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Dairy Globalization Refresh: 2011 Update Summary FindingsSummary Findings Conducted by Bain & Company C i i d b D i M t I & U S D i E t C ilCommissioned by Dairy Management Inc. & U.S. Dairy Export Council

FINAL June 21, 2011

Globalization Task Force

■Kevin Toland, Glanbia (Chair)

■Dermot Carey, Darigold, Inc.y, g ,

■Kimberly Clauss, Hilmar Cheese Company

■Richard Cotta, California Dairies, Inc.

■Les Hardesty, USDEC Chairman

■ Jeff Kaneb, HP Hood LLC

C l Kit h L d O'L k■Carol Kitchen, Land O'Lakes

■Keith Murfield, United Dairymen of Arizona

■Steve Shelley Schreiber Foods■Steve Shelley, Schreiber Foods

■Sue Taylor, Leprino Foods

■ Jay Waldvogel, Dairy Farmers of America

1

Agenda

Introduction/Executive summary Updated view on supply and demand Potential wild cards Summary and recommended actionsSummary and recommended actions

2

In 2009, we identified several trends impacting the outlook for global dairy…

Dairy demand will continue to grow at a rapid pace in developing markets

Dairy supply will be challenged to keep pace − Slow growth in Oceania/Europe

B il Uk i t− Brazil, Ukraine years out− China will remain an importer

The global dairy trade is the primary source of growth for U S dairyThe global dairy trade is the primary source of growth for U.S. dairy, and the U.S. is positioned to become a much larger player, but

must address weaknesses

A latent demand gap is developing and creating a sizeable, though finite, window of opportunity for U.S. dairyg , pp y y

3

…and recommended 7 industry and company-specific initiatives

Reform U.S. pricing and risk

management

I. Reform of the regulated milk pricing systems (Federal and State) and the price support mechanisms

II. Development of better mechanisms for risk management and

Increase access

management policies

reduction of volatility

III. Continued pursuit of trade treaties that provide net exportto international

markets

III. Continued pursuit of trade treaties that provide net export benefits

IV Analysis and prospective redirection of industry’s global pre

Improve responsiveness

IV. Analysis and prospective redirection of industry s global, pre-competitive sales and marketing investments and capabilities

V. Build on existing food safety assurances and traceability as a competitive strength p

to global demand VI. Develop better ability to meet customer product specification requirements globally

VII. Encourage increased product and technology innovation

4

The desired outcome was for U.S. dairy to become a Consistent Supplier to the global market

“Fortress USA” Status Quo Consistent Supplier

Global Dairy Player

• Complete focus on domestic market

• Use of additional tariff and non tariff barriers to

• Limited industry efforts to address globalization

• Current policies and regulation

• Commitment to global opportunities for U.S. milk supply

• Broad efforts to improve

• Consistent exporter strategy, plus:

• Industry moves to an t f d d land non-tariff barriers to

overcome foreign competition

• Supply mgt. as a means to balance production

regulation

• Opportunistic participation in global trade as prices allow

• Individual companies

• Broad efforts to improve commercial focus and align product portfolio

• Collective effort to reform FMMO and price

export focused model that includes milk supply and processing assets outside of U.S.

• Commercial and and demand, and limit volatility

• Attempt to limit effects of globalization

• Individual companies may choose to develop differentiated export capabilities

• Limited effort to manage

support • Efforts to improve

forward contracts, futures markets

• Strong domestic market

innovation capability development

• May include off-shore investment and other significant effortsvolatility • Strong domestic market

as a basis for global trade

• Joint industry efforts to build insight/ capability

significant efforts

• Capabilities will support domestic market, though investments may be diverted globallyg y

5 Recommended

by IC Board

Since then, however, the global downturn significantly impacted the dairy industryp y y

During the downturn, global trade slowed…

…stalling production growth… …and driving down prices

YoY net global trade Global raw milk World dairy prices(USD/MT)

6

8%

ggrowth (by weight)

6.2% 400

500M MT

production

458 455

Decline

$6,000

(USD/MT)

4

6

2 3%

200

300

-1%

2,000

4,000

Butter

Cheese

SMP

WMP

0

2

2008 2009

2.3%

0

100

2008 20090

06-07 07-08 08-09

Note: Global raw milk production refers to 27 key markets S FAPRI (2011) IDF (2010) ABARE (2011)

“The financial crisis in the global economy caused international demand for dairy produce to decline in late 2008 and had a dramatic impact on product prices during the first half year of 2009…the financial crisis impacted every aspect of the dairy business: production, trade, consumption and prices.”

