May 31, 2018
New growth drivers, a secular production upturn for China's dairy industry
Productivity is booming and fluid milk output might is growing at its fastest pace since the mid-2000s. At the same time dairy product and consumption fundamentals are in a state of rapid transformation.
By Eric J. Brooks
An eFeedLink Hot Topic
After a decade of hard times and two years of little or no profitability, things are finally looking up for China's beleaguered dairy sector. Productivity is rapidly improving, short-term fundamentals are good, and we could be on the verge of a secular, long-term upturn in the industry's fortunes too.
For a second consecutive year, 2017's average farmgate milk price was RMB3.4/kg (US$0.53/kg) falling below an average production cost of RMB3.5/kg (US$0.55/kg). Milk has failed to sell anywhere near an average price of RMB4.00/kg every year since 2014 when the world dairy market peaked. Together with costly new environmental regulations and rising feed costs, four years of low prices forced many smaller milk producers out of business.
On the other hand, with integrated dairy farms enjoying below average unit costs, they have sufficient capital and high enough returns to expand their herds. The ongoing expansion of integrator herds and simultaneous exit of small dairy producers from the industry has stepped up the industry's pace of consolidation.
From 11% in 2005, the proportion of dairy farms with at least 100 cattle rose to a USDA estimated 28% by 2010, to 50% by 2016 and is projected around 55% at the present time. According to the USDA, while national milk output fell, China's top 15 dairy farms accounted for 19% of milk production and boosted their output by 10% in 2017. They have also been actively replacing inferior cattle with newer ones that have superior genetics and productivity.
Even so, expanding integrator dairy cattle herds could not offset the exit of so many smaller producers from the industry. Hence, 2017 saw the number of cows in milk fall by a steep 10%, from 8.0 million at the start of 2016 to 7.2 million at the start of 2017. It was part of a long-term decline that started when their number peaked at 8.4 million head in 2014.
With the number of dairy cattle declining more than expected, fluid milk production missed its initial 37 million tonne USDA estimate. At 36.95 million tonnes, fluid milk output was 1.8% lower than 2016's 37.62 million tonnes.
With the proportion of milk accounted for by large-scale herd expanding farms rising so quickly, 2018 will finally see the number of cows in milk finally stabilize at 7.2 million head. Despite flat inventories, the improvement in dairy cow genetics means that output will increase for the first time in three years.
At 40.50 million tonnes, 2018's 9.6% increase in fluid milk output is the highest production increase since 2007, before the melamine contamination scandal and a decade of woes hit the industry. It is also significantly higher than the USDA's initial 38 million tonne fluid milk output estimate. These revisions reflect the surprisingly strong improvements made in Chinese dairy productivity.
Milk production per dairy cow has jumped a whopping 22.1% in just four years, from 4.435tonnes/cow in 2014 to 4.924tonnes/cow in 2017 and 5.417 tonnes/cow this year.
Higher than expected milk production is being complemented by milk demand, which has grown faster than expected. Supported by rapid increases in the production of processed dairy products, total fluid milk demand is rising by 9.5%, to 41.15 million tonnes. That is nearly three times more than the 3.5% increase initially anticipated.
This is mainly due to local fluid milk used by dairy processors and the processed food industry, which is rising a whopping 14.7%, from 22.80 million tonnes in 2017 to 26.15 million tonnes this year. -In particular, domestic processors are trying to keep up with demand for fatty and high-end products including butter, cheese, yogurt, condensed milk and infant formula.
While this is indicative that local production of processed dairy commodities is rising, this is not the case for commodity product lines. For example, two years ago, WMP production was expected to rise to a USDA estimated 1.4 million tonnes in 2017 and 1.45 million tonnes next year. Instead 2017 WMP production was only 1.375 million tonnes and it is forecast to decline another 5.5% in 2018, to 1.3 million tonnes.
Not only is foreign WMP cheaper than the domestic version, but the USDA reports, "All major dairy processors in China have established overseas WMP production facilities, and the products produced there are targeting the Chinese domestic market." With most of these new investments in New Zealand, this country accounts for 92% of WMP imports. Australia is China's second most popular foreign dairy investment destination and provides most of the remaining WMP imports.
