‘Dairy sector needs zero-tax rating’

BR Research September 6, 2019

Ali Ahmed Khan joined FrieslandCampina Engro Pakistan as its Managing Director in March 2017. He has more than two decades of top management experience in leading FMCGs where he has led personal care at Iffco in the UAE and Far East, as well as leading Reckitt Benckiser Pakistan as its CEO. Prior to that, he was associated with Pepsi Cola International as Head of Marketing. He holds an MBA from the Institute of Business Administration, Karachi.

In this interview, BR Research picks his brains on the prospects of Pakistan’s processed dairy industry, its challenges and opportunities; we also discuss concerns relating to livestock, milking yields and milk powder usage, in addition to of course his outlook for the company’s outlook for top-line growth and margins.

BR Research: Two years ago, Punjab government passed a law on minimum pasteurisation that states that by 2022 only pasteurised milk would be sold in the Punjab. There have finally been some developments towards that since August 2018. What is your view on this front?

Ali Ahmed Khan: Although significant progress has been made since August 2018, meeting the 2022 deadline will require increased collaboration within the industry, additional investments, and new entrants in the documented dairy sector. At the government level, efforts are being made to make Lahore one of the three packaged milk cities within this year; the other two being Islamabad and Peshawar.

Momentum is being gained with increased activity and dialogue between many stakeholders including the government, regulators and the Pakistan Dairy association. We look at these as encouraging signs in progressing towards standards uniformly.

BRR: Do you think it is possible to make Lahore a pasteurised city in such a short time?

AAK: There are many components which need to be addressed to make this a reality in the given timeframe. Separate from supply-related complexities, Lahore demands and consumes about 5 million litres of loose milk per day. Instead of an overnight shutdown of loose milk, we propose bringing dairy under a zero-tax rating regime, and passing the price benefit on to the consumer, which will ease the friction associated with a change and increase their motivation to switch to safe, packaged milk. Otherwise, there will likely be some resistance if consumers, who are used to paying between Rs80-85 for a litre of loose milk, have to suddenly pay Rs130 for a litre of processed milk. The government will likely experience some backlash from the loose milk industry owing to the sheer number of livelihoods associated with the practice. The transition should be a phased one in three or four stages.

BRR: What do Pakistanis prefer; pasteurised or UHT milk? Surely, there must have been some consumer studies done by industry players individually or as an association? Consumer is the king after all!

AAK: Consumers generally prefer the taste they are used to. I do not believe there is any published study about the taste profile of Pakistani consumers. The more pressing conversation at this stage is about health and safety. Nutrients are sensitive to higher heat and UHT is more nutrient-friendly than open pan boiling; a practice that is commonplace in Pakistan. Additionally, due to lack of best practices in dairy farming, the loose milk being supplied to masses has high aflatoxin levels. Toxins are widely associated with many medical diseases and issues. Most informed and health conscious Pakistanis prefer UHT milk as it is convenient and safe.

BRR: Even if the minimum pasteurisation law is implemented, isn’t growth prospect of packaged milk limited because of price control in loose milk market? For consumer, the cost of shifting from loose milk to packaged milk would still be high.

AAK: We have to broaden our perspective and look at both, global practices and the opportunity cost of not changing. Without food safety testing, checks and regulation, is there any way to guarantee unadulterated loose milk? Is cheaper adulterated milk more valuable than safer milk? We also have to look at the direction the dairy sector is heading in globally. Without standards across the entire supply chain, we will have too many issues arising with varying amounts of impact. I don’t believe price regulation will be a barrier to an alternative with higher value. Also, as mentioned previously, the transition can be made without any financial burden being placed on the consumer, simply by making dairy a zero-tax rate sector and passing the benefit onto the consumer.

BRR: At present, the market share of packaged milk is about 10 percent. What’s the growth outlook for your industry?

AAK: In Egypt, the share of packaged milk went from 15 percent to about 40 percent in about 10 years. In Turkey, it went from about 30 percent to 70 percent in a similar timeframe. We expect the share of packaged milk in Pakistan to grow by 10 to 15 percent within the next 10 years.

BRR: Can you walk us through your sources of milk?

AAK: We have about 3000 milking cows at any given point in time, which gives us about 8 percent of our total milk needs. We also have 1100 milk collection centers – mostly in Punjab (70 percent), with the rest in Sindh. We also reach out to around 250,000 small-medium farmers having 2-10 cows per farmer. Our Dairy Development Unit has teams work diligently to improve their yield, quality of milk and farming practices. We will continue to engage with small farmers and assist in developing medium sized farms with 50-100 cows

BRR: What incentive does a small farmer have to invest in quality feed, clean-in-place (CIP) and so forth, when the milking yield of those small farmers does not justify the investment?

AAK: On average, the yield from those farmers is 4.5 liters per day. At about Rs50 per liter, Pakistan has the most expensive milk in the world, and despite that, farmers do not make enough money because we have such low yields in this country. By improving their feed and conditions, that yield can be doubled to 7-8 liters per day, which will result in an increase in revenue for farmers. My biggest interest is in increasing the yield per cow and to create sustainable livelihoods for small dairy farmers.

BRR: What is the number one problem in increasing the yield?