International Dairy Federation, “The World Dairy Situation” (2010)

Source: FAPRI (2011); IDF (2010); ABARE (2011)

6

And although these trends have largely reversed, key questions remain

Demand is picking up… …and prices have recovered

What (if anything) has changed about the outlook for dairy? How might these changes impact the ‘Consistent Supplier’ strategy?

S FAPRI (2011) ABARE (2011)Source: FAPRI (2011); ABARE (2011)

7

To answer these questions, the Innovation Center commissioned a globalization refresh

Project objectives Determine if globalization trends have substantively changed Agree on which changes could materially affect the primary conclusions of the original study Assess any expected change to the duration of the “window of opportunity” facing the U.S. dairy industry Synthesize updated findings to determine potential impact on the U.S. dairy industry, the “Consistent Supplier” strategy and the recommended industry initiatives derived in 2009industry initiatives derived in 2009 Communicate the findings of the project to key dairy stakeholders and constituentsconstituents

8

Agenda


9

Executive summary: a refreshed view of dairy fundamentals shows export opportunity still existsp pp y

• Long term demand for dairy products will remain strong, driven primarily by emerging markets (with China remaining a net importer)

Import demand

• Traditional sources of supply are constrained and will fall short of expected demand, although Europe and New Zealand may expand output more than originally anticipated

• Brazil and Ukraine stumbled in recent years and Argentina and Belarus have yet

Export supply

Brazil and Ukraine stumbled in recent years and Argentina and Belarus have yet to emerge as major global players

• Buyers desire an alternative source of supply and have affirmed that the U.S. is well-positioned to meet this need, but the U.S. still has clear areas for i t

Buyer feedback improvementfeedback

• The demand gap is likely to be wider than anticipated, the window of opportunity remains open over the long term and U S dairy is the primary source of supply toremains open over the long term, and U.S. dairy is the primary source of supply to satisfy that demand

• However, company, industry and policy efforts to increase pricing and supply flexibility, reduce the impact of volatility and improve commercial focus are still necessary

Long-term outlook

necessary

10

And, the export market can provide value to U.S. dairy beyond what is available domesticallyy y

Available export prices exceeded U.S. actuals for much of the last

two years

…and U.S. prices have benefitted less than those in New Zealand two years…

S USDEC l b li ti t i F t A l R t F t M di R l NZX A if M thl D i R t

11

Source: USDEC globalization metrics, Fonterra Annual Reports; Fonterra Media Releases; NZX Agrifax Monthly Dairy Reports

Import markets: estimated change in demand gap (1 of 2)g g ( )

Chi D i ti th h i d d i t i d th th l t

Note: Net import figures as of 2010

Estimated impact on 2013 latent demand gap

Bigger gap

Small change

Smaller gap

Impact on demand gap:

What has changed since 2009

China (Net imports: 486K MT, 11% of global)

• Dairy consumption growth has increased and promises sustained growth over the longer term as economic development moves inland and 200M more Chinese join the middle class

• Production took a big hit from melamine crisis in ‘08-’09, widening China’s demand gap. Current industry structure makes large production increases unlikely without major investments in large, industrial farms

• Ongoing quality issues and lack of trust in domestically produced products create near-term g g q y y p popportunities to boost imports

• China will continue to be a net importer over the long term, but government tightening of import documentation requirements may create difficulty for U.S. imports

SE Asia (Net imports: 777K MT

• Although milk production increased faster than expected, local production still covers <10% of consumption

777K MT, 17% of global)

• SE Asia remains a sizeable importer of dairy products with strong potential for consumption growth

Russia (Net imports: 658K MT,

• Production dipped during ’07-’10 due to droughts, high temperature and high feed prices, widening demand gap

• Future production unclear due to recent instability in milk production and shifting government policies658 ,14% of global)

