concede that the supplier base was made up of both smaller operations – 2,000 farmers have 60 cows – and larger operations, with 700 farmers supply a quarter of Tirlán’s milk.

Molloy said that Tirlán is “very open” to new entrants, but “is very respectful of milk supply agreements that exist between a farmer and his or her co-op, and respectful of ICOS protocols. We will not encourage or engage in the breaking of those, and in the same way would expect the industry to be respectful of ours.”

“Having said all that, once a farmer says they want to leave a co-op and serves out their notice, they are free to go wherever he or she wishes.”

Milk supply for 2024 so far, had run about 10% behind last year’s level, despite no drop in the number of cows.

“We’re probably going to end the year 3% to 5% down, hopefully at the lower end of that.”

In brief