Milking the Emerging Market Dairy Demand | Aranca Articles and Publications

EMsMilking the Emerging Market Dairy Demand
December 16, 2014
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Global dairy market − Betting Big on Asia-Pacific
The global dairy industry is witnessing a change of guard as demand shifts further east to Asia-Pacific. Expanding population, rising
prosperity, increasing levels of urbanization, western influence on dietary patterns, and awareness on the health benefits of dairy
products places Asia-Pacific at the forefront of growth in dairy. The burgeoning demand and widening demand-supply gap is fuelling
international trade and boosting capacity investment. However, challenges like volatile feed prices, exchange rate fluctuations,
changing product trends, and complex regulatory structures make this opportunity less than easy to seize. On the other hand,
developed markets look nearly muted, but their significance remains given the sheer size and scope for growth in value-added product
categories. Given the network of prospects and challenges, international dairy players’ ability to view sources and supply on a global
level and ability to discreetly win export prospects, while upholding demand in the domestic market would discern winners from losers.
Tanuja Chitre, Assistant Manager – Investment Research, Aranca
Nursing the milk appetite of Asia-Pacific seems to be the next big story for global dairy players
Asia-Pacific stays at forefront of growth in dairy
Sneak peek into dynamics of dairy demand
The global dairy market is primarily divided into five product types: liquid milk (plain liquid milk and liquid milk products), butter, cheese,
whole milk powder (WMP), and skimmed milk powder (SMP). According to TetraPack’s Seventh Dairy Index data, the global
consumption of white milk is likely to increase at a CAGR of 1.8% from 212bn liters in 2013 to 223bn liters in 2016. The demand for
dairy products is anticipated to surge from more than 520million tons (mt) in 2014 to over 710mt by 2024 (in liquid milk equivalent −
LME). This growth would be supported by an increase in the per capita consumption (PCC) of milk from markets like Asia, Africa, and
Latin America on expanding population, growing prosperity, high rate of urbanization, and western influence on dietary patterns. The
per capita consumption of dairy products in developed regions (like the US and Europe) is much higher (around 257 kg/capita) than
developing nations (about 100 kg/capita in Asia and Pacific countries). However, growth in the PCC of developed markets is nearly
stagnant, while that in developing markets is increasing faster. According to OECD-FAO Agricultural Outlook 2011, the PCC of LME of
Asia-Pacific is expected to increase at a CAGR of 2.0% from 2013–20 relative to the global average CAGR of 0.7%.
PCC of milk in LME* by region Growth in PCC − Emerging vs. Developed
Source: OECD-FOA Agricultural Outlook 2011 *LME - Liquid Milk Equivalent
Asia-Pacific is likely to remain at the forefront of growth in dairy, as China emerges as one of the largest consumers of dairy products.
Traditionally, China accounted for 15–20% of the global dairy imports. However, between December 2013 and February 2014, China’s
dairy imports accounted for 20–25% of the dairy imports.
150
350
550
750
950
2002 2006 2010 2014 2015 2016 2017 2018 2019 2020
Inkg
North America Europe Latin America
Asia and Pacific North Africa Others
-0.5%
0.5%
1.5%
2.5%
3.5%
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
N.America EU LatAm
Asia -Pacific N. Africa Others
Asia's PCC of dairy products in LME is
expected to increase 2% on average
between 2013 and 2020.

