Monday’s decision by the finance and agriculture ministries to cut the controlled prices of dairy products threatens to hit profits in the industry and stoke conflicts between manufacturers and retailers.
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The move may also undermine plans by dairy giant Tnuva’s controlling shareholder, British private equity fund Apax, to sell shares in the company in an initial public offering.
The decision to lower the prices paid by consumers for milk and dairy products by an average of 1.1% this week was announced by Finance Minister Yair Lapid at a press conference with Agriculture Minister Yair Shamir. Among the 12 products whose prices will drop are sour milk, butter and yellow cheese.
The two said 5% white cheese and 38% sweet cream would be subject to price controls and their prices slashed by 20%.
“Price controls are not a solution for market failures over the long term. Let’s not be mistaken about that,” Lapid told the press conference. “We will not hesitate to use price controls any time we find someone exploiting market dominance and the absence of competition to generate large profits at consumers’ expense.”
The decision was reached after a joint agriculture and finance ministry commission found that dairies’ profit margins over the past six months had reached 20%, exceeding the level the panel deemed appropriate for price-controlled products: between 6% and 12%.
The drop in prices for other price-controlled products will be achieved by reducing government-set prices for raw milk sold to dairies and dropping the controlled price of other production inputs.
According to Shamir, the committee had said the industry should exercise price restraint. Only after it became clear that the companies wouldn’t act did the panel act unilaterally, he added. Dairy producers would probably begin examining their margins for other products, such as sliced yellow cheese, and cut prices voluntarily, Shamir said.
The commission decided when determining profitability at the dairies not to factor in discounts they give to retailers because the reductions usually are not passed on to consumers. Typically, the diaries deduct the discounts from their reported revenues, thereby lowering profits.
Industry sources told TheMarker that Tnuva, the dominate manufacturer in the market, is likely to suffer the most from the price reductions. Between 40% and 55% of its products will be affected by the decision, the sources said.
With annual sales of between 4.5 billion and 5 billion shekels ($1.44 billion), Tnuva could see its earnings before interest, tax, depreciation and amortization fall by as much as 80 million shekels, a drop of close to 11% for the 12 months to the end of September.
Tnuva, like the other dairies, could take steps to offset the effect of price cuts, the sources said. Still, lower EBITDA threatens to undermine Apax’s plans to take the company public since its valuation is likely to be based on that figure.
The dairy industry’s two other big producers – Strauss Group and Tara, the latter controlled by the Central Bottling Company, the local Coca-Cola bottler – also face a hit to their profits. The two firms, which control 28% and 12% of the dairy market, respectively, have significantly lower profit margins than Tnuva, giving them less room to absorb the shock of price cuts, industry sources said.
The new, lower prices will make it harder for all three dairies to continue giving food retailers the discount on wholesale prices that have been traditional in the industry. That’s likely to spark a bitter conflict between manufacturers and retailers like Super-Sol, Mega and Rami Levy over who will absorb the lower mandated prices.