• Future production unclear due to recent instability in milk production and shifting government policies• Consumption growth slow due to a declining population

• Russia expected to remain major dairy importer despite government efforts to encourage domestic production and stricter documentation requirements (effectively blocking Ukrainian and U.S. imports)

12

Import markets: estimated change in demand gap (2 of 2)Note: Net import figures as of 2010; MENA includes Algeria, Egypt and Saudi Arabia

p g g p ( )

M i C ti till i d t d t ti ith t bl i th H i i


Bigger gap

Small change

Smaller gap



Mexico (Net imports: 299K MT, 7% of global)

• Consumption still growing, and expected to continue with stable economic growth. However, rising concerns over obesity may shift consumption toward lower-fat products

• Despite faster production growth, Mexico projected to remain a significant importer through 2015 and beyond

• Mexico extended retaliatory duties to U.S. cheese in late 2010 but recent progress on trucking dispute may restore trade levels

MENA (Net imports: 519K MT, 11% of global)

• As a group, Algeria, Egypt and Saudi Arabia are significant dairy import markets, collectively importing more than China in 2010

• Production growing slowly, but not sufficient to cover domestic needs, and water/ forage limitations will constrain future growth

• Unrest across the region threatens near-term economic growth, though political reforms may also lead to significant long-term upside for economic (and therefore, dairy) growth

India (Net exports: 20K MT, 0.4% of global)

• Supply has failed to keep up with domestic demand due to bad weather hampering production and continued growth in consumption

• Near term consumption expected to outpace production despite government’s encouragement of self-sufficiency

global) • Imports have increased by small amount to fill demand-supply gap, with similar opportunities expected

in near term • Production has large potential to improve and should grow with government’s National Dairy Plan • Although currently inaccessible to U.S. exporters, India’s growing imports will create opportunities for

the U.S. elsewhere in the world

13

Export markets: estimated change in demand gap (1 of 2)p g g p ( )

New Zealand • Production grew faster than expected during 2007-10 due to cow population growth from conversion of sheep


Bigger gap

Small change

Smaller gap



Note: Net import figures as of 2010

New Zealand (Net exports: 1997K MT, 41% of global)

• Production grew faster than expected during 2007-10 due to cow population growth from conversion of sheep land to dairy; Consumption slumped in 2006-08 due to soaring prices, adding to export growth

• Future production growth expected to slow; fluid milk production could reach peak level of 23M MT by 2020

• Despite higher production than previously anticipated, NZ will not produce enough milk to close the latent demand gap

Australia (Net exports: 390K MT, 8% of global)

• Production took a hit due to droughts and then floods. Water table has improved & should spur limited production growth over next few years

• Consumption growth will remain flat, and Australia will remain a large exporter, albeit with slow production growth and limited ability to expand

EU (Net exports:

• Consumption slumped in 2006-10 as high prices were followed by recession and added to export growth; consumption growth expected to remain low(Net exports:


consumption growth expected to remain low

• Quotas increasing 1% annually 2009-15; growth scenarios show aggregate EU-27 production could increase by 5-8% from 2010 to 2020

• Production growth most likely the result of a step change in output at 2015 by some countries such as Netherlands and Ireland as they expand production to use the full potential capacity of existing farms

• After 2015, further growth will be constrained by environmental regulations and the steep incrementalAfter 2015, further growth will be constrained by environmental regulations and the steep incremental investments required to expand the industry

Ukraine (Net exports: 64K MT, 1% of global)

• Production lower in 2007-10 than previously projected due to financial, policy and quality issues; future export growth dependent on addressing these issues

• Consumption growth also slowed due to high prices and a weak economy

• Growth still possible, though unlikely to be a major exporter in the near termGrowth still possible, though unlikely to be a major exporter in the near term

14

Export markets: estimated change in demand gap (2 of 2)


Bigger gap

Small change

Smaller gap



Note: Net import/export figures as of 2010

Brazil (Net imports: 48K MT, 1% of global)

• Brazil became a net importer as production fell mainly due to poor profitability and bad weather

• Consumption continued to increase, spurred by income & population growth

• Should return to small net exporter by 2015. Still has strong exporter potential in the long term

