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Dairy outlook – Interim report Ernst Janovsky

Ernst.janovsky@absa.co.za June 2015

International trends

Milk production in major dairy exporting countries is

forecast to increase. This increase is mainly due to the

result of higher yields, lower feed costs and the

abandonment of the Europe quota system. On the other

hand world demand for milk is also expected to continue

to grow as world economies recover. Demand growth

will possibly outstrip milk supply leaving the world in

short supply. This will lead to a strengthening of world

milk prices.

There has been mixed signals coming from Europe and

with the abandoning of their quota system some argue

that production will not increase as there is a tax on the

production of effluent mainly in Germany, France and

Holland. Others argue that we can expect production to

increase in Ireland and England. However in general

production increases will be taken up by an expected

increase in demand.

Exports and imports are expected to increase in order to

equalize the mismatch between production growth areas

and demand growth areas. This will also create some

export opportunities for South Africa as we are a net

exporter. This export opportunity will also supported by

an expected further weakening in the Rand which should

improve South Africa’s competitiveness internationally

and into Africa as the bulk of African states tend to trade

in US dollars.

In the past, dairy trade was mainly limited to products

with a shelf life like butter, cheese and milk powder,

however due to new technology and the development of

a new market for long life milk (UHT), long life milk has

now been exported for the first time and competes

directly with fresh milk. This has also caught regulators

off guard as UHT milk does not carry an import duty

which implies that imports of long life milk are zero-rated.

Although Europe traditionally is the bigger producer of

milk, New Zeeland is the bigger exporter of milk and milk

products. One’s competitiveness is therefore measured

against how well you can compete with New Zeeland.

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Domestic Trends

In a bid to remain competitive due to a constant eroding

of margins as costs increased faster than milk prices,

farmers consolidated their farming operations in a bid to

gain economies of scale. At the peak of the

consolidating phase we almost lost one dairy farmer per

day. In spite of this the South African dairy herd only

declined slightly while production actually increased. It

is expected that production increases will slow down

due to an oversupply which has already lead to a

decline in the producer price of 30c/l in the first half of

2015. This creates the opportunity to stimulate exports,

as South Africa remains highly competitive in terms of

its producer prices. The development of exports into

Africa is where the main opportunity lies. Currently the

failure of one of the biggest processor and distributors

of milk in South Africa has caused less completion in

the milk market thereby causing the producers share in

the consumer’s rand to decline substantially. This failure

has created opportunity for new entrances into the

market as the gap between retail and producer prices

has widened. This implies that profit margins for

processors have improved substantially on the back of

local producers. This provides an opportunity for the

more entrepreneurial farmers to vertically integrate into

the production and distribution of dairy products.

Producer margins have declined substantially due to lower producer prices as well as an increase in

feed prices. This will trigger a reduction in production as threshold values have been bridged. If one

liter of milk buys less than 1.68 kg of maize, farmers

will cut back on feed in a bid to manage costs with a

resulting decline in production. To manage these

negative terms of trade, producers will have to up their

productivity. This will drive producers to implement

new technology, better genetics and improved

economies of scale. We therefore expect further

consolidation within the industry and more farmers to

leave the industry. Given current assumptions on feed

prices as well as potential milk price increases in the future it is expected that margins will return to

normal towards the end of 2016.

Outlook

International demand for dairy products is expected to grow due to improved economic

conditions in almost all key economies.

International demand is expected to exceed expected increases in production.

International prices for dairy products are expected to increase in the short to medium term

before consolidation in the longer term.

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International profit margins are expected to improve given a decline in feed prices in general,

hence the expected increase in production.

Domestic

Domestic demand is expected to remain depressed; this is mainly the result of slow economic

growth due Eskom, low labour productivity and political uncertainty hampering investments.

Production on the other hand has increased and is expected to continue to exceed demand

placing pressure on especially producer prices

Retail prices remained fairly stable in spite of a decline producer prices hence improved

production and distribution margins This opens the door for new entrance in to the market

which will normal come from bigger producers distributors (PD’s).

Lower producer prices also creates the opportunity to build new export markets especially in

to Africa.

Production margins are expected to improve towards the end of 2016 bringing some relief to

the industry. In the short to medium term further consolidation within the industry can be

expected with more farmers leaving the industry.

Disclaimer: Although everything has been done to ensure the accuracy of the information, Absa

Bank takes no responsibility for actions or losses that might occur due to the usage of this

information.