December 16, 2014
P a g e | 2
Demand for milk in China grows on radical shift in consumption patterns
Traditionally, Chinese population largely depended on green vegetables, beans, and bean-related products for protein and calcium
requirements as they were lactose intolerant. However, after the Mao period (after 1978), children were given milk and dairy products to
meet the daily requirements of protein and calcium and develop their ability to digest lactose. This led to the creation of a huge market
for milk and dairy products. In the last five years, China’s dairy market advanced rapidly at a CAGR of 14.4% to USD40.6bn in 2013
from USD20.7bn in 2008 and PCC multiplied at a CAGR of 5.3% to 10.4kg per annum (kg p.a.), for the same period. Despite this,
China’s PCC is significantly lower than that of developed nations (the US, Canada, the EU) consuming 80.1kg p.a. on average. Low
milk consumption and rising demand for dairy products offer substantial potential for growth in China.
Growth in China’s dairy market – 2008–13 China’s PCC relative to other markets – 2010–13
Source: CLAL.it; Note 1 - The RHS graph depicts the per capita consumption of milk over the last five years; Note 2 - As per CLAL.it, the per capita consumption of each
country is derived by dividing total consumption (Source FAS-USDA) by the population (Source FAO) and the data is updated as of 2014-08-06.
The demand for dairy products from other Southeast Asian countries and the Middle East is also expected to increase. In addition to
China, other emerging market sweet spots for dairy consumption are illustrated below.
The dairy market sweet spots
Source: International Monetary Fund (IMF) WEO, April 2014; Note1- The size of the bubbles indicate IMF population estimates in millions as of 2017; Note 2- RGM’s- Rapid
Growth Markets
Growing demand for milk from Asia boosting international trade
Production, export, and import dynamics differ across regions and countries. Milk production is mainly concentrated in Europe and
Asia-Pacific, which accounted for around 63% of the global milk production from 2008–10. The top three countries accounted for 50%
of global milk production. Large-scale production from Asia-Pacific can be primarily ascribed to India, one of the largest milk producers
(almost equal to the EU bloc), which produced 132.4m tons of milk in 2012–13. Large-scale production makes India almost self-
sufficient in meeting the demand for liquid milk; however, opportunities exist in value-added product categories, which are in demand.
20.7
23.7
27.1
31.0
35.5
40.6
10
20
30
40
50
2008
2009
2010
2011
2012
2013
USDbn
125
107
100
88
86
71
66
60
53
43
34
31
15
10
10
40
70
100
130
160
Ukraine
Australia
NZ
US
Canada
Russia
EU-27
Brazil
Argentina
India
Mexico
Japan
Taiwan
China
Philippines
Inkg
China India
US
Indonesia
Nigeria
Philippines
Ethiopia
Germany
Myanmar
Thailand
UK
France
Italy
South Africa
Kenya
Saudi Arabia
Canada
GhanaMalaysia
UAE
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
0.0% 0.4% 0.8% 1.2% 1.6% 2.0% 2.4% 2.8% 3.2%
GDPgrowth
Population growth
Highlighted area shows RGMs* with
▪ Population growth above 1%
▪ GDP growth above 4%

December 16, 2014
P a g e | 3
On the other hand, China stands out as one of the leading producers of milk in the world, but is unable to meet the demand of the vast
population, thus providing attractive trade opportunities for surplus milk producers across the world.
Global milk production is skewed toward Europe, Asia-
Pacific
Top producing countries (2008–10 and 2020E)
Source: OECD-FAO Agricultural Outlook 2011–20; *RF - Russian Federation; Note1 - Milk production from China includes Mainland China only.
In terms of trade, markets like China, Hong Kong, Singapore, Taiwan, Philippines, and Malaysia are largely dependent on imports and
offer attractive opportunities for surplus milk producing countries like the US, New Zealand, Australia, the EU, Belarus, Germany, and
Argentina. As seen below, nine of the 17 importing countries are located in Asia-Pacific. New Zealand is the largest dairy exporter in the
world, accounting for about one-third of the international dairy trade on an annual basis (according to New Zealand Trade & Enterprise).
Major importers and exporters of milk and milk powder across world
Source:TetraPack Dairy Index Issue 7- A Global Balancing Act:Dairy Supply & Demand presentation released on September 30, 2014
13.7%
30.1%
32.4%
4.9%
10.9%
8.0%
North America Europe Asia-Pacific
Africa LatAm RoW
154
153
101
59
43
36
35
149
111
86
40
33
32
29
20 50 80 110 140 170
EU (27)
India
US
China
Pakistan
RF*
Brazil
In 000' tons
2008-10 2020

