Asia's Dairy Supply Deficit: Attractive Opportunities

BMI View: Asia will remain a large importer of dairy products in the coming years, as production expansion does not keep up with robust consumption growth. We see attractive opportunities to fill the continent's growing dairy products deficit. More specifically, South East Asia is home to some of the most interesting trends, as consumption recently started to bloom, while production growth has limited room to grow. Milk powder will remain the largest imported product, but we see other products gaining ground.

As domestic and foreign interest in China's dairy industry has swelled in recent years and led to large investments in capacity and efforts to tap the import market, all eyes are now turning to the next driver of dairy consumption growth, South East Asia.

Emerging countries in Asia, with the exception of China and India, do not have a long tradition of producing milk. The domestic milk production in the ASEAN countries covers only 5-30% of consumption in South East Asian countries. As a result, many Asian countries have grown largely dependent on milk powder imports. Many dairy deficit countries have a governmental policy to expand their milk production and have ramped up direct support to the sector, via dairy genetics improving programmes. We forecast double digit growth in liquid milk production from 2012/13 to 2017/18 for all Asian countries with the exception of Japan.

However, production expansion will fail to keep up with robust demand growth. Production in Asia is hindered by a number of factors. The natural resources in Asia for making milk are not ideal. For milk, production optimal conditions are abundance of feed, land, water (it cost 10-15 litres of water to make 1 litre of milk) and a moderate climate. The low availability of domestic feed grains and the need to rely on large imports in Asia usually makes production costs higher than in Oceania or Europe for example. In China, production growth will also be constrained by stricter government standards aimed at improving milk quality. Although a number of large dairy projects are coming online, smaller producers are leaving in large numbers as they are unable to comply with the new standards.

Growing Imbalances
Select Countries - Whole Milk Powder Production Balance ('000 tonnes)

Meanwhile, consumption of dairy products will record unprecedented growth over the medium term. The Asian region is presents interesting characteristics supporting growing dairy consumption: high birth rates and young populations, rising incomes and the emergence of the middle-class, improving diets, urbanization and country-wide school milk programmes. The boom in convenience and mass retail stores in Asia will also support access to dairy products and incentivise demand. Retail sales done via mass grocery retailers remain low in those countries: households still go to independent grocery shop for 52% of their retail shopping in China. This numbers reaches 85% in Vietnam, 80% in the Philippines and 77% in Indonesia. On the contrary, households in Japan and Australia do 85-88% of their retails shopping in mass grocery shops according to our Food & Drink data.

India and Malaysia have the largest consumption rates of dairy amongst emerging Asia. Malaysians consume on average 51 kg of dairy per person each year (mainly non-liquid milk products) while Indonesians consume just 8kg. Comparing this with consumption in developed Asian economies such as Japan, where annual per capita dairy consumption is 85kg, indicates there is significant growth potential in these markets.

Large Increases
Select Countries - Food Spending (USD per household)

Consumption growth will be the strongest in China and South East Asian countries. For liquid milk, we forecast the strongest demand growth coming from China, Vietnam and the Philippines, mainly due to the fact that consumption per capita is low in those countries, especially in the two latter ones. For whole milk powder consumption, the Philippines, China and Indonesia will see the most robust growth out to 2018, as those countries are characterized by rapidly growing infant population. Although China is characterised by a rapidly ageing population, the easing of the one child policy from 2013 will incentivise births in the coming years and further boost milk powder demand. We forecast cheese consumption to grow across Asia in the coming years, as demand for westernised restaurant food, which usually use cheese, will grow. However, demand growth will be slower for cheese and butter than for milk powder ( see 'Shift In Dietary Trends To Benefit Dairy Companies', April 3).

Overall, Asian countries mainly consume fresh milk, produced locally. However, consumers are slowly turning to more value-added products. In Vietnam for example, the consumption of UHT or sterilized liquid milk has a 90% penetration in cities and 70% penetration in rural areas, while infant milk powder has a 43% penetration in cities and 30% in rural areas, according to a consumer panel made in 2012 by Kantar Worldpanel. For functional dairy products (i.e. products that provide health benefits beyond their inherent nutritional value, probiotics in the case of drinking yogurt or milk for example), penetrations drops to less than 20% in cities and below 5% in rural areas. In urban areas, the fastest retail growth, both in terms of volume and value, is currently coming from infant milk powder and functional products. In rural areas, most dairy product consumption is blossoming, with infant milk powder, UHT liquid milk and cup yogurt recording the most robust growth.

Large Opportunities Across Products
Vietnam - Annual Penetration Of Dairy Products In Urban and Rural Households (%)

Opportunities To Supply South East Asia

We see strong opportunities to fill Asia's growing dairy products deficit. Apart from China, which is on track to see its milk powder imports continue to rise steadily to unmet levels in the coming years, other regions will attract growing interest. In particular, South East Asia is home to some of the most interesting trends, as consumption recently started to bloom, while production growth has room to grow. Milk powder imports will most likely soar in the coming years, while butter and cheese imports will grow at a significantly slower pace. Liquid milk imports are likely to remain limited in the medium term, as the countries in the region lack cold chain capacity. Foreign companies which export to South East Asia have an edge over local rivals thanks to enhanced supply security, stronger safety records and a broader, more innovative product range.

However, we see structural challenges to the growth in imports. Dairy is not fully entrenched in consumers' diets, which makes the market particularly price sensitive. In times of elevated dairy prices, South East Asian countries usually change the mix of dairy products, towards non-dairy components (vegetable oils for example). Moreover, high import-dependency has resulted in protectionist moves by some governments, including price controls, quotas, technical or sanitary requirements and import permits and certificates, which increase the time and costs of trade.

Finally, exports to the region also face supply chain inefficiencies. Under-developed supply chain and especially cold chains is even more prevalent in the Philippines and Indonesia. They count thousands of islands, which provide major challenges in terms of distribution of perishable products. So far, most of the distribution of local products is based around seaports and regional depots. The modern retail market in these countries continues to expand rapidly but it is still dominated by traditional grocery stores that lack access to dairy suppliers and refrigeration capacity.

Import Growth Across The Board
Select Countries - Dairy Imports, 2009 & 2013 ('000 tonnes)

White Gold Rush In South East Asia?

The Indian and Chinese processing sectors have expanded rapidly in recent years producing increasingly more varieties of dairy products. Many foreign investors have made their entry in the country, through the export of products produced abroad or via capacity expansion. Domestic companies have also participated in the acquisition spree. As a result, the two local markets are undergoing a fast consolidation. In China, industry consolidation took off in 2012. The Chinese government aims to reduce the number of domestic milk powder manufacturers to 50 from over 120 currently and to nurture 10 large-scale dairy entities to take over 70% of the market in five years. This move demonstrated the government's resolve to clean up the Chinese dairy industry's reputation, avoid more food safety lapses at smaller players and fend off competition from foreign companies, who now account for more than 60% of the market compared with less than 30% before the 2008 melamine scandal.

Given the attractive features of the South East Asian market, the investment and M&A rush seen in India and China's dairy sectors could be repeated in the ASEAN countries. However, most investment is likely to be concentrated in the manufacturing sector rather than in the upstream segment due to the limited milk production potential in these countries.

This article is tagged to:
Sector: Food & Drink, Agribusiness
Geography: Asia, China, India, Malaysia, Philippines, Thailand, Vietnam

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