James McKeefry, ANZ: Dairying - a challenge and an opportunity
JAMES MCKEEFRY: Dairying, a Challenge and an Opportunity, what I want to talk about today is both the challenge and opportunity that I feel the industry faces, looking at some recent data and trends, which will provide a bit of a start of a road map for the future. In understanding both the challenge and opportunity, we are better able to manage both risk and ultimately reward, which essentially underpins our capacity in financing farmers and the industry more broadly.
So some of what I'm going to say is no news to any of you here. The current season has been difficult. There's no doubt. However we see that there's a strong potential future in the dairy industry with a slow but steady resurgence in terms of price.
And perhaps we would rather that than any boom-bust cycle going forward, despite what Fabrizio says about volatility. That's going to be part and parcel of it, but we would like to see a slow and steady resurgence in price.
There is confidence that the milk prices is recovering after last year. And although there will still be volatility around the market as the economic instability continues, the supply coming from the EU will continue to fluctuate as they adjust to deregulation and the impact that the Phosphate Reduction Plan my have on reducing herd numbers.
However, as we know, prices are covering. But is this on the back of reduced production, particularly across Australia and New Zealand? Or is it more on global demand increasing? Maybe it's a combination of both, and both of them have a part to play. In terms of on-farm profitability, there's no doubt that lower fertiliser and lower grain prices are helping, not to mention reduced interest rates, or the last interest rates we've seen in the current cycle.
But that's only part of the story. There is a supply and demand issue impacting on price as well. So the question here may be, do we fully understand the impact on price the EU surplus of skim milk powder has or the reported cheese [? amount ?] the US has? I'm sure that our more learned colleagues will have something to say about that later.
In terms of challenges, let's look at history. This graph shows weighted average price and milk production for the last 45 years in Australia. And while there has been an upward trend in price over that time, it has become more volatile in recent years, in part due to the GFC, and also in part the impact of China entering and exiting the market at will.
Production, interestingly enough, has steadily dropped since deregulation and a maximum production level of around 11 billion litres in the late 1990s. For the current season, however, we're looking at production levels of between 8.7 and 8.9 billion litres. However, most commentators would suggest that it's probably going to be at best 8.7 and probably slightly less than that, as we've already heard.
And it's been 20 years since we had that level of production in Australia. At this point, we need to consider the impact on global markets of this reduce supply. We have shifted from being a 60% export, 40% domestic supplier 10 years ago to flipping that around to being 40% export and 60% domestic these days.
So as supply continues to erode, what will happen to the shift? Will we maintain our export markets and start importing milk from New Zealand-- God forbid-- to make domestic demand? Or will we risk losing our export markets to maintain our domestic need? It's a question that we need to consider in terms of the challenge. Do we see that as a challenge and an opportunity, or just a challenge? And in terms of challenge, it's not just about supply.
Challenges that the industry faces are broader. Is reduction in supply impacted by farm size, by a reducing numbers of cows being milked, by the changing scale of dairy farmers, by the labour, by the impact of labour, or the lack of labour, or even from a point of view of young farmers and young people returning to the industry? In any discussion that you may have, it seems to be a perennial problem or a perennial question that I face.
What are we doing in order to attract young people back to the industry? I think it's a challenge that it's very important that we sort of look at from a grassroots point of view. And I don't see that it will change in terms of what the industry is facing.
So that's talk about challenge. Let's talk about opportunity. We've all heard about the Asian story, and we've certainly heard about it today, and how this will still underpin our export markets.
We heard yesterday from one of our speakers here. The expanding Asian middle class market is one that we can capitalise on with branded, high-value products, as opposed to commoditised, high-volume product. And in this picture, the countries shown in the top right of the figure show the main countries that we are likely to grow our export markets in due to the growing demand for high quality, safe and secure, clean, green dairy products from Australia.
We are in a good position to meet their increasing need for dairy products. Understanding what the consumer demand is for and what product type will be critical, absolutely critical, and our products remaining in demand and relevant to these markets. My feeling is that with our domestic export split now being 60-40, we actually also need to focus on what our product mix is at home.
There remains opportunity here, too, and perhaps both go hand in hand. Often the Asian dairy story is about value-added product. But I suggest a deeper analysis of this, that it's maybe more about nutrition, for their children to grow up to be healthy and strong, like Aussie kids. And perhaps in looking at consumer demand, we shouldn't forget what our consumers at home want as well.
So while we understand the situation from the growing emerging middle classes in Asia, recently global demand has begun to pick up again with growth in China and Southeast Asia. The improvement in prices looks set to continue. And supply levels globally are constrained for most major exporters, with only the US showing significant growth.
There is still some risk of a resurgence in supply levels from Europe and New Zealand. And as reported in the Dairy Globe yesterday and certainly from GDT last night, the outlook for continued lift in dairy prices has softened slightly on the back of improving supply. As regulations in China around infant formula are changed, we may see a reduction in the number of companies in the market. But those that will remain will have an increased supply demand.
Consumers purchasing these products have a strong requirement for food security, allowing our products to be highly competitive. Recently China has also had a reduction in their domestic production which further expands the gap in their consumption, as can be seen in the graph on the right. And this also extends our export opportunity.
The good story is that demand globally for dairy products is expected to continue. We saw that from one of Fabrizio's slides. The challenge will be being able to maintain and grow supply to meet that demand and so keep our share of the global market.
And I think that's a really important point. There is a challenge around maintaining or increasing production to maintain our share of global markets. We must as an industry remain relevant in those export markets, and that is underpinned by our capacity to maintain production, maintain or actually increase it.
So in talking about volume on one hand, it's also extremely important to look at what we're selling and how those markets are actually growing in value. The total value of Australian dairy exports has fluctuated, as can be seen. But throughout the past seven years, we have continued to grow into the Asian market.
And as John mentioned, currently 74% of our export value is coming from there, up from 69% in the '14-'15 season. This value, however, does not represent the volume of product we have been exporting. With nearly a 6% increase in volume of dairy products exported year on year, the industry is in a position to continue to increase volume.
This is set to expand further into the future as relationships between Australia and Asian countries are developed and consolidated. It will be aided by free trade agreements continuing to be developed in other Asian countries, particularly India. And I think that from one of the presentations earlier today, certainly understanding a little bit more about India was an important point for this conference.
Our strongest opportunity for growth remains China. Although there has been some variability in the value of exports there in the past, the free trade agreement that we have will make market access easier and allow us to grow, provided we have the supply to meet those markets and remain relevant in terms of the products that they are looking for.
In terms of my own experience over the last little while-- and I'm from a banking perspective and in my travels-- that the impact of the price shock has certainly increased it on a working capital overdraft basis across the industry. Much of that debt is now being restructured by farmers. The ring structure is allowing farmers to take advantage of cheaper interest rates, for sure, improving profitability with fertiliser prices decreasing, and also the cost of grain and feed dropping.
We know that milking cows are in demand as farmers rebuild herds from last year, with many culled very heavily early on in the year, taking advantage of the strong beef prices, and also attaining the balance from the sale of export heifers. The future of the industry is strong.
However, we must remain relevant to both the export and domestic markets, particularly given we have a diminished supply curve, at least 9 billion litres. We remain confident in the industry and look forward to continuing to support our farmers as they meet the challenges and take advantage of the opportunities and to the future. Thanks.
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