Milking China’s growth spurt

Australian dairy companies are lining up for a bigger piece of China’s dairy pie.

Summary: While New Zealand has the lion’s share, rising demand from China has created a bigger opening for Australian dairy companies to export larger volumes of milk produce. Reflecting the increased demand, the price for milk solids hit a record level in April and Australian listed dairy companies are gearing up for higher growth.
Key take-out: There’s room for growth. Australia accounts for just 2% of the world’s milk production and has about 7% of the total export market.
Key beneficiaries: General investors. Category: Agriculture.

Earlier this week, farmers woke up to major dairy processor Murray Goulburn setting a record opening price for the 2013-14 season. The co-operative said it would pay an opening price of $5.60 per kilogram of milk solids, a 24% rise on last year’s opening price.

Behind that news is an improving story for Australia’s dairy industry.

Soft commodities are known to be notoriously volatile, with adverse events like droughts and floods having a major impact on prices. But a rising middle class in emerging markets such as China, South America and India is certain to put upward pressure on the global food supply and soft commodity prices.

Indeed, in recent months we’ve already seen the impact that constrained supply can have on one segment of soft commodities: dairy. Following significant drought conditions that curbed New Zealand’s milk production in the latter half of 2012-13 season, milk prices hit record high levels in April and remain at exceptionally elevated levels today.

Oceania dairy prices for whole milk powder soared to a record high of $US5,600 per tonne in April. Prices in May declined slightly to $US5,260 per tonne, but remain 91% higher than the June 2012 lows and are 57% above the five-year average.

The surge in dairy prices pushed New Zealand’s terms of trade higher in the three months to March, the first time in seven quarters that the country’s terms of trade had increased. There are also high expectations for the country’s terms of trade to improve even further over the rest of the year as New Zealand continues to capture the benefits of excess demand, led by China.

The competition for China’s dairy market is fierce, and New Zealand is by far in the lead. It holds the lion’s share of the Chinese whole milk powder market, accounting for 86% of the volume. By contrast, Australia contributes just 3%.

As a low-cost producer of quality milk powders, New Zealand has reaped the benefits of its close proximity to Asia and the rise in Chinese dairy consumption.  

New Zealand dairy giant Fonterra Ltd has even gone one step further, setting up dairy farms in mainland China in a bid to ramp up supply to locals. According to Fonterra’s website, it is the world’s largest global milk processor and dairy exporter, and has two farms in the Hebei province in China, with more being developed. It plans to produce 1 billion litres of milk every year in China by 2018.

New Zealand’s free trade agreement with China is also of huge benefit to producers. The agreement effectively means New Zealand faces just half the border tariffs that Australia has to pay and has resulted in China displacing Australia as New Zealand's biggest export market. In the three months to March, New Zealand exports to China surged 32% to $2.3 billion. This compares with $2.2 billion of exports to Australia in the same period, a drop of 7.3%.

But China’s insatiable thirst for the so-called “white gold” could soon see New Zealand struggle to keep up with demand, giving Australia the chance to step in.

The timing couldn’t be more fitting. While New Zealand’s terms of trade are on the rise, Australia’s terms of trade are under pressure. The decline in resources demand from China is hitting Australia hard, but dairy provides us with an opportunity to remain a key part of the Asian Century.

According to research by Commonwealth Bank, China’s per capita skim milk powder demand is rising by 25% per annum.

Further, since 2010 China has accounted for 33% of global fresh milk consumption growth, 36% of global skim milk powder growth, and 80% of whole milk powder growth.

Luke Mathews, agricultural commodity strategist at CBA, says that China is the brightest light in the global dairy market and Australia is well positioned to benefit from it.

“There is still a long way to go before the Chinese dairy segment matures,” he says.

“As China embarks on that journey, we believe Australia will have a role to play in satisfying that growth in Chinese dairy demand.”

To capitalise on that demand Australia needs to ramp up production capacity. Our relatively small export program relative to New Zealand is not because we have an inferior product, it’s simply because we don’t have enough product to export at the same level.

Australia accounts for just 2% of the world’s milk production. It exports about 45% of milk produced and is has about a 7% share of the export market. This compares with New Zealand’s 35% market share.

Australian producers have been hit with a number of challenges over the past 18 months that have limited the rate of expansion. Drier than normal conditions curbed milk production and added to milk production costs, which hurt the profitability of dairy producers.

The persistent focus on the supermarket milk price war has also undermined confidence. Lower than desired milk prices in the first half of the 2012-13 season were another contributing factor, and the high Australian dollar didn’t help either.

Still, milk production in Australia is moving in the right direction. It’s expected to rise from 9.35 billion litres this season to between 9.4 billion and 9.6 billion next season.

Milk prices are also expected to remain strong in the coming months. Alongside its record opening season price, Murray Goulbourn has forecast a full-year price of between $5.80 and $6 per kilogram of milk solids.

Meanwhile, big players like ASX-listed companies Warrnambool Cheese & Butter (WCB) and Bega Cheese (BGA) continue to look to overseas markets for growth. Roughly 50% of WCB’s sales volume comes from exports, mostly to Asia. Meanwhile, Bega Cheese has invested nearly $11 million in dairy manufacturer and exporter Tatura Milk Industries, which it merged with in 2011, as it looks to capture a bigger slice of the Chinese pie.  Bega has high expectations that the nutritional milk formula business will grow materially faster than other divisions as demand from China continues to grow.

The exposure to overseas markets and expected growth over the long term has seen both companies’ share prices rise, with WCB lifting 30% since last July and Bega Cheese surging more than 75%.

Increasing spending power and a more ‘westernised’ diet will ensure rising demand for dairy in China.

Australia has a unique opportunity to breathe new life into the industry and give Australian farmers a brighter, more secure future.

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