May 1, 2015
A nasty year for New Zealand's dairy sector
Prices fall, profits plunge with a new round of industry consolidation ahead.
By Eric J. BROOKS
An eFeedLink Hot Topic
It is not an easy year to be a dairy farmer in the world's leading exporter of all things milk-related, New Zealand. In fact, after enjoying several very fat years, some of them may not make it through 2015.
Exports fall
After 2013's drought shriveled milk production, with plentiful rains returning, the USDA estimates that New Zealand's 2014 milk output jumped a healthy 8% to 21.74 million tonnes. Unfortunately, with over 90% of production exported, the rebounding supply crashed headfirst into the past year's 35% dairy market price crash, and a 3% drop in world dairy export volumes, the first such decline since 2009.
Moreover, China, the world's leading importer, sources 85% of its foreign dairy powder purchases from New Zealand -and China's fourth quarter 2014 dairy import volume was down 55% from its level in the same period of 2013.
Some products were particularly hard hit. Infant milk formula exports totaled 48,000 tonnes in 2013 and 25,000 tonnes of this figure was bought by China. But in 2014, infant milk formula exports fell by over 27%, to a USDA estimated 35,000 tonnes or less. The entire export drop off was due to China, which first temporarily suspended milk formula and why imports due to the detection of a contaminant and thereafter saw its demand for all dairy imports fall off substantially.
Across most dairy product lines, second tier buyers taking advantage of the low prices and China's withdrawal from the market could not make up for the resulting, massive drop in export demand, which hit New Zealand harder than any other supplier.
On one hand, because pastureland is used for most of New Zealand's milk production, the 50%+ fall in feed costs over the last two years did not reduce expenses by much. In fact, with the proportion of dairy cattle relying on feed rations increasing during this time, overall milk production costs may have increased marginally.
On the other hand, with costs nearly constant, the farm gate milk price has fallen from steeply. From NZ$6.05/kg-NZ$6.75/kg (US$4.3/kg2-US$4.82/kg) range in 2011-12, it peaked into the NZ$7.80/kg-NZ$8.60/kg (US$5.57/kg-US$5.72/kg) range in 2012-13. In 2013-14, farmers enjoyed a record payout of NZ$8.40/kg (US$6.00/kg).
Unfortunately, by the end of 2014, it had crashed, from over NZ$8.00/kg (US$5.71/kg) at the start of the year to NZ4.70/kg (US$3.36/kg) in the late fourth quarter.
Drought, low prices, culling rates squeeze output
With April's deregulation of EU milk production promising intensified world market competition, early 2015's partial, short-lived dairy market recovery slumped back into deflation in the early second quarter. In response, leading exporter Fonterra announced that it would again slash the farm gate milk price to NZ$4.50/kg (US$3.21/kg). Revenues are now down by approximately 45% from their peak record of 18 months ago, and profit margins have fallen by much more.
Even before Fonterra's latest price cut, Rabobank's Q1 Global Dairy Quarterly noted that, "At this low price, the cash crunch for farmers is now imminent, as retrospective milk payments from May to September will be minimal, but new expenditure will be required for the 2015/16 season."
Earlier, the USDA had commented that even at NZ$5.30/kg (US$3.79/kg), "It is projected 25% of farmers won't cover their farm working and debt servicing expenses in 2015." With the farm gate milk solid's price having sunk 15% below even this level, it is reasonable to assume that close to 40% of New Zealand's dairy farms will face severe financing difficulties, and some will not be able to make it through this year.
To make matters worse, this downturn's economic impact was later exacerbated by supply-side problems: Late 2014 and early 2015 saw dry pastureland conditions bordering on drought afflicting many milk production regions.
That means that while farmers are facing low prices, their efforts to bail themselves out will be exacerbated by a lack of pastureland. Technically, they could substitute feed in place of barren pastureland. Unfortunately, according to Rabobank's report, "At the forecast milk price, there is no incentive to purchase supplementary feed."
Consequently, while the USDA forecasted fluid milk production to rise by 1.9%, it states this projection was based on adequate rainfall early this year. Dry conditions during January and February made it more likely that output will either stay flat or decline. Moreover, with farm gate prices falling substantially lower than initially anticipated have undermined the incentive to produce
Large scale farms that use feed will try to control their input costs by milking cows only once a day, which will result in lower production. At the same time, the low farm gate milk prices will force smaller operators out of the industry faster than their large competitors can boost production.
With high beef cattle prices causing first quarter dairy cattle culling rates to rise 40% above their level in early 2014, the lower number of animals will also work to limit production. In an interview with Radio New Zealand, Federated Farmers dairy chairman Andrew Hoggard stated that, "There may be an option for some farmers to cull a little bit heavier this season, take advantage of good cull cow prices."
Hoggard added that the worst was yet to come for dairy farmers, explaining that, "They are going to lose quite a bit of money out the cash flow in August and September, which is the time where all costs are ramping up, so it could mean people's overdrafts at that time of year, when they're generally already stretched, could get stretched even more."
With marginal dairy farms facing a more serious financing crisis in mid-year, their efforts to bail themselves out is likely to keep dairy cattle culling rates high. Consequently, Rabobank now projects 2015 milk output to fall back 1.5% to 2.0%, into the 21.2 to 21.4 million tonne range, but even this may turn out to be too optimistic.
Consolidation resumes
Hemmed in by deeply negative gross margins, sufficient access to external financing, and an inability to boost short-term output enough to cover fixed costs, we can expect a large proportion of the weakest, least profitable farms to fold and be consolidated into larger operations.
That will merely represent the continuation of a trend that was temporarily halted by the past decade's extraordinary, export-driven prosperity: According to industry association figures, from the early 1980s to late 2000s, the number of dairy cattle herds fell by an average of 170 per year. From approximately 16,000 in 1982, the number of New Zealand dairy herds fell to slightly over 11,500 by 2007. The average herd size also tripled, from 140 head in 1983 to 413 head in 2013.
Thereafter, the Chinese dairy sector's melamine-driven implosion's created an exceptional five year export boom temporarily paused this secular trend. Larger producers reinvested the resulting windfall profits to boost farm scale, such that from 2008 to 2014, herd size increased by 25%. This era's exceptionally strong windfall profits also saw many marginal farmers enter the industry, such that the number of dairy cattle herds rise from 11,500 in 2007 to 11,927 by 2014.
However, this year's deep losses will certainly force smaller, less capitalized producers to exit the industry, the longterm trend towards consolidation and larger scale will resume. Expect the number of dairy cattle herds to resume falling back towards 11,500 level or lower and for the number of cattle head per herd to continue climbing, reaching 450 head within a year or two of the market's recovery.
Over the long run, the consolidation and productivity improvements made during this time will leave the industry in better shape and more competitive. But over the short term, smaller producers will face great cost pressure and many will be forced to leave the industry. Over the longer term, with China poised to become more self-sufficient in dairy products, New Zealand's milk producers need to adjust their expectations, expect a modest market recovery and slower export growth in the years ahead.
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