DairyBusiness

By Dave Natzke

After a couple of years of “retrenching” on legal issues and restructuring or dissolving unprofitable joint ventures, Dairy Farmers of America (DFA) president and CEO Rick Smith said the nation’s largest dairy co-op is in a better position to focus finances and energy on a profitable future for its members.

Addressing delegates at DFA’s 11th annual meeting, March 23-25, in Kansas City, Mo., Smith said DFA recorded revenues of $11.7 billion and net income of $61.7 million in 2008, both up compared to a year earlier. DFA reported $11.1 billion in revenues and $48.8 million in income in 2007, but debt write-downs resulted in a net loss of $109.3 million. 

DFA marketed 61.2 billion lbs. of milk from 10,178 member farms in 2008, making $7 billion in milk payments. The average milk price for the year was $18.60/cwt., down from $19.38/cwt. in 2007.

National Dairy Holdings, subject to debt write-down and restructuring in 2007, returned to profitability in 2008, Smith said, and 2009 could be a record year for the business. DFA also received a “stable” Investment grade financial rating from Moody’s Investors Service and Standard & Poor’s.

“Now we can invest time and money in profitable businesses,” Smith said, including expansion and diversification of ”formulated products” plants and products. DFA is looking at investment in areas where there is a growing milk supply and/or a market deficiency. Three plant improvement projects are underway, including expansions in Fort Morgan, Colo.; Schulenburg, Texas; and Adrian, Mich.

2009 shaping up as tough year for producers

While 2008 was a strong financial year for DFA, Smith said it was difficult to be celebratory when 2009 was becoming so difficult for producer-members.

“Dairy is used to cycles, but this could be the toughest cycle yet,” he said. “It’s not so much the milk price is lower than ever before, but it’s because the cost side has changed.

“Supply and demand got more complicated because it’s not just the United States, but world supply and demand,” Smith explained. “We were expanding production into a growing export market. We can’t stand a decline in international demand growth, because we’ve been growing beyond the demand growth in the United States.”

On a hopeful note, Smith said US. demand appears to be improving, pointing to better financial days ahead for DFA’s producer members.

“U.S. supply/demand balance is already coming back into alignment, and crossed the line (into a positive position),” he said. “It may also be back on a worldwide basis, but we still have some inventory. The greatest unknown and variable will be world demand.”

Legal issues

Smith, named DFA’s president and CEO in 2006, said his first years at DFA were that of problem-solver. He believes DFA is no longer the subject of investigations by the U.S. Department of Justice, Internal Revenue Service or Commodity Futures Trading Commission (CFTC). 

Last December, DFA paid $12 million in a settlement with the CFTC over “market manipulation” charges related to 2004 cheese trading on the Chicago Mercantile Exchange. Smith said DFA attorneys believed the co-op had a strong case, based on cooperative protection under the Capper-Volstead Act, but that legal costs and energy to continuously fight the case were prohibitive.

“Manipulation is bad in either direction” Smith said. “DFA was accused of holding milk prices for farmers up. This was not a secret market; DFA bought and used the cheese.”

While a settlement with CFTC was reached, there are “ancillary” legal issues remaining, including civil lawsuits – filed by some dairy product marketers/processors due to higher milk and cheese prices – related to the market manipulation charges. In settling with CFTC, Smith said DFA had placed itself in good position to fight the civil lawsuits.

“There’s lots of legal maneuvering ahead,” he said. “We want the lawsuits thrown out before they get to trial.”

Fonterra relationship 

DFA has a 50-50 partnership with New Zealand’s Fonterra on a milk powder/protein concentrates export business, DairyConcepts. That partnership will evolve as each co-op seeks a larger individual share of the global dairy market, Smith said.

“As we become more proactive in this market, there may be more overlap,” Smith said. “We will try to be engaged in our own right. We want our own relationships in Mexico, Latin America and South America, and we don’t want to cede markets in China, Korea or Japan.”

Smith admitted going head-to-head with Fonterra will be difficult, because the United States previously regarded global markets as largely a means to get rid of excess product not consumed domestically. Fonterra, which exports 95% of New Zealand’s milk production, already has established markets in many parts of the world.

(Henry van der Heyden, chair of Fonterra, also addressed the DFA annual meeting. He said Fonterra will be more aggressive in the international market, with a goal of being the “global supplier of choice” for the world’s major food companies who use dairy products and ingredients. It has also targeted Asia and Latin and South America for expansion. Fonterra’s newest venture is its Global Dairy Trade platform, monthly electronic auctions in which it sells up to 10% of its production, up to 3-6 months in advance. He said it has been Fonterra’s most successful sales channel in the past 6-8 months. Look for an article on van der Heyden’s comments later this week.)

Humboldt Creamery

Smith also addressed the recent developments at California’s Humboldt Creamery, a commercial enterprise of which DFA has a 25% ownership stake. Smith said the business venture gave “all control to Humboldt, a venture we would not do again.”

DFA primarily used Humboldt as a balancing plant, selling excess milk to the creamery. Typically, DFA left payment for milk from Humboldt build – up to 90 days or more and sometimes reaching $5 million to $7 million – when Humboldt would then make a large lump-sum payment to DFA when dairy products were sold.

Last fall, however, Humboldt stopped making payments and, after a DFA audit of Humboldt in early 2009 found “concealment of the true state of inventory,” DFA stopped shipping milk to Humboldt and sent a letter demanding full payment. Within days, Humboldt CEO Rich Ghilarducci left and, through his attorney, notified the co-op there might be inaccuracies in the company’s financial statements.

Smith said DFA will exercise its legal rights in the matter, but will likely lose its ownership interest and milk payments, totalling $7 million to $10 million. “The worst-case scenario, however, is for the farmer members of Humboldt, some of who will be forced out of business. It will be a disaster for their organization.”

Challenges ahead

“We’re starting to hear ways to manage production, things like quotas or two-tiered pricing,” Smith said. “One thing we have to remember is that this is a national industry, and the eastern half of the United States has more demand for milk than production. It’s hard to come up with a supply/demand national solution when east of the Mississippi River we don’t have enough milk.”

Smith said the entire dairy industry was moving to address “sustainability” issues, from producer-members to DFA employees. He said steps taken by DFA staff in Kansas City offices had reduced energy use by 7%.

In addition to market volatility, immigration, food safety and animal well-being are emerging issues that will affect the co-op and it’s members in the near-term, he concluded.