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Russian Dairy: taking a long position in a short market

with Vivek Verma, Managing Director & Global Head, Dairy, Coffee and Funds

It is now a known fact that Russia is one of the most attractive markets for dairy farming. This stems from a number of factors. A high demand for milk and a large, growing demand-supply gap have made Russia the second largest importing nation of dairy products in the world. It is the world’s largest importer of butter and cheese and amongst the top five importing nations for milk powder. This in turn supports high local milk prices. The Russian government’s import tariff structure is designed to encourage local dairy investments. Yet the country continues to suffer from a long term structural shortage of raw milk.

Recent food import restrictions have exacerbated the situation. Sanctions have had a significant impact on the supply of dairy products like butter and cheese, spurring increases in domestic production, which has in turn boosted the call on raw milk. The country’s milk deficit is likely to be more acute than that suggested by supply and demand data, as over 30% of domestic production is deemed unsuitable for processing because it does not meet the high quality standards of international processors operating in Russia.

The shortage will take many years to address. Russia’s dairy farming sector is fragmented. Very few dairy farm operators have the management capability, technology and access to capital to lead the industry out of its current challenge. New farms have a long gestation of more than seven years from start of construction to reaching full potential.

Fundamentally, these are the barriers to entry in the Russian dairy farming industry. Conversely they are also the basis for its long term competitive advantages. The country’s milk production costs are as competitive as any dairy confinement system in the world, taking into account its competitive “price-maker” position due to the demand and supply dynamics and incentives for the local industry. Commercial viability has been established. However, what excites us the most is the potential to achieve scale. Dairy farming systems in Russia can be scaled up at a relatively lower cost than competing origins due to the availability of good quality agricultural land for forage production and commercial agriculture. That’s our logic for getting into Russian farming.

Rusmolco rising to the occasion

In 2012 when we invested, Rusmolco was the largest raw milk producer in the Penza region (550 kilometres south-east of Moscow) with seven dairy farms comprising 7,200 head of cattle of which 3,600 were milking cows, and a land bank of 133,000 hectares. Both its founder Naum Babaev and former CEO and now President of Rusmolco Rashid Khairov have continued as owners in Rusmolco, maintaining our strong local context and relations with the local communities and regulatory authorities, which are key to operating effectively in Russia.

We are proud to say that Rusmolco today is the third largest dairy farm operator in Russia with 13,600 head of livestock, of which 7,300 are milking cows, double what we had in 2012. In fact, the new dairy farm in Arshinovka which we completed in 2014 is now the single largest dairy farm on the European continent. Rusmolco’s milk output has more than doubled to 44 million litres in 2014 and is expected to grow by over 15% to about 51 million litres this year. The quality of milk has also significantly improved with the entire production rated at premium quality. An important indicator of future productivity – the cow pregnancy rate – has doubled to 20% and our peak performance hit 24% this year, closing the gap with the top 5% percentile in the US.

Rosmolco_Milk_Production_Chart1

Rusmolco has a land bank of 133,000 hectares, of which 76,000 have been cultivated compared to 52,000 hectares in 2012. About 55,000 of the 76,000 hectares are dedicated to commercial agricultural farming of crops, including wheat, soy and sugar beet, while the balance is farmed for dairy crops that go into feed for the herd.

Rusmolco_Agri_Output

Above: Output in 2014 was impacted due to drought conditions. Significant improvements in efficiency, such as drying, storage and output quality resulted in higher output, revenue and EBITDA in 2015.

With improving key metrics, Rusmolco is well-positioned to be part of the solution to answering Russia’s call for high quality raw milk. It is now a high-growth, leading dairy farm operator that is capable of meeting international dairy processors’ needs in Russia.

 

More about the author: Vivek Verma

Vivek Verma is Managing Director and Global Head of Dairy, Coffee and Funds in Olam International.  Vivek joined Olam in 1992 as a business manager and started Olam’s India operations. He was transferred to the Singapore office in 1996 and was subsequently promoted to Managing Director where in addition to heading the Coffee business, he developed the Dairy and the Commodity Financial Services businesses.  A member of Olam’s Executive Committee of Olam International, the top leadership team in the Company, Vivek is also a member of the Executive Human Resource Committee. He is also a director on the board of Rusmolco. Vivek holds a Bachelor of Technology from the Indian Institute of Technology, New Delhi, India.