British dairies are fast disappearing as European companies look for new markets to sell their butter and cheese, and distressed UK farmers grab the chance to sell out.

The stakes are high. The United Kingdom is the third-largest milk producer in the European Union after Germany and France, producing about 13.5 billion litres of milk annually.

However, cut-throat price wars among supermarkets like Tesco and Asda, low bulk cream prices, and higher input costs have hit British farmers, who are paid much less than their European counterparts.

The merger of Arla Foods, a large Danish-Swedish farmer co-operative, with British co-operative Milk Link last week signals that the British dairy industry may see more churn.

The deal, which creates the largest dairy company in the UK, follows the acquisition of Scotland's Robert Wiseman Dairies by Müller, a privately held German dairy group, in January.

"Our view would be that there is likely to be further consolidation," Milk Link's Chief Executive Neil Kennedy told Reuters.

The UK dairy industry, mostly a stronghold of farmer cooperatives that dot the countryside, has now shrunk to four key players - Arla, Müller, Dairy Crest Group Plc and First Milk.

Arla, which is also expanding its business in China, expects annual turnover of Arla-Milk Link to be around 2 billion pounds ($3.14 billion) - ahead of Dairy Crest's 1.6 billion pounds and First Milk's 573 million pounds.

"There could possibly be a merger between a southern Irish co-op and First Milk. And ... there could well be that another company purchases Dairy Crest by the end of the year," said David Cotton, chairman of The Royal Association of British Dairy Farmers.

Cotton, who manages a herd of 165 cows, is also a member of Milk Link.

"First Milk now looks a little bit vulnerable," Investec Securities' analyst Nicola Mallard said.

"Most of the milk industry is either in private hands or co-operatively owned so Dairy Crest is unusual in that respect, but we've not really had any suggestions of a deal," added Mallard.


Typically, European dairy firms focus more on milk products such as cheese and spreads, which are more profitable than liquid milk. On the other hand, only half of the milk produced in UK is sold in the form of milk products.

"European markets have less involvement in liquid milk," said Patty Clayton, senior analyst at DairyCo.

"The milk that's produced in Europe tends to have a wider variety of uses. More goes into powders, more goes into butter, more goes into cheeses than (in the UK)," added Clayton.

With consumers in the UK switching to low-fat milk, dairy processors are generating surplus cream.

Processors who turn cream into higher-margin goods like cheese, butter, yoghurt and spreads have withstood the decline in their raw milk business, putting them in a better position than those that simply sell cream in bulk.

Shares in Robert Wiseman, a publicly listed company until the takeover, had halved in value over the previous two years, hurt by a sharp decline in bulk cream prices.

Dairy Crest has remained profitable, riding the success of its cheese and spreads brands, such as Cathedral City, while its liquid milk business struggles.

The weak milk market has hit not just the processors. In the dairy supply chain, farmers languish at the bottom.

The average UK farm gate price - the price paid to the farmer - was 27.91 pence per litre of milk in April, according to government body DEFRA.

That is roughly 4 percent less than what the farmers were being paid at the beginning of this year and 3 percent lower than the average price in the EU.

Caught between supermarkets driving down prices and processors undercutting each other to gain more shelf space, co-operatives may be increasingly forced to sell out or merge.

"Don't get me wrong, the retailer is putting the squeeze on processors but it's not helped by the way the processors have reacted particularly in the liquid milk market," said Mansel Raymond, Chairman of the Dairy Board at National Farmers' Union.