The Australian dairy industry continues to navigate a complex and uncertain period. RaboResearch senior analyst – Dairy and Consumer Foods, Michael Harvey, provides an overview of the global dairy landscape.
Against the backdrop of geopolitical conflict, a slowing global economy and rampant inflation (including food and energy prices), dairy industry players are operating in a volatile environment with everyone keeping a close eye on what happens to the underlying market and industry fundamentals from here.
Growth with caution
Globally, Rabobank expects the combined Big-7 milk pool – from major producers New Zealand, Australia, the EU, the US, Brazil, Argentina, Uruguay – to return to growth in Q4 2022, ending five consecutive year-on-year quarterly declines.
This is an unprecedented accomplishment in the past two decades. However, buyer caution is still required. The forecast growth rate exhibits weather risk, is against a weak comparable, and is likely to be below the long-term average through 2023.
Meanwhile, everywhere you look, consumers are paying more for dairy and this is driving some changes in purchasing behaviours. Inflation is a global challenge, with some economies facing multi-decade high inflationary pressures.
Inflationary challenges
There is a range of supply and demand drivers behind the rampant inflation.
In Australia, headline inflation was 6.1 per cent in the June quarter. Food inflation was also elevated and was broad-based across most food categories.
Dairy consumer prices are rising (in some cases significantly) across many categories and regions and the peak in the cycle has not yet passed. Dairy demand settings are complex and uncertain, but have a softer tone, which is leading to some volume impact in the dairy aisles.
Cost headwinds prevail across the entire Australian dairy supply chain. On farm, high costs of feed, fuel and fertiliser have squeezed farmgate margins. While benchmark prices for most of these key inputs have fallen from Q2 2022 highs, they remain well above long-term averages with upside risk lingering through the next 12 months.
Global disruptions
Zooming out, global feed benchmark prices have also fallen through Q3 2022, largely as a result of a Ukraine grain corridor opening and Russian exports lifting. Nonetheless, extreme heat in the US threatens crops, and EU spring crops also suffer from unfavourable weather. More disruption to Black Sea trade is still possible in the months ahead.
Downstream dairy companies are paying record levels for the key Cost of Goods Sold (COGS) raw milk. And cost headwinds are visible across many other aspects of the business.
Labour availability, high packaging costs, rising energy costs and distribution costs are crimping processing margins. Some relief has come from Covid-related costs which have begun to recede.
In response, dairy companies are pulling many levers across their businesses to protect margins, and pricing action is a key one.
Falling local supply
For Australia, a real challenge is that local milk supply is still falling, which is generating supply chain issues. Despite the cost headwinds, Australian dairy farmer margins remain healthy.
Record high milk pricing locked in for the 2022/23 season has been warmly received, but labour availability issues, competition for resources and unfavourable weather continue to crimp milk supply, with falls in production evident across the country.
Australian milk production fell 3.9 per cent in 2021/22 and has started the new season with a fall of more than eight per cent.
The footings are in place for a milk supply recovery in 2022/23. However, the recovery will be modest, with a slow herd rebuild being the major handbrake. There is good availability of irrigation water, healthy soil moisture profiles and ample home-grown and supplementary feed. But Rabobank expects a modest recovery in the new season at best.
The shrinking milk pool has been dialling up the competition for milk supply amongst dairy companies while also ensuring the companies are focused on the right products and markets to maximise the value of milk solids.
Meanwhile, a weaker tone has set into the global market in Q3 2022, reflected in the broad-based softening across the Oceania dairy commodity complex. Spot Oceania prices have fallen by more than 20 per cent since the Q2 FY22 peak.
Rabobank is not ruling out further downside in global dairy markets in the months ahead, especially those more dependent on Chinese demand.
When looking at the global market fundamentals, a potential collision is approaching, with Q4 year-on-year milk supply growth, softening Chinese import demand and broader demand rationing in developing countries weighing on price forecasts.
The Australian dairy sector continues to navigate these major global events. While it has not come without its challenges with pressure on the profit pool, the industry will be looking for some normalisation in the operating environment in the months ahead.
This article first appeared in the October edition of Food & Drink Business magazine.
