Milk Monitor Record milk price is on the cards

Record milk price likely

By Gerald Piddock

Each month the milk monitor delves into the dairy industry and gives us the low-down on the good, the bad, the ugly and everything in between.

Alopsided supply-demand equation looks to be the defining feature for the 2022 dairy market, with a lowerthan-expected production coming out of New Zealand and other dairy exporters over the short-term.

It’s seen Fonterra react by lifting its payout to a record $8.90-$9.50/kg MS, with a $9.20/kg MS midpoint.

Chief executive Miles Hurrell says the increase is the result of consistent demand for dairy at a time of constrained global milk supply.

“In general, demand globally remains strong, although we are seeing this vary across our geographic spread,” he says.

“Overall, global milk supply growth is forecast to track below average levels, with European milk production growth down on last year and US milk growth slowing due to high feed costs.

“It’s a similar supply picture in New Zealand. Earlier this month we reduced our forecast milk collections for 2021-22 from 1525 million kg MS to 1500m kg MS due to varied weather and challenging growing conditions,” he says.

Those conditions have seen a cold, wet spring give way to a hot, dry summer across many parts of the region, keeping a lid on milk production.

It all contributed to the big jump in values at the January 18 GDT, which saw prices lift 4.6%. WMP was the biggest mover, up 5.6% to $4082 a tonne.

NZX analyst Stu Davison says it was a staggering result, calling it a market reset.

“It seems the physical market is finally agreeing somewhat with the derivatives market, as we see both milk powder products fall roughly into step with the price range that the derivatives market has been setting for some time,” Davison says.

He says buyers turned up to the auction with a willingness to secure the product at any cost.

“It seems the market has also taken full stock of the tightness of milk supply globally and are now increasingly willing to pay the price to secure product,” he says.

He concluded by saying it “will also push the global dairy market into a renewed frenzy; what a great way to start the new year off”.

The high level of demand and the willingness of buyers to pay premiums for it saw ASB revise its forecast to $9.10/ kg MS.

“With all contracts trading north of USD$4000/t at present and longer-dated contracts trading at a premium, prices should keep up the momentum over the near-term. We think that’ll be enough to push this season’s farm gate price north of the $9 mark,” economist Nat Keall wrote in its Weekly Commodities publication.

Westpac has maintained its $9/kg MS forecast, with senior agri-economist Nathan Penny saying the auction result backed up that price.

“The strong result cements our 2021-22 farm gate milk price forecast at $9/kg. In the short-term, the risks to our forecast are mostly on the upside. For example, ongoing dry weather could put additional dents in New Zealand production and push prices higher again. Meanwhile, Omicron-related supply chain issues could also lead prices higher,” Penny says.

Prices are now at their highest level since March 2014, with both cheddar and butter prices set record highs overnight, and Penny says the jump in prices also erases the ground lost in the second December auction.

Back inside the farm gate, farmers are facing similar challenges to last season. Labour shortages continue to be a problem. In November, the industry asked for an additional 1500 workers while a month later, the Government amended its class exemptions to allow more dairy assistants into the country.

Likewise, the contracting industry’s well-documented labour struggles with finding staff could affect what has been an outstanding season for growing maize.

There is also no sign of the rise in input prices easing. Globally, urea prices have almost quadrupled since 2020, from an average US$229 to $828 last year. The latest agrichemical to see a lift is glyphosate, up 100% in some countries.

Exactly how much this will erode farmers’ margins won’t be known until autumn when the season starts to wind down.

So how long will the high prices last? It looks like it’s here to stay for now. Prices for the new season should start high but could lose steam as the season commences.

Penny says prices are likely to eventually ease off as supply inevitably starts to balance out demand once again.

In the meantime, this new record milk price will be the bright spot in a challenging season. n

The dry conditions will mean most farmers will now be using more supplementary feed as paddock rounds lengthen as they try to capitalise as best they can on the high milk price.

Will a2 Milk have an A+ year?

By BusinessDesk

A2 Milk investors have been hit by another annus horribilis. Will 2022 be better and should bargain hunters be snapping up the shares?

The price certainly looks attractive.

At $5.93, the shares are now worth less than half of what they were at the beginning of the year and that’s after tanking 20% in 2020. The dual-listed company now has a market capitalisation of $4.4 billion versus $10b in 2020.

So far, buyers aren’t out in droves. In fact, some continue to vote with their feet, with institutional investors like Goldman Sachs, BlackRock and UBS Group selling down their stakes in early December alone.

It’s been a rough ride and a fall from a significant height.

At the end of 2019, Bloomberg said a2 Milk was the best performing stock of the decade with a return of 16,150%.

Then covid-19 hit. While the company initially benefited from massive stockpiling in its key market of China, it didn’t last.

In the end, there was far too much aging inventory and the closed borders severely hampered its daigou or reseller channel. The result was four consecutive earning downgrades.

Shareholders aren’t impressed and the dairy company is now facing two separate class action suits in Australia, both alleging they were misled by the company’s inflated forecast of baby formula sales.

The company, meanwhile, is promising a turnaround, targeting sales of $2b over the next five years and improving margins. Revenue hit $1.2b, down 30%, in the 12 months to June 30.

Everything, however, hinges on China, which drives more than half of its sales.

A2 says “while we would, of course, like to have greater diversification in our markets over time, the reality is that the size of the opportunity we have in China is substantially greater than other options”.

Its revamped strategy is aimed at capturing that opportunity and includes increased brand investment and a reorganised Asia-Pac division.

Øyvinn Rimer, director, senior research analyst, says that while China is “magnificently important” there are many challenges.

Among other things, he pointed to a falling birth rate in China, down 15% in 2020.

“When the birth rates were growing as nicely as it was, it was much easier for all the brands to take market share and they didn’t have to step so much on each other’s toes. Whereas now, the battle is intensifying,” Rimer says.

The result is pricing tensions, with a squeeze on margins and pressure to spend more on advertising and distributing.

He says the company is also working hard to take steps like addressing excess inventory, but it doesn’t know yet how it is going to look in six to 12 months.

As investors, he says, “it’s about watching the data from here on in and see if they are starting to improve”.

The market may be expecting a bit of improvement this year, but he says they’d only believe that once they saw data.

He said a2 Milk is definitely giving it the best shot they can and from “now on, it’s about putting runs on the board”.

Bell Potter analyst Jonathan Snape was more upbeat. He rates the stock at a ‘buy’ and he’s on board with a2 Milk’s targets. He has a 12-month target price of A$7.70, some 41% higher than the closing price on December 31.

“We see the scope for the earnings per share to double by FY26 if a2 Milk can execute on the China offline expansion strategy, while recovering 50% of the lost sales (from FY20-21) in the English label IMF,” Snape says.

“We do not see the current share price as reflecting this potential.”

China infant formula market expert Jane Li isn’t convinced.

“I do not know quite where their optimism comes from, when generally no one is optimistic about the infant formula industry in China anymore,” Li says.

She says with an increased marketing budget they might see an uptick in sales of their China label formula, “but remember that is off a fairly low base”.

“Overall, I think a2 Milk will struggle to achieve a positive return on investment from increased sales and marketing budget against aggressive competitors with deeper pockets in China,” she says.

She also noted that the company’s proposition is based solely on the idea of the alternative A2 milk.

“For Chinese consumers, this trend is also past its peak. And one feature of the China market is that once a trend has moved on, it never comes back.” n

Covid 19 and closed borders have contributed to the drop in the value of shares in a2 Milk, which are now worth less than half they were in 2020.