Fonterra says current industry forecasts most optimistic

By NZPA

Tuesday 3rd April 2007

Dairy co-operative Fonterra said its current set of forecasts are the most optimistic the industry has ever had.

Global demand for dairy products is forecast to grow by 2.7% per annum for the next 10 years. In the last 10 years, it was just above 2%.

To supply that demand, 10 dairy industries that produce what New Zealand currently produces will be needed.

Health conscious consumers who see dairy products as natural and rising incomes in countries like China are two trends driving consumption. A third of the growth in dairy product consumption is expected to be in China.

Global supply is forecast to grow at 2% per annum, so demand is expected to outpace supply.

It is a big change from 15 years ago when the industry had conversations about either burying or burning stockpiles of butterfat and in the end it was sold cheaply to Russia, Fonterra's strategy manager Graham Stuart told a media briefing.

When Fonterra was formed, Europe was the major supplier of dairy products to the world, said chief executive Andrew Ferrier. Now it is Oceania, and with the Australian drought it is New Zealand in particular.

"We are seeing New Zealand becoming increasingly a dominant player but we are also seeing growth in world markets far greater than New Zealand can supply," said Ferrier.

So the view from Fonterra at a briefing of journalists, following a round of farmer meetings last week, is that New Zealand dairying is in a pre-eminent position globally, in an industry where demand is expanding more rapidly than it has been and exceeding supply.

But there are trends within that big picture that threaten the New Zealand dairy industry's position in the long term.

One is that the demand for liquid milk is far outstripping demand for the powdered products that New Zealand traditionally exports in some markets, and another is that local suppliers in China are unexpectedly emerging to meet local demand.

New suppliers are also emerging in countries that haven't traditionally been major players in the dairy industry.

Ferrier said the biggest threat to New Zealand milk powder used in substitution was not coming from non-dairy products but from fresh and liquid milk.

Fonterra is forecasting growth in consumption of liquid milks in China of 22% per annum over the next 10 years, and the figure for yoghurt is higher at 31%.

While global demand is forecast to grow at 2.7% per annum, the cross border part of the market that New Zealand traditionally has done much of its business in is only forecast to grow at 1.2% per annum.

"That is not something to beat ourselves up about. 1.2% demand is more than enough to meet our reasonable expectations of growth in production in New Zealand," said chairman Henry van der Heyden.

Another threat is that the rising cost of land in New Zealand means that farmers have more debt and their costs are higher.
That erodes New Zealand's traditional position of being a low cost producer.

Fonterra estimates that four years ago, farmers' debt servicing costs were 73c a kilogram of milksolids, and now they are closer to a dollar. Many farmers face cashflow constraints if the payout is anything less than $4.20 per kg of milksolids.

But Ferrier said:"I don't think there is any panic that we are going to lose the New Zealand model in the global market place in the foreseeable future".

Fonterra's strategy hasn't changed since it was formed, he said.

Its first priority is maintaining New Zealand's position in the global industry. But it is also sourcing milk in other countries to build relationships with customers. It is using its supply chain to develop new business and building consumer power brands and its ingredients business.

By being able to source milk in more countries, it has been able to increase the amount of business it does with large customers who don't want the risk of only sourcing supply from one place.

Its supply chain is not being outsourced. Instead it is being used to build business in other countries and build relationships with customers who might have only bought milk powder in the past.

"Now they buy the finished product packaged in their can made by Fonterra in New Zealand, packaged in New Zealand or Asia and delivered for them.

"We are getting rewarded with that in a higher margin in the finished product.

"We are making ourselves increasingly indispensable to our customers around the world," Ferrier said.

Business commentator Rod Oram questioned the strategy of transplanting the things that had given New Zealand farmers an edge, such as knowledge and the supply chain, to countries New Zealand competed against.

Fonterra's position is that it is leveraging its expertise to make money for its owners. It is doing it in areas, such as liquid product, that will never be supplied by New Zealand farmers and the New Zealand market is never going to meet the global consumption growth that is currently forecast.

"In regions where it is not practical to supply with New Zealand milk, we recognise that we have an opportunity to strengthen our profitability by leveraging what we know best. What we know is vertically integrated supply chain from cow right through to customer," Ferrier said.

"Fonterra can't sit still. Fonterra has to continue to move ahead," he said.

"If we don't do it someone else will," said van der Heyden.

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