December 16, 2014
P a g e | 4
By product type, trade of whey, cheese, and SMP is expected to increase more than 2% p.a., while that of WMP and butter is expected
to increase 1.7% p.a. and 0.7% p.a., respectively, over the next decade (according to OECD-FAO Agricultural outlook data). Majority of
this growth would be met by increasing exports from the US, the EU, New Zealand, and Australia.
Abolishment of EU milk quota in 2015 to encourage flow of trade from the EU block
The milk quota regime in the EU was introduced in 1984 to control milk production and high costs associated with the management of
dairy product surplus. However, the quota is due to expire in 2015 unless regulatory authorities renew it. According to the International
Dairy Federation’s annual World Dairy Situation report, lifting of quotas is expected to accelerate milk production in Europe, which
consistently produced about 149–152m tons for more than a decade (2000–12).
Given the EU is a net exporter of milk, the abolishment of quotas is expected to lift milk production and export of milk cheese and other
dairy products from Europe. According to the European Commission, the EU’s total milk output is expected to increase from 152.3m
tons in 2013 to 160.4m tons by 2023. Similarly, the EU block is expected to export 11.1% of the output by 2022 compared with 10.1% in
2013.
Encouraging investment in capacity expansions
Stable increase in demand from importing regions like Asia-Pacific, the Middle East, and the Russian Federation is prompting dairy
players to invest in expanding processing and value-added product manufacturing facilities. Some recent and notable investments in
milk processing and value-added product manufacturing facilities are indicated in the table below.
Notable investments in dairy processing facilities
Country
Company/Coope
rative/Brand
Investment
(USDm) Plant location
Further details on investment and other initiatives by the
company
China
 Yili owned
Oceania Plant
 400  New Zealand
 In November 2014, Yili announced plans to triple the milk
processing capacity at the Oceania plant to 630m liters by 2020
from 220m liters presently. Construction would commence in 2015.
 In August 2014, Oceania started processing milk received from 48
local farmers in Glenavy, New Zealand, to produce 13,000 tons of
WMP1
and infant formula powder.
India
 Amul brand
owned by Gujarat
Cooperative Milk
Marketing
Federation
(GCMMF)
 654.4−736.2  India
 From 2015–16, GCMMF plans to construct 11 new milk processing
plants under its brand Amul across Gujarat (5), Uttar Pradesh (3),
Haryana (2), and Kolkata (1).
 In the last three years, GCMMF expanded the milk processing
capacity from 17m liters to 23m liters.
New Zealand
 Fonterra
Cooperative
Group
 976  New Zealand
 In August 2014, Fonterra revealed two major deals:
o USD463m construction of a milk powder drier and three new
processing factories – The drier, to be built on the North Island,
would have the capacity to convert 4.4m liters of milk into fine
powder. A separate plant would separate protein from skimmed
milk and convert it into protein powder. Two other plants would
process milk into cream.
o USD513mworth global partnership with Chinese infant food
manufacturer Beingmate to meet the growing demand from China
– According to the deal, Fonterra would issue a NZD 615m partial
tender offer to gain 20% stake in Beingmate. After securing
necessary regulatory approvals, Fonterra and Beingmate would
1
Whole milk powder

