Steering in the right direction: How dairy trusts can milk out strong returns

While most of Australia was not too thrilled by the rain deluge of late 2021/early 2022, dairy farmers were finally rejoicing. After a multi-year drought, the outlook for dairy trusts has been turning with the downpour starting to outweigh record low prices at the farmgate. 

But as with every industry, costs are also rising to make extra litres of milk. That will make the lofty return goals of Prime Value Asset Management's Elizabeth Blackhurst and Kirsti Keightley even more challenging to achieve. Nonetheless, both are confident that the tailwinds will outlast the costs associated with labour, supply chains, and the ESG transition.

In our latest Expert Insights, you can hear from Elizabeth and Kirsti on a range of issues including:

• Why Aussie dairy is an interesting prospect
• Performance of dairy trusts against inflation
• The role of ESG in their portfolio construction
• How their fund has been performing

EDITED TRANSCRIPT 

What market fundamentals make Australian dairy interesting for investors?

Elizabeth Blackhurst:

What we look for are the right supply-demand fundamentals, of course. So what we've seen in Australia is a significant reduction in the national herd that's been going on for several years. 

So some years ago we were exporting probably 50% of our production. Now we're down below 30%. That's a result of farm farmers exiting the market, and that's due to climatic conditions in marginal areas. 

You know, the drought did hit a lot of dairy farmers quite hard, but so did very low milk prices. We've been in a low milk price environment for a very long time. Things like the dollar per litre of milk were really detrimental to the farming industry. 

So we see this as an opportunity, with the fundamentals really stacking in our favour. And you're certainly seeing that now with supply falling, there's a big demand and a big push up in milk prices.

With inflation in mind, why should investors consider these assets?

Elizabeth Blackhurst:

At the moment in this environment, the dairy industry is certainly coming into play. Certainly, as we went through COVID you could see a consistent production still. We continue to milk every day and we can continue to be paid for that milk every day, and putting food on the shelves was a really good position to be in. What we're seeing now is a continuation of that. 

Also with inflation and food prices kicking up from an investor's point of view, we're really keeping pace with that. So milk prices are rising. Our cost inputs are also rising, fertiliser prices, grain prices everything's going up, but we're keeping pace with it with prices for our product. 

Also from an inflationary point of view, which a lot of investors are concerned about at the moment, farmland values are also appreciating strongly. And certainly, in the areas that we've chosen, this is premium land and it is scarce. It can only go up in value, as far as we're concerned over the long term.

Of course, things will flatten out and it will be variable year on year, but we believe the medium to long-term outlook is exceptionally strong for milk, and for farmland.

How does ESG factor into your assets?

Elizabeth Blackhurst:

ESG is really fundamental to everything that we do. We really believe that if you get the environmental aspects, right, you get your sustainability, right, the bottom line will take care of itself. In the short term, of course, you need to make capital investments in getting it right, but in the medium to long term it's critical. 

So, dairy farming; in terms of what we do for the environment because we want to leave it in a better place and a better condition than we found it. There's a big focus on soil quality and pasture quality. Effluent management is very important. 

There's a lot of resources, you know, you can put your effluent back over your pasture as a natural fertiliser, which reduces your cost, but also stops the chemical addition to the land, and we're trying to do that. In terms of additions that you can make, there's a lot of research right now about additives in cows' diets to stop the methane, the ruminants that they are. So there's a lot of work going into that. Now, we're not at the point yet. There's a lot in trial, and we're following that very closely with respect to our sustainability.

We're also focused on waste-to-energy. With every dairy farm, naturally you've got manure, which has a methane component to it. So what we've done is partnered with a group called innovating energy. The first project involves 19 dairy farms in Nowra, collecting the affluent and putting it into a bio digester, creating electricity and biomethane. 

This is a game-changer in terms of agriculture, and we're very proud to be partnering with them on this first project in Australia. With that, we also have intentions to do that on our farms as well, so partnering at this stage of the game is very exciting. The most exciting bit about it is this is base load. It's not solar, this runs 24/7, so it is a game-changer

Kirsti Keightley:

We're also cutting back on the amount of fertiliser that we use, so we are looking at things like extending the area where we irrigate the effluent onto the farms and also composting. This means using any waste material that's actually on the farm and composting it to be able to spread that as a fertiliser. So, as Elizabeth said, there's a lot of research going on in this area, and there'll be a lot of developments, I think over the next one to five years,

Elizabeth Blackhurst:

We're also focused heavily on water recycling. Dairy farms do use a lot of water, so we're very conscious of that. We're doing as many things as we possibly can to reduce our footprint, but it's also about the condition of the environment that we believe we're improving.

How is the fund's performance? What is its outlook?

Elizabeth Blackhurst:

We're targeting a return of 12% per annum for our investors, and that's through a combination of income and capital growth. And we like to view that as probably a 50/50 mix, pretty much. So with respect to the income, that's primarily from milk sales. And capital growth aspect, that comes from a combination of factors. One being just the general farmland appreciation. So, Northwest Tasmania and Southwest Victoria, they've increased in value, approximately 7-8% per annum, on average, over the last 20 years. So we're coming from a very solid platform there. 

Then what we look at is our value-add that we do on top of the farms on top of that. So, we've bought turnaround opportunities with a lot of our farms, which means they are poorly performing, but we have bought them at better value. 

So when we inject our energy, our capital to improve the infrastructure, pasture renovation, and also improving water security, you start to be able to add on quite significant value.

We certainly have a case in point with one of our farms in Southwest Victoria. So that was an exceptionally good buy, we did buy at the right time, but we also did buy a poorly performing farm with lots of potential. And that's what we could see. That's really what we look for. Can we improve this? What can we turn this into? So with this farm, with relatively little capital injection, we've added quite significantly to the value. Of course, a lot of energy and effort goes into that as well, but it's really a great turnaround story. And it's performing exceptionally well, and certainly above our target return level so far on a capital value point of view, but also on an income point of view, as we've taken it from a 300 cow farm to a 550 cow farm now. So that's just an example of the kind of work that we do, to bring in returns to our investors.

And it's a similar story with the portfolio farms that we bought in Tasmania. Again, underperforming farms that need love and attention, and that's really what we're doing now. So we're midway through our development programme. We've been, in terms of our infrastructure and pasture and water security that we're improving, all of those aspects will deliver, we feel, the same kind of returns to investors. So that's on the capital side. On the income side, we're very proud to have delivered a 6% per annum return to our investors and that's been paid quarterly. That has to be borne in mind that that's all throughout COVID, all of the difficulties of the pandemic, and now laterally with the Russia Ukraine conflict that's caused a lot of cost-driven inflation, where the milk price environment is exceptionally strong, so that's really keeping pace with the inflationary aspect of our costs.

So we're very positive about the outlook for this year. We've secured our income and secured most of our costs. So the next 12 months looks very good, and the long-term outlook from a supply and demand fundamental point of view, the scarcity of land, and also the scarcity of milk available at the moment. So all in all, we're very, very confident and positive about the dairy trust.

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