Argentina (N t t

• Downturn saw production and consumption growth, but exports continued to grow off a small base. Still a l ti l ll t ith d t th t ti l d it t ti i t li i(Net exports:


relatively small exporter with decent growth potential, despite protectionist policies

• Improved dairy-grain price ratio should encourage use of feed and improve cow yields

Belarus (Net exports:

• Industry dependent on demand from Russia, but exports have grown at a very strong pace • Poor economic situation will limit consumption growth and limit government ability to invest in( p


• Poor economic situation will limit consumption growth and limit government ability to invest in production, though production has shown strong potential

• Exports are starting to diversify to markets other than Russia

U.S. (Net exports: 322K MT

• Global recession, slow reaction of U.S. trade policy and period of high feed prices could lead to a less competitive U.S. dairy industry


• Production and consumption trends remain steady with slow growth expected through 2015

15

Forecasted growth remains strong in emerging marketsg g g gDairy consumption is expected to

grow quickly in key emerging markets…

…from which ~75% of new dairy consumption will come markets…

Source: Projected growth for India, Mena and SE Asia from FAPRI (2011); projected growth for China based on Bain analysis derived from OECD (2010) and GDP/consumption i l i

16

regression analysis

China leads emerging market growth rate in dairy product demand

Strong economic growth… …will drive 3-6% consumption growth

Source: Projected growth for India, Mena and SE Asia from FAPRI (2011); projected growth for China based on Bain analysis derived from OECD (2010) and GDP/consumption

17

regression analysis

Despite foreign investments in China, commercial dairy farms unlikely to overcome demand gapy g p

2007 -

Fonterra has long-term plan to develop dairy farms in China

At most, these farms will add a fraction of total production

Additionally, they are likely to price at a premium

• Tangshan Fonterra pilot farm

2011

2007 2010

g pdeveloped in Hebei province

- Herd size ramped up from 3000 to 7200 dairy cows over 3 years

• $34M USD invested in a d i d f i H b isecond indoor farm in Hebei

province - Cows expected to be

milking sometime in 2011 - Location of third farm

expected to be d i l 20

Med. Term

Long

announced in late 2011

• Plans in place to complete Hebei cluster with 6 total farms

• Second cluster of farmsLong Term

Second cluster of farms (location TBD) is in the pipeline

Note: Current yields based on data from pilot farm; long-term yields assume increase to 8 MT/cow. Medium term based on 2015, long term on 2020. China herd size assumes 2.6% CAGR through 2020; China production assumes 5% CAGR through 2020.

Source: “Fonterra benefits from Chinese dairy market” stuff co nz (4/14/2011); “Fonterra to invest in two more farms” Fonterra media release (2/2/2010); Bain analysis; Expert interviews

18

Source: Fonterra benefits from Chinese dairy market , stuff.co.nz (4/14/2011); Fonterra to invest in two more farms . Fonterra media release (2/2/2010); Bain analysis; Expert interviews

Even with production growth, China likely to rely on imports to meet growing demandp g g

“In response to tight domestic milk supply, many Chinese companies including large-scale manufacturers have shifted to imported ingredients for entire production lines….China’s growing reliance on imports will continue for the foreseeable future.”

Dairy and Products Annual, USDA (10/2010)

Note: 2010 data from FAPRI; consumption growth based on GDP regression, production growth assumed to be 5% based on FAPRI and OECD forecasts Source: FAPRI (2011); Bain analysis

19

Source: FAPRI (2011); Bain analysis

In recent years, New Zealand has increased its focus on Asia and Middle East/North Africa

AsiaAsia

Middle East/ North Africa Other markets

Note: New Zealand’s exports to ROW excluded from chart, but increased 175 K MT Source: USDEC; Bain analysisSource: USDEC; Bain analysis

20

New Zealand continues to increase production, but there are limits to growthg

A l ilk d ti

2011 view Data summary 2009 2011

20

25M MT

Annual raw milk production

1.7% CAGR

forecastCAGR

(‘08-’13)

forecastCAGR

(‘10-’15)

Australian commodities

5.3% N/A

15

20NZMAF 4.2% N/A

OECD 3.8% 1.7%

USDA 3.2% N/A Accelerated growth

due to increase in dairy

5

10 FAPRI 1.1% 2.9%

BMI N/A 2.5%

Historical

5.8% CAGR

due to increase in dairy land from sheep/ beef

conversion

003 05 07 09 11F 13F 15F

“Production is forecast to increase by around 2–3 % in 2011–12, and by ~2% a year over the medium term.”