AAK: People think that the quality of local breed and short supply of good quality local breed is the biggest problem to increasing milk yields in Pakistan. However, those problems are fifth or sixth on the list. The biggest problem is the feed. The cows in this country are underfed, especially in the off-season. They are not sufficiently watered, and they have heat stress because they are not covered. If you address just these issues, yields would increase from 4.5 to approximately 9 liters per day, and if you improve veterinary practices, then that number could rise to up to 11-12 liters per day.

BRR: But most stakeholders say we need at least 25-30 liters average yielding milking animals?

AAK: This is a fallacy. According to the government of Pakistan, 52 billion litres of milk is produced per annum. Our estimates suggest it is about 25-30 billion. We are a milk-deficient country, but we can’t absorb a 4x increase in output either. We don’t need cows with an average yield of 25-30 liters when you can double it by just improving the basics. The cost for the farmer will increase from Rs25 to Rs30, but he will make more money in absolute terms because of higher volume their income will double.

 

Meanwhile, the genetic makeup of our animals can be significantly improved in the next 5-10 years and that is the way to get to your 20-25 liters in the long run, as the population, market and demand grows. As a policy, the government needs to encourage the usage of good quality of feed, CIP, while working on genetics instead of trying to take a leap directly to 25-30 liters per cow.

BRR: What is your company’s revenue growth outlook for the next five years?

AAK: Our last quarter growth in 2018 was 18 percent volumetric growth; our first quarter growth in CY19 was 27 percent. We are looking at 15-20 percent top-line growth in CY19, and with our investments in innovation, technology and category development, we should be able to grow 15-20 percent on average over the next five years.

Currently, only ten percent of the milk industry is processed. If that 10 percent goes to 15 percent and we keep our fair market share, our sales will more than double. In the last three years, the industry declined by about 25 percent. Now the worst is behind us, and the industry has moved to growth again. In our case, the biggest setback was Tarang. It was about half of our business and was badly impacted by a very strong campaign against tea whiteners. Today, Tarang is about 25 percent of what it used to be; we have rebuilt it and it is now double of what it was at its lowest point, in terms of volume sales.

BRR: How will you tackle the margins problem?

AAK: The margins will come from three particular sources. First is volumetric growth. This will increase our capacity utilisation from less than 50 percent at present, to about 75 percent by 2023, before we will feel the need to expand our infrastructure, although it is difficult to say which year because it also depends on the product mix. In this business, capacity utilisation is a big driver to improve margins dramatically.

Second is innovation. What we sell is very commoditised. We have wonderful brands like Olpers, Omore and Tarang, which are reasonably strong in terms of brand equity. We will continue to invest and innovate in those. The mix will get better; Omore our ice cream and frozen dessert brand for example will see a healthy growth. The third source of margin growth will be pricing; as our brands grow stronger, we should be able to charge accordingly.

BRR: What does the market compete on in this business?

AAK: It is a lot to do with freshness, purity, and nourishment. Therefore, a lot of our communication is around our sourcing story, and the journey from grass to glass.

BRR: If it is a commoditised business and everyone has the same story of freshness and sourcing, then pricing would be competitive, so how will you be able to improve your margins through better pricing?

AAK: Prices are indeed sticky. But we should be able to increase prices to the extent that we are able to keep our head above water in terms of inflation. It is more of a challenge in commoditised business, but it is less of a challenge in powder etc., where you can demonstrate value addition.

That said, as a philosophy, we are a very different company; we are a company with a strong purpose. We are owned by over 18000 farmers and farmers have a very long-term outlook beyond volume growth, because nourishment and food safety are far more important. Therefore, as much as we can, we will go towards value addition, but if five years down the road, 95 percent of our portfolio is still UHT milk with not so fantastic margins, then that is ok. As long as we are converting loose milk into packaged milk, we will be well on way to achieving our purpose.

BRR: Will you be experimenting with retailing/franchising, as did Engro Foods a few years ago?

AAK: We will explore all possibilities and opportunities to grow our business in accordance to our purpose, and our values, but it would be completely a business decision.

BRR: There is some confusion about the technical fees and royalty. Can you please share some details?

AAK: Two percent of total top-line is fee for technical assistance; another two percent of top-line is royalty on brands that are owned by FrieslandCampina. So far, we have not had any brands that have come from FrieslandCampina. Even if there is, any innovation under Olpers, such as the milk powder that we recently launched, FrieslandCampina gets 2 percent of the top-line but not royalty because Engro developed all the brands before the deal.

The technical fee was negotiated when the deal was structured between Engro and FrieslandCampina, obviously approved by the Government of Pakistan. FrieslandCampina is the sixth largest dairy company present in about 32 countries worldwide; its brands reach 100 countries across the world, with an annual turnover of about 12.1 billion euros. Thanks to that global experience, the input we get from FrieslandCampina in terms of R&D and cost savings is worth multiple times the technical fees. Elsewhere in the industry, technical assistance and royalty go as high as 6 percent and as low as four.

BRR: Do you plan to expand the size of your own farm to lower the cost of milk sourcing?

AAK: Much depends on the impact and consequences of the minimum pasteurisation law and how will it affect our milk sourcing. The good thing is that we have the infrastructure already in place, and if we were to add more animals, the marginal cost per unit would be very low. But it also involves capex in terms of setting up shelters, milking parlors etc. We are currently evaluating various milk sourcing options and strategies, from corporate farms, to small farmers and milk collection centres.

Copyright Business Recorder, 2019

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