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Cheese pairing

19 November 2013 By Ethan Bilby

Australia’s dairy battle needs cheap debt to stack up. Three bids in as many days for Australia’s Warrnambool have lifted the price tag above A$500 million ($469 million). Local cost savings and projections of China’s thirst for foreign milk help justify the frenzy. But the investment case rests on low borrowing costs.

On the face of it, the bidding war has become detached from financial reality. Warrnambool is forecast to earn A$20.75 million in the year to June 2014, according to Eikon. At the A$504 million price tag the bidders have put on the company, that implies a return of little more than 4 percent.

It’s tempting to assume that increased Chinese demand for foreign dairy products will translate into higher earnings for Warrnambool. Euromonitor expects 16 percent annual growth for overall dairy in China to 2018. But other competitors are also vying for that market, and the Australian company’s exports to China are still small.

Local bidders Bega Cheese and Murray Goulburn have the advantage that they already own respective stakes of 18 percent and 17 percent in their target. They should also benefit from cost savings: Bega reckons it can squeeze an extra A$7.5 million before tax out of Warrnambool in the first year of ownership. Put these two factors together and Bega’s projected return on investment rises closer to 6 percent. Murray Goulburn has not put a figure on cost savings – presumably to minimize scrutiny from Australian competition authorities who still have to approve its offer.

Without a pre-existing investment in Warrnambool and lacking obvious synergies, Canada’s Saputo appears to be at a disadvantage. But its secret weapon is access to cheap financing. The company’s interest costs over the past four years are just over 5 percent of its net debt. That gives its wholly debt-funded offer the advantage over Bega, which is paying mostly with its own shares, which carry a higher cost of capital.

The risks for Saputo are that interest rates rise and Chinese demand disappoints. But as long as the company is able to borrow cheaply, its pursuit of Warrnambool may not be as reckless as it seems.


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