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November 28, 2017

From Quantity to Quality: The myths & realities of China's evolving dairy market

Demand for fluid milk, dairy powders has tailed off sharply but long-term import growth remains nearly constant. The quantity and value of China's dairy imports is changing more than their overall quantity.

By Eric J. Brooks

An eFeedLink Hot Topic

China's dairy is evolving rapidly but these profound market changes have hidden behind a widespread myth: That it was China's falling demand for dairy products that triggered the world dairy market crash -This was is not the case: It was more of a mismatch between world dairy supplies and the type of dairy products China is demanding.
The accompanying graph clearly how despite cyclical fluctuations, the quantity of dairy goods that China imports expanded at a near constant rate both before the world dairy market crash and even in the years after it. The rate at which dairy imports grow is decelerating but far more gradually than the 2014 market crash leads people to assume. -But while the total quantity of dairy imports rises at a relatively steady pace, the type of dairy goods imported has undergone profound phase changes.
Phase I: Dairy powders dominate imports
The first change in the industry's fortune's occurred a decade ago, after the exposure of domestic milk's widespread melamine contamination. On one hand, tighter government regulations and a succession of additional dairy safety scandals kept milk production relatively flat. On the other hand, China's demand for processed dairy goods kept expanding.
Consequently, a growing gap between fluid milk output and dairy demand was met by an exponential rise in the volume of imported dairy commodities. From 2008 through  2014 inclusive, imports of WMP(+56%/yr) and SMP(+29%/yr) rose at near exponential annual rates.
But there was more than a shortfall of raw milk feedstock behind this import surge: Fearing for both their own safety and that of their children, consumers distrusted domestic milk, causing imports of fluid milk (+85%) and infant formula (+25%) to rise at rapid annual rates comparable to those for commodity dairy powders.
Spurred by rapid growth in the consumption of fast food meals and processed food products, annual growth in import volumes of higher-value dairy goods such as butter(+41%/yr), cheese(+28%/yr), yogurt(+44%/yr), cream(+27%/yr) and condensed milk(+20%/yr) surge ahead at double-digit rates.
Phase II: Fluid milk keeps the market going, fatty dairy products sustain the market
Nevertheless, from 2008 through 2014, it was relatively unprocessed dairy powders and in later years, fluid milk that keynoted China's import surge and the dairy market boom it sparked. As the attached graph shows, they dominated China's dairy import portfolio through the mid-2010s and their volumes grew more quickly than that of processed goods.

From a mere 46,000 tonnes in 2008, WMP imports peaked at 671,000 tonnes in 2014. Those of SMP roughly quintupled, from 55,000 tonnes in 2008 to 253,000 in 2014. After the 2014 dairy market crash however, some of these trends went into reverse.
 On one hand, imports of WMP and SMP fell by 48% and 27% respectively before staging a partial recovery. Even so, China's 2018 imports of WMP (500,000 tonnes) and SMP(200,000 tonnes) will be 26% and 21%  below their 2014 peaks.
Fluid milk imports did better, rising 6,240% in the eight years from 10,000 tonnes in 2008 to 634,000 tonnes by 2016. Indeed, it was China's demand for fluid milk, fatty or processed dairy goods such as butter and cheese that sustained the world dairy market over the past three years.
But one fact remained unchanged: Despite the crash in China's imports of WMP and SMP, commodity goods such as dairy powders and fluid milk would continue to make up a majority of imports for another three years. That's because China's appetite for milk powders was saturated, fluid milk imports ignored the market downturn, rising 242% from 2013 through 2016.
But just as had happened earlier with dairy powders, China's supposedly insatiable demand for foreign milk fell sharply and without warning. Superficially, the 85% annual growth in milk imports in the five years up to 2014 gave way to a slower 12.9% average growth rate from 2014 through 2018 inclusive -in reality fluid milk imports doubled from 2014 through 2016 but fell steeply this year.
That happened because fluid milk demand dropped 4.9% over two years, from 39.485 million tonnes in 2015 to a USDA estimated 37.553 million tonnes this year. At 38.50 million tonnes, this year's demand for milk is lower than it was in 2014, even though China's population has grown 2.5% over the past four years. It reflects the first drop in Chinese milk consumption since the 2008 melamine scandal.
With harsh economic conditions putting pressure on consumers, the drop in fluid milk demand was mostly due to consumer's falling milk consumption. Processed food buyers are using only 1.5% less milk for their processed goods in 2017 than in 2016 -and that was mostly due to their substituting of cheaper reconstituted WMP in place of freshly produced milk.
Consumers by comparison, saw their fluid milk consumption fall 5.0%, from a peak of 15.36 million tonnes to 14.6 million tonnes in 2016. Even though China's economy is now recovering, in both 2017 and 2018, fluid milk consumption will rise by a mere 0.6% annual rate. This is below the rate of China's population growth and will result in fluid milk consumption of 14.8 million tonnes in 2018, 3.7% less than the quantity of milk China's population drank in 2015.
With almost all foreign milk being used for personal consumption, the drop in consumer demand had an immediate market impact. Imports of fluid milk have crashed 9.3% in 2016, to 575,000 tonnes from the previous year's 634,000 tonnes.
Fluid imports will fall by an even steeper 9.6% this year, to 520,000 tonnes -and 18% below their 2016 peak. They now join WMP and SMP, whose import volume declined an average of 12.5% and 3.8% from 2014 through 2017 inclusive.
Phase III: Fatty, high-end goods overtake imports of milk, dairy powders
Interestingly, even after fluid milk succumbed to flat or falling imports in the manner that dairy powders had earlier, China's dairy demand -and dairy import volume continues to grow at almost the same rate it did earlier in the decade -but in a manner that triggered its dairy market's third transformation in ten years.