ABARE M h 2011ABARE, March 2011

21

Constrained by several factors, dairy land growth should reach peak by 2020

Dairy land likely to grow slowly beyond 2015 and peak around

2020

Several factors are expected to constrain further land growth

beyond 2020

0.8% CAGR 1.2%

CAGR 2.1% CAGR

• Most opportunity for dairy land growth/ conversion is on the South Island, where good land is increasingly limited

- Most of the optimal land for dairy production has already p y p ybeen converted

- Much of the remaining land is steep and rocky, which will increase production costs and reduce profitability, thus reducing benefits from conversion

• Tighter environmental regulations are expected• Tighter environmental regulations are expected, which will limit additional land growth and cow herd density

• Irrigation on the marginal land in the South Island is also limited due to regulations and limited access to

So rce LIC Dec 2010 Dair NZ USDA GAIN No 2010 Lit search Bain anal sis

also limited due to regulations and limited access to a sufficient water supply

“We expect land growth to slow down in this decade.” DairyNZ interview, April 2011

Source: LIC Dec 2010, Dairy NZ, USDA GAIN Nov 2010; Lit. search, Bain analysis

22

Elimination of quota will lead to modest expansion in overall EU milk product…

CAGRCAGRAnnual raw milk production

2011 update Data summary

Source CAGR (’10F-’15F)

FAPRI 0.5%

CAGR (’08F-’13F) 0.9%

140

150MMT

Annual raw milk production

OECD 0.4% 0.0% 130

140

EC 1 0%0 1%

110

120EC 1.0%0.1%

10005 07 09 11F 13F 15F

Production forecasts do not point to major

increases in dairy output Note: OECD used for historical data; data prior to 2005 not available for all EU-27 countries; 2005 data excludes Bulgaria

S FAPRI (2011) OECD (2010) E C i i (2010)

23

Source: FAPRI (2011); OECD (2010); European Commission (2010)

However, this is a mixed story – some countries will expand production, while others will be flat to downp p ,

20 0

30.0%

Projected growth (2010-20)Countries most frequently mentioned by experts as likely to experience strong growth

Bar width proportional to

0.0

10.0

20.0

EU-27

Bar width proportional to country’s share of EU

production

-10.0

0.0

% of total EU cowmilk production

Aggregate production projected to increase ~5% * Belgium and Luxembourg were grouped together in this report’s analysis Note: Production increases show projected change in cow milk production in year 2020 as a result of quota abolition Source: European Commission “Economic Impact of the Abolition of the Milk Quota Regime” (2/2009); Eurostat (for 2010 country level production)

24

Source: European Commission, Economic Impact of the Abolition of the Milk Quota Regime (2/2009); Eurostat (for 2010 country-level production)

The Netherlands and Ireland seem to have strongest potential p

Netherlands • Efficient production with highest yields among EU member • Dairy sector large contributor of nitrates, placing a cap on

Producing region Competitive advantages Key constraints/challenges

p g y gstates

• Current production levels at or above quotas, indicating potential for expansion

• Strong dairy processing capabilities

y g , p g pexpansion opportunity

• Potential greenhouse gas regulations may restrict expansion potential even further

Ireland • Climatic advantages enable pasture-based farming which insulates production from feed prices

• Underdeveloped processing industry • Lack of quota trading has prevented structural change within theinsulates production from feed prices

• The government has shown strong interest in attracting investors and promoting growth

• Lack of quota trading has prevented structural change within the dairy sector

• Significant challenges due to credit availability and investment risk caused by banking crisis

Austria • Grass-based production in mountainous areas may benefit from European Commission "less favoured region" subsidies

• Lack of additional moisture-rich land likely requires shift to feed-based production C t ti f ll f k i ld i t diffi lt • Concentration of smaller farms makes yield improvement difficult

