dairy-cows-web xheadjohndroppetwebReport’s key points

* Global dairy commodity prices have increased 20% as the market rebalances; some consolidation is likely.

* Internationally, demand is presenting a mixed picture, with China returning to growth, while other markets are more sluggish.

* Australian farmers face an ongoing margin squeeze, and milk production will likely be lower in 2016/17.

* The first two months of this season have seen significant year-on-year declines in national milk intakes averaging 9%, but this is expected to moderate as the benefits of good rainfall and lower input costs accrue. However, the full impact of flooding across several regions is yet to be determined.

* The domestic market continues to evolve, as consumers pursue more natural products and look to support farmers

Recovery is on but challenges remain

International dairy commodity prices have staged a significant recovery in recent months, as global supply and demand slowly return to a more balanced outlook, according to Dairy Australia’s latest Situation and Outlook report.

However, this season’s low farmgate prices continue to squeeze farmer margins in southeast Australia, impacting national milk production.

The October Situation and Outlook has revealed decreased milk production from Australia, New Zealand and Europe is helping ease the downward pressure on global commodity pricing caused by the oversupply issue of recent years.

Dairy Australia senior analyst John Droppert said Australia’s milk production was forecast to drop 5% over the full season for 2016/17, as a response to low milk prices, tight margins and the ongoing impacts of flooding and excessive rain in some regions.

“The pain that many farmers in southeast Australia experienced last season, and the ongoing challenges around margins will prove significant obstacles for some processors in securing supply in the short term,” Mr Droppert said.

“Overall milk production will remain constrained in southeast states as farmers defer investment and focus on management to breakeven points, and conserving equity where margins are negative.

“The first two months of this season has seen significant year-on-year declines in national milk intakes averaging 9%, but the impact on the overall national milk volume is expected to moderate as the season progresses and the benefits of good rainfall (excluding flood and excessive rain damage) and lower costs for feed, fertiliser and water accrue for farmers across the nation.”

Situation and Outlook has also highlighted domestic-focused regions have experienced relative stability in margins and weather conditions, and milk production is steady or higher in Queensland and Western Australia.

Mr Droppert said commodity markets were in a much better place than this time in 2015, but downside risks remain.

“The perennial challenge for both processors and farmers is to secure adequate milk flows to capitalise on market opportunities, while protecting against damaging price shocks. This will remain top of mind as the industry finds its feet in 2016/17,” he said.

Internationally, demand is presenting a mixed picture, with China returning to growth, while other markets are more sluggish. The value of global exports fell by 19%, with falls across all major markets, largely reflecting the lower global prices for key dairy commodities.

“Total global dairy export volumes to Greater China increased nearly 20% over the 12 months to June 2016,” Mr Droppert said.

“Australia-China export volumes grew by 30%, from around 136,000 tonnes to 178,000 tonnes, while their USD value increased by over 65% year-on-year, from US$350 million in 2014/15 to US$579 million in 2015/16.”

Global dairy exports to Japan fell by 1% in volume over the course of 2015/16. Overall demand in Southeast Asia also slowed, with 2015/16 import volumes falling 1% year-on-year, whilst the USD value fell 27%. Australian export volumes to the region grew by 2%, however. Mexico saw strong growth in overall volumes of dairy imports up by 11% on last year – mainly sourced from the United States. Export volumes to the Middle East decreased slightly in 2015/16, falling 3%. Australia’s dairy export volumes to the region fell by 17% from 71,000 tonnes in 2014/15 to around 59,000 tonnes in 2015/16.

Mr Droppert said the Australian domestic market remained characteristically steady.

“Total milk sales volumes have grown moderately, increasing by 1.5% to 1,358 million litres over the 12 months to September,” he said.

“Fresh, white full cream milk sales have increased their share, up 7% in terms of volume, and 9% by value. This reflects an ongoing shift away from modified (reduced fat) milk varieties.”

The report revealed cheese volumes have grown steadily over the last 12 months to April 2016, increasing by 2%, driven largely by growth in sales of deli cheeses. Meanwhile, growth in butter sales has moderated, with an increase in volume of almost 4%.

“We’ve also seen a noticeable shift within the yoghurt category from sweetened to natural, unsweetened yoghurt,” Mr Droppert said.

“Sales of natural, unsweetened varieties have grown by about 9% in volume and value, while sweetened varieties have fallen almost 8% in volume and 9.5% in value.”

To view the full report visit www.dairyaustralia.com.au/SO

Executive summary

International dairy commodity prices have staged a significant recovery in recent months, increasing by over 20% as global supply and demand slowly return to a more balanced outlook. In a familiar pattern, sentiment has raced ahead of the fundamentals, with price increases arriving earlier and more rapidly than expected.

With this in mind, caution is advisable, as current pricing remains vulnerable to reverses in sentiment until the fundamentals catch up. Nonetheless, the oversupply issue that has maintained downward pressure on commodity pricing for so long looks to be receding, as New Zealand, Australia, and (increasingly) Europe are seeing milk production track below year-ago levels. Demand is presenting a mixed picture, with China returning to growth, while other markets are more sluggish.