December 16, 2014
P a g e | 5
establish a JV to buy Fonterra’s Damum facility in Australia and
establish a distribution agreement to sell Fonterra’s Anmum brand
in China. The partnership would create a direct supply chain from
farmgate to Chinese consumers using Fonterra’s manufacturing
facilities in Australia and Europe.
Australia
 KPMG promoted
milk powder
factory in
Australia
 1000
 Tasmanian
Midlands,
Australia
 KPMG completed a pre-feasibility study of the “Big Cow Project” to
be built on 76,000 hectares (ha) of land in Tasmania’s Midland in
Australia.
 According to the project plan, nearly 160,000 cows would be leased
out to a cooperative that would supply milk to a USD215m
processing factory located at the Midlands. This project is being
pitched to Chinese investors.
 Once completed, the plant would produce 100,000 tons of premium
Tasmanian branded milk to be converted into powder and exported
to China.
Source: News articles
Emerging market dairy demand: Chasing opportunities or overcoming challenges?
Despite attractive trading opportunities, the success of an international dairy operator depends on several factors. The growing
importance of convenience-based foods is increasing the demand for “table-ready” value-added dairy products (VADP) like varieties of
butter, cheese, ice creams, and yoghurt. However, to meet the demand, adequate knowledge about the international market’s ethnic
tastes and preferences is required. One of the most critical challenges faced by international dairy players include:
Tackling the volatility in milk and feed prices
Over the past five years, rise in global milk prices was supported by the increasing demand from developing nations, growing cost of
production, and supply constraints. In 2013, prices of several dairy products reached record highs due to robust demand from Asia-
Pacific.
World milk prices – Combined IFCN World Milk Price Indicator
Source: International Farm Comparison Network (IFCN)’s latest update as of November 10, 2014; Note1 - The world market price considers the weighted average of three
IFCN World Milk Price Indicators, including SMP and butter (35%), cheese and whey (45%), WMP ( 20%); * ECM - Energy Corrected Milk: 4% fat and 3.3% protein
Milk prices differ by region depending on weather conditions and cost of production. In 2013, prices in the EU hovered between EUR
34/100kg and EUR45/100kg, whereas those in the US remained relatively stable between EUR 34/100kg and EUR 36/100kg.
According to the USDA dairy outlook, large-scale production is expected to keep US milk and dairy product prices low in 2015 relative
to 2014.
15
30
45
60
Jan-06 Apr-07 Jul-08 Oct-09 Jan-11 Apr-12 Jul-13 Oct-14
USD/100kgECM*

December 16, 2014
P a g e | 6
Since the beginning of 2014 (especially between March and September), global milk prices slid more than 40% due to high inventory
levels in China and supply glut prompted by the Russian Federation’s ban on milk imports in the EU in August 2014. The ban resulted
in 2.5bn liters of surplus milk in the market. However, a fall in prices appears unsustainable over the medium term as demand starts
increasing from China and other Southeast Asian countries.
In addition to demand dynamics, milk and dairy product prices are influenced by the following:
 Rising feed prices: One of the major determinants of milk prices is the feed price, which directly impacts the cost of production
and efficiency levels. The demand for feed increased faster than supply, pushing global feed prices up to USD32/100kg in
2013 from just about USD13/100kg in 2006. The milk-feed price ratio under one indicates high pressure on farm economics as
world market prices are transmissioned at farm levels.
Global milk-feed price indicator
Source: International Farm Comparison Network (IFCN)’s latest update as of November 10, 2014; Note1 - The world market price considers the weighted average of three
IFCN World Milk Price Indicators, including SMP and butter (35%), cheese and whey (45%), WMP (20%); * ECM - Energy Corrected Milk
The rise in feed prices can be mainly ascribed to volatile weather conditions and high usage of crops in the production of bio
energy. For instance, in 2012, Russia lost 25% of the grain harvest to drought, pushing up feed prices and production cost of
milk. The US experienced similar drought conditions earlier. Feed costs in countries like China and India have also started
increasing due to lack of arable lands.
 Volatility in exporting countries’ exchange rate against USD: Dairy exports’ ability to generate profits also depends on the
domestic country’s exchange rate against USD. Depreciation in domestic currency keeps farmgate prices favorable and
increases the upside potential from exports. The exchange rate scenario appears favorable, as USD is strengthening on
tapering of the QE program (albeit not at the desired level). From this point forward, much of the strengthening in USD would
depend on US interest rate hikes, which are unlikely to take place until mid-2015. Given the situation, most global currencies
remain at more than desired levels. However, stable rate of recovery anticipated in the US economy is likely to strengthen
USD, over the medium term.
Taking stock of situation
As milk consumption in developed markets nears saturation, dairy majors are shifting focus to emerging markets across Asia-Pacific,
the Middle East, and Latin America for growth. According to TetraPack, untapped emerging markets consist of nearly three billion
potential dairy consumers. While most global dairy majors derive major portion of revenues from developed markets, growth in these
markets remains muted or is contracting. Conversely, sales contribution from emerging markets is inching forward, with better growth
than developed counterparts. The table below highlights the geographic revenue breakdown and y/y growth in sales from developed
and emerging markets for five dairy players.
0.50
1.00
1.50
2.00
2.50
3.00
0
10
20
30
40
Jan-06 Apr-07 Jul-08 Oct-09 Jan-11 Apr-12 Jul-13 Oct-14
Feed price (USD/100 kg)- LHS Milk-feed ratio- RHS