Belgium/ Luxembourg

• Small but efficient producers, currently close to quota levels • Limited land available and environmental regulations pose limitations on future expansion

Spain • Relatively high yields, which have increased in recent years • Climatic differences among producing regions and lack of water supply y

• Exposure to feed prices challenges margins • Strong competition from expansion in protein (beef/pig)

production

Germany • Large and mature dairy industry should make expansion possible with limited additional investment

• Relatively high land prices and competition from other industries likely to limit potential upside, though strong growth still likely

25

However, Ireland and the Netherlands only represent 13% of EU-27 cow milk production p

Note: Data represents “cow’s milk collection” from Eurostat S E t t (2011)Source: Eurostat (2011)

26

Sources of low-cost production are likely to grow, but they are small and have been slow to emergey g

Growth in low-cost producers expected in the medium term…

…driven by key growth drivers in each country

For context New • Currently very small herd sizes and low yields offer strong For context, New Zealand alone

exported 2M MT in 2010

y y y gpotential for future growth

• Demand from Russia continues to grow, driving strong dairy growth

• Strong future potential due to low yields and plenty of pasture land

• Structural changes occurring which could revive the industry, encouraging large farms and thus improving quality and quantity

• Gains in yield should continue with further feed use

• Growth in exports projected, despite government regulations that limit exports

• Cow yields have large potential to expand due to currently

Source: Data for Brazil, Argentina, and Ukraine from FAPRI (2011); historical Belarus data from FAO and IFCN; Belarus forecast based on Bain analysis

fragmented farms and immature farming practices

• Industry consolidation and government investments will continue to bolster production

Belarus forecast based on Bain analysis

27

In summary, the window of opportunity remains open and appears to be expandingg

2013 demand gap widened during the global economic downturn…

…leaving the window of opportunity open at least through the medium term

China • China shows continued growth in demand while ongoing melamine incidents raise questions regarding

Impo

rter

s Russia

Southeast Asia

Mexico

MENA

ongoing melamine incidents raise questions regarding future supply

• Russia production dipped, forcing continued exports to satisfy domestic demand Potential low cost producers such as Brazil andI MENA

India

Brazil

Ukraine

• Potential low-cost producers such as Brazil and Ukraine stumbled in recent years, with Brazil becoming a net importer

• New Zealand and EU, despite expected growth and some production increases are unable to fill the

Expo

rter

s

Ukraine

New Zealand

European Union

Australia

some production increases, are unable to fill the demand gap

• Other sources such as Argentina and Belarus have good potential, but are still relatively small

E

Net impact on 2013 demand gap:

Argentina

Belarus

Note: MENA includes Algeria, Egypt and Saudi Arabia. Southeast Asia includes Thailand, Indonesia Vietnam Malaysia and Philippines

The previously estimated latent demand gap of 6.5-7B lbs. still exists and may be larger than previously estimated

demand gap: Indonesia, Vietnam, Malaysia and Philippines

28

Agenda


29

Feed prices have risen quickly over the past decade

S Bl b (2011)Source: Bloomberg (2011)

30

Dairy producers will almost certainly face high feed costs (relative to the previous 20 year average)( p y g )

Sustained high commodity prices also likely

Producers and processors should reassess their cost structures to ensure competitiveness over the longer term

S EIU (2011) Bl b (2011) B i l iSource: EIU (2011), Bloomberg (2011); Bain analysis

31

High feed prices not likely to shift U.S. cost position; major expansion will be costly for most competitorsj p y pDespite higher feed prices, the U.S.

should maintain its cost position And, even for traditionally lower-cost producers, major

commercial growth will be costly Raw milk estimated marginalproduction costs 2011F ($/MT) ESTIMATED

Costs based on IFCN average-sized farms

600

$800Costs based on IFCN

large-sized farms

Range of potential marginal commercial costs

200

400

New Zealand marginal costs include cost of

shifting to 100% feed after peak production is

0

200

US largefarm(a)

Nether-lands

(b)

China,large farm

(c)

