No crying over high-priced milk

Dramatic price increases in dairy prices have propelled the butter and dairy product manufacturing industry in recent years.

In 2007-08 strong growth in world demand for dairy products outweighed supply growth due to supply constraints in some key exporting countries, leading to significant growth in world dairy prices. Those price increases helped with a difficult time for the industry as drought conditions reduced production. Prices were forecast to decline strongly in 2009-10 but to still remain relatively high due to fall in demand for the industry’s products with the slowdown in global economic growth and increases in world supply. IBISWorld forecasts that industry revenue will grow by 2.3% per annum during the five years to 2010-11, to $2.5 billion.

Revenue is forecast to increase as dairy farmers recover from drought and increase milk production but it will be dampened by some easing in world butter prices. Improved economic conditions will further assist demand over the five-year period. Prices received by Australian dairy manufacturers will be affected by a forecast appreciation of the Australian dollar against the US dollar during the next five years.

Industry revenue will be influenced by a number of variables, including international trade liberalisation and consumer health perceptions of dairy products. The industry is forecast to grow by 2.5% per annum during the five years to 2015-16, to total $2.9 billion.

Industry Outlook

Future prospects of the industry will be affected by domestic seasonal conditions, expected recovery in world demand and economic conditions, and continued product innovation. The outlook for domestic milk production seems optimistic given a meaningful autumn season, which is critical to spring pasture and feed grain crops. The global economy is expected to begin its cyclical upswing during 2010-11, driving demand from Asia, the European Union and the United States.

Strengthening world economic activity over the next five years is expected to support the demand for dairy products, particularly in developing countries. Milk production is forecast to contract or stabilise in major dairy-producing countries. The build-up of intervention stocks in the European Union and United States since early 2009 will limit further rises in world dairy product prices.

The Australian economy is forecast to make its upswing towards the middle of 2010-11 and is expected to post strong growth over the remainder of the next five years. Prices are not expected to recover to 2007-08 levels due to global supply growth exceeding demand. While prices are expected to average higher, recent significant appreciation of the dollar, if sustained, will temper returns to Australian exporters.

Domestic conditions

Another key factor will be changing trends in domestic consumption. Given the maturity of the industry revenue is expected to be driven mainly by population growth and continued shift in production towards healthier butter blends. The Australian population is forecast to grow at 1.3% per annum over the period. Consumer perceptions with regards to the health content of dairy products will also be an important determinant.

The industry is expected to face increased competition from soy, rice, nuts and oils, making the promotion of dairy nutrition an important strategy for the industry’s long-term benefits. Consumers are expected to increase demand for environmentally friendly products, including those with a low carbon footprint. There are growth opportunities in the production of higher value products such as reduced fat options and new products including functional foods like fortified butter, organic products and nutraceuticals.

There is expected to be increased demand for product labelling information to assist healthy and environmentally friendly choices, with increasing obesity and awareness of climate change, which will increase production costs.

Increased milk production

Dairy product production is forecast to grow over the next five years based on forecast growth in milk production in Australia, which is forecast to grow at a strong rate per annum over the five-year period, assuming a return to average seasonal conditions. Milk production is forecast to grow as dairy herds are rebuilt and milk yields grow.

Dairy cow numbers are forecast to increase at a strong annual rate, while milk yields are forecast to grow at a marginal annual rate. Dairy farmers are expected to increase herds in response to increased profitability with higher prices, lower feed costs with a return to average seasonal conditions, and increased efficiency with consolidation and investment in technology and equipment. Yields per cow will rise with improved weather conditions and ongoing improvements in farm management practices and new research into herds, pastures, breeding and fodder.

Profitability

During the five-year period industry profitability is expected to grow marginally, with declines during the early years due to falls in milk prices. Profits are expected to rise in line with price stability, volume growth and shift towards high-margin products. Investment in automation and production technology is also expected to aid profits as costs are kept to a minimum while productivity continues to rise. Industry net profits are estimated to average 1.5% of industry revenue over the next five years.

Exporters to face increased competition

Reflecting lower expected returns for dairy products, domestic producers are likely to shift their product mix away from butter and skim milk powder to cheese and whole milk powder. With world dairy prices are  forecast to remain relatively subdued during the next five years and combined with appreciation of the Australian dollar, if sustained, are likely to result in downward returns to domestic exporters.

Another major challenge facing the industry is to maintain its competitiveness internationally and domestically. Competition in international markets will increase due to greater production from up-and-coming dairy nations including China, India, Brazil and Argentina given increases in domestic demand, lower production costs, spare land capacity and greater investment in production activity, which is expected to reduce import demand.

It is expected that key export markets will require increases in dairy imports to meet demand, particularly Russia. It is also expected that Australia will face increasing competition on the world market from New Zealand as it increases production and exports in response to higher prices and from the United States. That increased competition may result in further consolidation and rationalisation within the industry.

Future trade liberalisation will be a key factor affecting the industry during the next five years. Australian exporters will benefit from any trade liberalisation in dairy because Australian manufacturers are already low-cost, efficient producers. Over the period Australia’s share of the  global dairy trade should gradually increase as the EU’s share of world dairy trade continues to fall in line with reduced farm subsidies.

Continued consolidation

Industry participation is estimated to fall by 1% during the five years until 2015-16 as economies of scale and the ability to establish national operations become more pronounced. Employment is expected to decline by an annual average rate of 0.2% over the same period. It is expected that most of that growth will come via research and development, with engineers and food scientists focussing on creating healthy and innovative products. Wages are expected to grow by 1.1% and account for 7.5% of revenue, with the average wage increasing by 6.7%.

Robert Bryant is the general manager of business information firm IBISWorld. Click here for more on this sector.