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Rabobank Predicts Strong Dairy Growth but Challenges in Market Dynamics

February 2, 2012

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The bank’s 5-year dairy outlook foresees attractive prospects, but high prices won’t translate to increased profits for all. Whey, not cheese, will be a star.

The global dairy market will offer strong growth prospects in the next five years, but the market expansion’s uneven spread and an era of elevated pricing will create as many challenges as opportunities for key players along the dairy supply chain.
 
That’s a key conclusion from the Rabobank Food & Agribusiness Research and Advisory report, "Global Dairy Outlook: Show Me the Money," released today. In it, the international bank investigates the five-year outlook for the global dairy industry and who is profiting from dairy’s changed market.
 
In the report’s executive summary, Rababank foresees solid market growth for the dairy industry. The bank expects the global dairy market to expand at 2.4% annually over the next five years, characterizing the growth as, "to some extent the envy of the food world."
 
But that growth will be unevenly spread, generating some important market dynamics.
 
Growth will be highly dominated by emerging markets, with countries like China, India and South East Asia expected to account for more than 80% of market volume growth. Many will require outside assistance to supply enough product to meet rising appetites for dairy. This will sustain an era of trade growth and provide a substantial opportunity for many farmers, traders and processors in export regions, the report noted. Western markets will continue to mature.
 
Supplying these growth markets with safe and affordable milk in coming years will require considerable advancement on many fronts. Those include developing safe domestic supply chains in emerging markets and expanding and marketing surplus production in export regions.
 
"Tapping into emerging market growth will present a particular challenge for many of the world's dairy processors, most of which are domiciled in, and still focused on, the EU and U.S. markets," said Tim Hunt, Global Dairy Strategist for Rabobank.
 
Growth opportunities also will be uneven across product categories. In particular, economic, demographic and dietary trends are likely to see cheese sales underperform in the broader dairy market. With sales of higher-end whey products set to track a much faster growth path, the strategic value of whey pools is rising rapidly.
 
"The divergence of cheese growth and whey demand represents a major structural shift in the market, and justifies a re-evaluation of ingredient production and sourcing strategies," Hunt said.
 
Rabobank forecasts that solid market growth, supply constraints and a structural shift in the costs of producing milk will sustain high milk and dairy commodity prices over the medium term. But this won't translate to increased profits for all.
 
The unprecedented leap in farm-gate milk prices in recent years has caused the position of dairy farmers to generally improve but less than many outsiders might imagine, the bank said. The volatility of profits is far greater, the skill required to manage the business is significantly higher, and the inflation of asset prices, particularly in pasture-based farming regions, ensures that most milk producers still earn a modest return on assets.
 
Downstream, the processing sector is also confronting enormous challenges from high and volatile input costs, difficult economic conditions and retail power. Despite a step change in ingredient costs and a difficult market environment for many, processors have generally maintained or improved their margins. Many earn a higher return on capital employed than they did before the boom, though only modestly so, noted the report. Processors have apparently achieved this through a combination of passing on costs to consumers, trading up to higher value-added products and stripping costs from the business.
 
But experience has varied greatly by sector, with Fast-Moving Consumer Goods (FMCG) players like Nestle and Danone faring well, and cheese makers also improving their returns. Liquid milk players and major Chinese processors, however, have seen their returns decline.
 
As a result, the vast increase in money flowing through the dairy supply chain in recent years has either been eaten up by farmers’ input costs or capitalized into the value of farmland, the report said.
 
"In reality, an era of strong demand and heightened prices for dairy has, and will continue to, bring as many challenges as opportunities for the sector," said Hunt. "Outsiders looking to enter what may in some regards appear to be an industry that has entered a golden age will need to carefully choose their investments, while those already inside need to continue to closely track industry direction and competitor moves to ensure they manage the risks adequately to position themselves to prosper."

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