NewZealand

(d)

preached under grazing model

(a) (b) (c)$19-21 ~$32 $24-26

(d)$15-28$/cwt

Note: 2011F total costs were estimated using expected feed and land cost changes; US (West) and EU calculated from 2008 data (a) US farm marginal cost change expected to be minimal due to accessible land and capital; range mostly driven by growth in land costs (b) Netherlands reflects total costs for average large farms; significant change in total cost structure not expected as dairy footprint is near peak (c) China costs estimated based on 340-cow corporate farm under feedlot production system; higher costs driven by imported cows and feed (d) New Zealand marginal costs estimated for move to 100% feed, with 50% purchased and 50% silage Source: IFCN 2010; USDA 2009; China Dairy 2010; Teagasc Ireland Dairy 2010; “The Wealth Report” (2011); Eurostat (2011); Expert interviews

32

Source: IFCN 2010; USDA 2009; China Dairy 2010; Teagasc Ireland Dairy 2010; The Wealth Report (2011); Eurostat (2011); Expert interviews

Currency was also considered as a wildcard, but it is unlikely to have a near-term impact on U.S. dairy

0%

Projected USD appreciation/depreciation vs. key import currencies (10-13F)

• Currency trends may influence the long-term cost position of suppliers and boost purchasing power for importing

-2

0%markets

• However, currency fluctuations are unlikely to drive purchasing decisions i th h t t

-6

-4-3

-4

in the short term

• This is because buyers are more likely to manage currency fluctuations through hedging operations than through short

-8

-6

-8

hedging operations than through short-term purchasing decisions

• Moreover, even with a strengthening U.S. dollar the latent demand gap will still

-10Indonesia Mexico China

8

Source: EIU (2011) Bloomberg (2011); Bain analysis

dollar, the latent demand gap will still exist, which creates pricing levels that are the primary driver for attractiveness of the dairy export market

Source: EIU (2011), Bloomberg (2011); Bain analysis

33

Agenda


34

While the window of opportunity is expected to endure into the long term…g

ILLUSTRATIVE Potential long-term U.S. trajectory

• U S dairy with Near-term Mid-term Long-term • U.S. dairy with increased commercial capability and less reliance on commodity trade

• Sustained import demand and supply constraints make dairy trade

• Growth markets continue to import while ramping up domestic

g

• Today’s emerging markets see their growth rates slow y

trade continuously attractive

• Buyers seek to rely more upon U.S. as an

domestic production

• New Zealand approaches peak production levels, inducing a need for

rates slow relative to current growth rates

• Low-cost exporters

• U.S. dairy as-is with internal focus and weakly differentiated export capabilities

U.S. as an alternative supplier, provided the industry can address

inducing a need for alternative suppliers

• Brazil, Ukraine, some EU players begin to emerge

exporters expand capacity and increase quality/ capability

capabilities weaknesses begin to emerge as low-cost suppliers

35

…and buyers have affirmed that the U.S. is well-positioned to play a greater role in dairy trade…

Buyers view the U.S. as an important source of future

supply

…but want the U.S. to commit to the global market

supply…

“We desire to open our portfolio and expand our supplier base beyond Fonterra. I would like to have the U S as a supplier and they

“Until now, their huge domestic market means they focus on local market and aren’t a

“The U.S. has one very big strength. They h l t f ilk ith lit ”

like to have the U.S. as a supplier and they are a natural choice.”

regular, reliable source. This creates problems.”

“We are afraid to contract with the U.S. because we can’t ensure that they willhave a lot of milk with no seasonality.”

“A few years ago we completed a study of “Supply is uncertain – they want to play when price works but we can’t be sure they

because we can t ensure that they will meet the commitment. That means I have to bear the risk.”

future milk supply and it became apparent that the U.S. has a major role to play. Whether or not they will step-up remains unclear.”

S I ti C t f U S D i “Gl b l D i B S ” d t d i S t b 2010

when price works but we can t be sure they will be there. It works for spot buys, but not for consistent, twice-monthly deliveries. We need suppliers who are committed.”