China's total demand for all dairy products is on track to rise approximately 29.6% over five years, from ann FAO estimated 49 million tonnes in 2013 to 63.7 million tonnes in 2017. Having expanded at a 6.8% annual rate in the four years since 2013, the pace of demand growth is picking up: For 2018, China's dairy product demand is projected to increase an FAO estimated 8.3%, to 69 million tonnes.
Now, however, it is high-value goods and fatty dairy products that are driving demand and ongoing import growth. While 2017's January to September fluid milk imports are 10% lower than a year earlier and total dairy powder imports are estimated to total 27% less than their 2014 peak, other dairy products are doing well.
Infant formula import's estimated 2014-17 annual 34.6% expansion exceeds their 24.5% increase in the six years up to 2014. In 2018, the volume of imported infant formula will be almost triple the 123,000 tonnes imported in 2014 when the dairy market crash occurred.
Whey is used in many processed foods and its import volume continued to rise at a 9.3%/yr in the years 2014 through 2017 inclusive. Over these same three years, imports of fattier, processed dairy goods such as butter(16.6%/yr), cheese(+21.0%/yr), condensed milk(+42.4%/yr), yogurt(+55.7%/yr) and cream(+55.1%/yr) all increased.
All this turned 2017 into the industry's third major inflection point in a decade: This year, for the first time, the volume of processed, high value or fatty dairy goods will exceed the combined total imports of WMP, SMP and fluid milk. With Chinese consumer tastes becoming increasingly sophisticated, this trend has many years of growth momentum left in it.
Going forward, with fluid milk production having recovered from its 2015-17 recession (which saw output fall 5.2% in two years), it is poised to grow at a 2% to 3% rate. As the accompanying chart shows, once rapid growth in dairy powder consumption and fluid milk consumption growth has leveled off. With milk production recovering, China dairy powder production will probably keep pace with demand growth.
On one hand, that means that fluid milk or dairy powder import volumes will no longer rise rapidly. On the other hand, with demand for fatty, processed dairy goods increasing 10 times faster than domestic milk production, there is a bright future for those who would export such high-end dairy products to China. For example, from 2013 through 2017, revenues from fluid milk sales will have risen 18% --while those from yogurt jumped 109% over these same four years.
Are western exporters taking full advantage of these opportunities? Not according to a recent Financial Times article ("China's yogurt sales poised to overtake milk for the first time", 25 Sept 2017, www.ft.com/content/3045fca8-9c50-11e7-8cd4-932067fbf946). It notes that "Chinese milk sales will grow just 4% in 2017 compared with last year, while yogurt sales will rise 18% to almost RMB12 billion (US$17billion), surpassing plain milk sales for the first time."
At 40%, the article states that yogurt profit margins are twice as large as those on fluid milk and -most surprisingly- that three Chinese dairies (Mengniu, Yili and Bright Dairy) control 70% of the market.
Ironically, while many western dairy exporters bemoan the low prices they get for dairy powders, the article notes how yogurt has 'salvaged' the sales and profits of Chinese companies. Stating that "Yogurt is an area where foreign brands should have had the advantage," the article notes that "They [western dairy exporters] were slow to react to the market trend."
Similar success stories can be read for a wide range of other processed dairy goods, ranging from whey used in processed food to cheese used in pizza and the condensed milk Chinese increasingly flavor their coffees with.
Hence, China's demand for dairy imports never really slowed down that much. Indeed, the demand for high-end dairy goods and returns to be made off them have never been better. China's dairy sector has moved solidly upmarket -and the commodity-driven, western dominated world dairy market clearly needs to put more value-added into its export offerings.

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