Such WMP imports totaled 420,000 tonnes in 2016 and 470,000 tonnes last year. However, with cheaper SMP being used by food processors in place of WMP, imports will only rise to 500,000 tonnes this year instead of the 600,000 tonnes initially forecasted. Due to this ongoing substitution of SMP, 2018 WMP consumption is falling 3.7%, to 1.848 million tonnes in 2018 from 1.918 the previous year.
While 47% of imported SMP is bought from New Zealand, it is large, discounted European inventories which keep its price low. The EU supplies 28% of imports, with Australia (13%) and America (11%) supplying most of the rest.
With less than 10% of China's SMP consumption coming from local production, import volumes are rising in tandem with its growing popularity among food processors. From 184,000 tonnes in 2016, SMP imports jumped 34.2%, totaling 247,000 tonnes in 2017 and will increase another 21.5% this year, to 300,000 tonnes.
All this means that in 2018 China will import nearly 19% more SMP than the record 253,000 tonnes it bought in 2014, when the dairy market crash occurred. On the other hand, despite falling domestic production and the ownership of overseas plants, 2018 WMP imports will be 19 below their 671,000-tonne record volume. -That's because aside from the fact that both WMP and SMP output are gradually falling, China's demand for these two dairy powders has remained stagnant at slightly above 2.1 million tonnes for a fifth consecutive year.
Moreover, when growth in the consumption import of these dairy powders halted, fluid milk import kept growing aggressively but even this trend has tapered off: After rising from 16,000 tonnes in 2010 to 650,000 tonnes in 2016, fluid milk imports are leveling off. They increased to 668,000 tonnes in 2017 and a USDA estimated 670,000 tonnes this year.
This does not reflect growing confidence in domestic supplies as it does faltering fluid milk consumption growth. Consumer consumption of fluid milk skyrocketed from 3.81 million tonnes in 2000 to 15.36 million tonnes in 2014 -but has fluctuated in the 14.6 million to 15.0 million tonne range ever since.
Hence, while milk production finally appears to be growing strongly again, consumption's new growth frontier is now in either in fatty dairy products used in fast food or high-end value-added products directly purchased by consumers. These include butter, cream, cheese, infant formula, condensed milk, yogurt and whey powder.
All this can be seen in the accompanying chart: From 2010 to 2014, total imports of fluid milk and dairy powders such as WMP, SMP, whey, and caseinate grew at an average annual rate of 24%. Over that same 2010-14 period, imports of fatty or high-end dairy goods increased at an average annual rate of 27.6%.
However, in the four years after the dairy market crash, imports of fluid milk and dairy powders were virtually flat, rising by a mere 0.2% annually -were it not for the fact that fluid milk consumption grew aggressively for a year after the crash, fluid milk and dairy powders would have suffered negative import growth. By comparison, the years 2014 through 2018 inclusive will have seen imports of high-end dairy goods continue to increase at a 29.5% annual rate.
Going forward, you can expect this rapid growth in China's demand for processed dairy goods to continue for more than a decade. How China satisfies this rising consumption of fatty and value-added dairy goods is another story. Constant demand growth will be accompanied by an inverse relationship between domestic milk production and the volume of high-end dairy good that need to be imported.
For a decade, a succession of food safety scandals and rapid turnover or exiting of small-scale producers made for five years of stagnant or nominal milk production growth. With over half the industry now consolidated, an upcoming expansion in dairy cattle herds will be complemented by rising productivity.
Even at today's low prices, the largest most efficient producers can turn a profit. With demand now rising rapidly, the industry is a year away from its milk price cycle -and returns - entering a market upswing. That means that the industry is poised for milk supply to grow faster than demand for dairy goods for the first time since the late 2000s (when the dairy import binge began).
On one hand, that means that in the 2020s, China's dairy sector could again grow almost as fast as it was in the early to mid-2000s. On the other hand, it also means that it may eventually substitute domestic production in place of imports for a growing number of fatty or high value processed dairy goods. That means that for China's dairy sector, the 2020s could feel a lot like the early to mid-2000s when the industry grew rapidly but in a more self-sufficient manner.
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