Source: Innovation Center for U.S. Dairy “Global Dairy Buyer Survey,” conducted in September 2010

36

…reminders remain that the window won’t stay open indefinitely

Import demand

• Major importers have renewed investments in domestic production in an effort to curb the need for growing imports

1

demand • Recent willingness to protect local producers (e.g., via import tariffs and certification

requirements) may give domestic producers time to increase their competitiveness 2

Export supply

• Oceania and EU aggressively pursuing FTAs with developing countries as they seek to secure their food supply

3

• Although the EU is not expected to see major mid-term expansion, long-term growth likely for some EU producers such as Ireland and Netherlands

4 supply likely for some EU producers such as Ireland and Netherlands

• Brazil and Argentina continue to hold potential. Ukraine and Belarus also emerging as key exporters

5

• The U.S. has yet to make key reforms, which are required to more quickly address and exploit the window of opportunity

6 Policy reforms

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Policy reform should seek to accelerate achieving critical outcomes

U.S. dairy is uniquely positioned to seize on long-term export growth

Updated dairy policies are needed before the U.S. can

fully benefit

The reforms, whatever their details, must enable

key outcomesg p g y y

• Global dairy demand continues to outstrip supply due to growth in developing markets

• Flexible pricing to let milk flow to the best/ most profitable use

• Reform milk pricing systems to improve the forward/ futures market to manage price volatility

markets

• Export markets are the strongest source for future U.S. growth

• Achieve greater predictability of price thereby decreasing the cost of volatility

• Reform price support to remove the government as a “last resort” buyer and remove disincentives for product innovation

• The U.S. can become a sustainably larger player provided it can address capability gaps

• Let market incentives better align product portfolios with customer needs

• Achieve value growth

• Develop better mechanisms for risk management to mitigate the impact of volatility

• Modify standards of identity- Global buyers want a more diverse supply base

• Yet, emerging suppliers make this a finite window

• Achieve value growth through investment in innovation, safety and quality

• Modify standards of identity closer to global norms if commercially needed to meet customer needs

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Failure to achieve needed policy change will weaken the U.S. industry and limit its higher value realization y g

• Limited opportunities for U.S. to grow milk supply and raise on-farm margins without global trade

• Greater value and profits will be available as emerging markets U.S. will miss out on t i bl l expand consumption – capturing this value is a priority for every

expanding industry

• Stagnant industry will undermine competitiveness, and investment and profit for entire sector

sustainable volume and value growth

p

• Failure to fulfill rising demand will incent investment in alternate areas of supply, accelerating their emergence as global competitors

• Without the U.S., investors and buyers must turn to higher-cost so rces s ch as the EU and contrib te to closing the indo of

Unmet demand will accelerate the

expansion of other sources such as the EU – and contribute to closing the window of opportunity

• Lack of higher growth outlets will dampen capital investment in the U.S. supply chain, leading to declining competitiveness

pproducers

The U.S. industry will see lower

• The impact of volatility will increase, further damaging the industry and encourage substitution by non-dairy alternatives in internal and external markets

competitiveness, and less ability to meet

market needs

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The same industry and company efforts will combine to make the U.S. a globally Consistent Supplierg y pp

Reform regulated milk pricing systems (Federal and State) and

price support

Develop mechanisms for risk management / reduction of

volatility

Priority

High

Invest in cross-border commercial capabilities/

partnerships

Continue pursuit of trade treaties that provide net export

benefits

High

Develop sales / marketing capabilities

Build on existing food safety

g p

Develop ability to deliver customer product

specifications Develop capabilities to package/manufacture high

value-added products to meet assurances and traceability as

a competitive strength Product & technology innovation (possible with financial

incentives)

pinternational standards

Cost and productivity

Company specific

Collective industry Low

p y

Export Marketing Board

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Lack of effective reform does not fundamentally derail becoming a Consistent Supplier, yet…

U.S. will retain many damaging elements of ‘Status Quo’ -Balancer of excess global supplyBalancer of excess global supply

-Opportunistic exporter as a supplier of last resort -Heightened impact of volatility

-Narrow product portfolio creates limited value growthp p g-Diminished returns will erode farm and processor equity

U.S. competitive advantage is created, secured and driven byU.S. competitive advantage is created, secured and driven by market forces and will ultimately face distortion and weakness

from non-market related policies

The window of opportunity is not open indefinitely; our actions will determine value available for the U.S. over the long termwill determine value available for the U.S. over the long term

41