December 16, 2014
P a g e | 7
Time for dairy majors to increase activity levels in emerging markets
Player Country
2013
revenue
(USDm)
Revenue
contribution (%)
y/y growth (%)
Emerging market activity
Developed Emerging Developed Emerging
Nestle Switzerland 28.3 55.7 44.3 1.0 9.3
Nestle has exposure to emerging markets
like Asia-Pacific, Latin America, Africa,
and the Middle East.
Danone France 20.2 39.4 60.6 0.4 4.7
Danone has exposure to emerging
markets like Asia-Pacific, Latin America,
Africa, and the Middle East.
Lactalis France 19.4 79.0* 21.0* NA NA
Lactalis’ emerging market exposure spans
Africa, Asia, and Commonwealth of
Independent States (CIS).
Fonterra New Zealand 15.3 58.6 41.4 (9.41) 0.12
Among emerging markets, Fonterra
operates in Asia-Pacific, focusing mainly
on China.
Frieslandcampina
The
Netherlands
14.9 72.1 27.9 10.2 12.1
Frieslandcampia’s emerging markets
include Asia, Oceania, the Middle East,
and Africa.
Source: Chinadaily.com, respective company reports; Note1 - Lacalis’ revenue contribution is taken as disclosed on website, updated as of January 2014.
Dairy players ahead of herd
With opportunities shifting to emerging markets, players with substantial exposure to emerging markets command a premium over other
incumbents in the market. The graph below shows how dairy majors are placed on the basis of 1-yr-fwd P/E and PEG ratio and
performance of stock price relative to FAO Dairy Index.
Dairy majors on basis of fwd. P/E and PEG ratio Dairy stock movement vs. FAO Dairy price index
Source: Bloomberg, Food and Agricultural Organization of United Nations’ FAO Dairy Index; Note 1- The FAO Dairy Price Index and stock prices of dairy players are rebased
to 100 (RHS chart).
Danone
Nestle
Kraft
Saputo
14
17
20
23
1.7 2.2 2.7 3.2 3.7 4.2
1-yr-fwdP/E
1-yr-fwd PEG
FAO Index
Danone
Nestle
Fonterra
Dean
Foods
Kraft
Saputo
60
80
100
120
140
Jun-13 Nov-13 Apr-14 Sep-14
Rebased

December 16, 2014
P a g e | 8
As seen above, despite higher PEG ratios, players like Nestle and Danone command a premium due to their widespread presence
across emerging markets relative to developed market dairy players like Saputo, Dean, and Kraft.
Compared with the FAO Dairy price index
2
(between June 2013 and October 2014), dairy stocks with emerging market exposure
(Danone, Nestle, and Fonterra) look favorably placed relative to Dean Foods, majorly a North American dairy pure play. Exceptions
include Saputo (North American dairy player) and Kraft (diversified staples producer). In 2014, Saputo’s stock price benefited from the
acquisition of Dairy Foods Division (US), while Kraft benefited from a diversified staples product portfolio along with dairy products.
The way forward: Balancing act to isolate winners from losers
While export opportunities across developing markets look attractive, international dairy players would need to balance between
clinching opportunities in rapid growth markets (especially emerging markets) and developing the stagnating yet large developed
markets. The ability to innovate and build extensive value-added product portfolios would enable players to sustain growth momentum
in developed markets (for instance, stretching the dairy product portfolio to include variants like juices and cereals). On the other hand,
dairy players in import-oriented countries would need to compete with international players by securing and boosting adequate milk
supplies either through vertical integration of the supply chain (securing sustainable milk supplies), leveraging the local consumer
knowledge base, or tying up with an international supplier. Overall, the ability to adopt a global approach on securing supplies and
meeting consumer demand would be the key to success and differentiate winners from losers.
2
FAO’s dairy price index depicts the monthly change in international prices of dairy products.

December 16, 2014
P a g e | 9
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