Buyers have been more actively seeking product, but resistance to further price increases is building. On balance, further recovery into 2017 is likely, albeit overlaid with ongoing price volatility. In Australia, the tumultuous end to the 2015/16 season gave way to a grim 2016/17 margin outlook for many southern farmers as opening prices were announced. Weather conditions have helped offset some of the pain, although rainfall has gone well beyond useful levels in large parts of northern Victoria, New South Wales, Tasmania and South Australia. The wet conditions are impacting farm operations, milk quality, fodder conservation, and in some cases causing direct damage via flooding.

Domestic-focused regions have experienced relative stability in margins and weather conditions, and milk production is steady or higher in Queensland and Western Australia. Combined with the enormous variation that already exists in margins and farm business management strategies between regions, processors and individual farms, these factors are making an ‘overall’ view of the season difficult to define. Having commenced with two months of significant yearon-year declines in national milk intakes (averaging 9%), 2016/17 is still expected to be better than the preceding season in terms of both costs (feed, fertiliser and water prices are well down), and seasonal conditions. Farmgate prices remain low however (though variation of around $1.00/kg MS exists between individual farms and processors in southern regions alone), keeping margins tight or negative for most farmers. This, the ongoing impacts of the 2015/16 price step-down, and the current flooding are likely to limit production through 2016/17. The impact on milk volumes is expected to moderate as the season progresses and the benefits of higher rainfall and lower costs accrue, equating to a 5% fall over the full season.

The Australian domestic market remains characteristically steady, though there have been some notable changes within key categories. While total milk sales volumes have grown roughly in line with population growth, (increasing by 1.5% to 1,358 million litres over the 12 months to September), fresh white full cream milk sales have increased their share, up 7% in terms of volume, and 9% by value. This reflects an ongoing shift by consumers away from modified (reduced fat) milk varieties, which fell 6.7% in both volume and value. Full cream now accounts for 61% of the fresh white milk category, up from 54% only three years ago as consumer attitudes towards dairy fats evolve. Branded milk has regained market share from supermarkets’ private label in the fresh white milk category, with branded sales volumes increasing by 7%, while private label fell by nearly 2%. The apparent reversal of the long term trend of increased private label share stems from consumer responses to the media coverage of the 2015/16 milk price step downs. Cheese volumes have grown steadily over the last 12 months to April 2016, increasing by 2.2%, while cheesevalues have grown by 1%. Within the cheese category, growth in sales of deli cheese have outstripped those of chilled cheese, increasing 5.6% in terms of volume and 3.8% in terms of value. This is a continuation of a trend observed over the past 5 years, where deli cheese growth has repeatedly outpaced that of chilled cheese. Growth in butter sales has slowed, but remains notable at 3.6% in volume terms, and 3.8% in value terms. The yoghurt category saw a continuation of the shift from sweetened (down 10% in value) to traditional, unsweetened (up 9%) varieties of yoghurt. In volume terms, sales of sweetened yoghurt have fallen by 8%, while those of traditional yoghurt have grown by nearly 9% in the past 12 months. As part of (and despite) a tumultuous few months, there have been a range of developments in the corporate sector.

Fonterra has announced a further investment of $4.3 million in its Wynyard (Tasmania) cheese plant, streamlining of its warehousing operations, and the sale of its Wagga (NSW) Riverina Fresh milk business. Midfield Group’s new powder dryer at Penola, South Australia continues to take shape, with the group inking an agreement with Louis Dreyfus that will see the latter market the finished product across the US, Middle East and southern Asia. Camperdown Dairy International is shelving its planned $500 million vertically integrated milk powder operation, while Murray Goulburn has reiterated plans to build a new nutritionals plant, originally flagged for Koroit, Victoria. Inner Mongolia Fuyuan Farming Co Ltd obtained a 79% stake in Burra Foods, while Warrnambool Cheese and Butter raised $142 million via rights issue, with major shareholder Saputo failing to dislodge Lion Dairy and Drinks from its 10% blocking stake. As the returns from international markets recover, an active processing sector will once again be seeking extra milk to capitalise on renewed export opportunities.

The pain that many farmers experienced last season, and the ongoing challenges around margins will prove significant obstacles for some in securing supply – in the short term at least. Overall milk production will remain constrained as farmers defer investment and focus on management to breakeven points, and conserving equity where margins are negative. The capacity and inclination of processors to offset this by passing market upside through in the form of higher farmgate prices will be influenced by the inherent risks in a largely sentiment-driven recovery.

In terms of the supply/demand balance, the market is in a much better place than this time in 2015, but downside risks remain. The perennial challenge for both processors and farmers is to secure adequate milk flows to capitalise on market opportunities, maximising profitability while protecting against damaging price shocks. This will remain top of mind as the industry finds its feet in 2016/17.