Across The Border

China’s raw milk producers have to deal with market glut

Raw milk price falls. Hurts suppliers. Helps product producers. Prices headed down if oversupply problems not resolved, analysts said.

PUBLISHED : Monday, 04 April, 2016, 7:10pm
UPDATED : Tuesday, 05 April, 2016, 1:56pm

China’s raw milk prices will continue to fall because of a continuing supply glut that hurts suppliers and benefits milk-beverage sellers, analysts said.

Uncertainty overhangs raw milk suppliers’ margins. Prices will continue to drop if the market oversupply is not resolved quickly, CICC said in a research report.

The brokerage downgraded its target share price forChina Modern Dairy, the country’s largest raw milk manufacturer, from HK$2.1 to HK$1.7, after the company said net profit fell 56 per cent last year. The gross margin at its farming business narrowed 5.37 percentage points to 37.10 per cent.

“We suggest investors exit (the company shares ) due to margin uncertainty in the near term and wait for a better time for re-entry,” CICC analyst Paul Yuan Feiyang said.

There has been oversupply in the upstream market — raw milk — and prices have fallen. At the same time the high prices drove downstream companies — makers of milk products— into deals with overseas suppliers able to provide cheaper milk powder instead of fresh milk for production, Yuan said.

China’s raw milk self-sufficiency ratio is 65 per cent. That means it has to import 35 per cent of its requirement. Pure liquid milk accounts for 55 per cent of total dairy demand, Yuan wrote in the report.

“The high price was the result of inefficient backyard farming and surging costs in farm land, labour, and feed production,” Yuan said.

The high price was the result of inefficient backyard farming and surging costs in farm land, labour, and feed production
Paul Yuan Feiyang, CICC analyst

The price that China Modern Dairy sells milk fell 12 per cent to 4.42 yuan (HK$5.3) per kilogram last year and may drop a further 9.5 per cent this year if low-efficiency farmers don’t exit the market rapidly. That could reduce the self-sufficiency ratio to 55 per cent, Yuan said.

Tumbling prices for corn, which accounts for 40 per cent of feed costs for dairy cows, offers buyers a chance to bargain for lower raw milk prices, Guotai Junan International analyst Sunny Kwok wrote in a research report.

Concern over margin deterioration is mounting amid signs that China’s ultra-high-temperature (UHT) milk market is overcrowded after retailers rushed to stock up on this high-end products and the domestic dairy consumption growth slowed, CICC said.

Cheaper raw milk prices will benefit downstream manufacturer’s gross margins.

China Mengniu Dairy, one of China’s largest milk-product makers, saw gross margins increase 0.5 percentage points to 31.4 per cent last year thanks to lower raw milk costs and its product mix, Morgan Stanley said in a report.

“Further gross margin enhancement is likely to be achievable this year and such cost savings are expected to be re-invested in brand building or direct promotions,” said Kwok of Guotai Junan.

Despite the cost benefits delivered by the upstream market, downstream players have their own problems, such as fierce competition and weakened demand for milk nationwide.

The 2 per cent decline in China Mengniu’s total revenue last year was mainly dragged lower by a 9.9 per cent sales drop in UHT milk and a 12.5 per cent fall in milk beverages, Guotai Junan said.