Guy Trafford wraps up the key changes affecting the New Zealand dairy industry, including prices, payouts, marketing strategies, and China's pivot to GM animal feed

International dairy prices have got back on the roller coaster with a fall of -1.5% following the +3.2% lift of the previous auction. Key results were:

- Butter index up 3.8%, average price US$4,922/MT
- Cheddar index up 1.5%, average price US$5,086/MT
- SMP index down 2.4%, average price US$2,769/MT
- WMP index down 2.0%, average price US$3,264/MT

Of note is the Butter and Cheddar results. These products are more closely aligned to the awakening of the hospitality sector and both products have shown significant improvements, likely precursors of the steady improvement to the Chinese economy. While a fall in the powders was unexpected the outlook, subject to the unexpected, is still positive. Again, largely on the back of China’s improving economy.

And now, Fonterra has trimmed its 2022/23 payout forecast, but only back to levels some analysts were expecting.

Separately, A2 Milk has got some commentators scratching their heads. a2’s recent 6 monthly financial results have largely been at the positive end of the spectrum:

For the six months ended 31 December, a2 Milk reported an 18.6% increase in revenue to NZ$783 mln. This was driven by a 54% increase in China and Other Asia sales and a 61.8% jump in US sales, which offset a 24.6% decline in ANZ sales.

Infant formula sales were up 18%, with China label sales up 43.5% and English label sales up a modest 1%. Whereas liquid milk sales were up 5.6% in the ANZ market and 62% in the USA.

a2 Milk’ EBIDTA came in 10.5% higher year over year at NZ$107.8 million, which equates to an EBITDA margin of 13.8%.

This reflects a +46% increase in marketing investment and a +16% increase in administrative and other expenses due to continued capability build, further investment in innovation and research projects, timing of long-term incentives, plus higher insurance and travel costs.

On the bottom line, the company’s net profit after tax rose +22% to NZ$68.5 million, which was ahead of the consensus estimate of NZ$60.6 million, which should have boded for the a2 Milk share price.

The head scratching came as despite the above results share price have fallen as they are sold off. One analyist felt that the share falls may have been due to investors inflated expectations of returns not being met or perhaps the lack of growth in the US contributed to it. Another possible reason may have been the news which has just emerged that China is “upgrading” its infant formula rules which is likely to push smaller players out of that market. While some 112 brands of 31 milk powder makers have been approved by the National Medical Products Administration as of February 15. Another 31 smaller players are likely to be pushed out.

The smaller companies are said to make up about 10-15% of the formula market in China. Blue River Sheep Dairy was caught up in a similar ‘change of rules’ after the Fonterra botulism scare which resulted in them having to go through a restructure. Hopefully this second round of tightening of formula imports does not also create casualties.

The regulation changes were unveiled back in March 2021 so most likely not a surprise to companies and certainly a2 with its predicted growth into China do not appear to be overly concerned. It’s possible investors were not as well informed and have had a case of the jitters.

Fonterra does not appear to be affected by rule changes although it is possible that some changes to the formula recipes may be required as the new regulations require lower protein levels (up to 30% reductions) to help prevent obesity. The updated rules make a distinction between step two (7-12 months) and step three (13-36 months) infant formulas. Some of the major changes are lowering the upper limit of protein while requiring certain levels of selenium, manganese, and choline, and banning the sugars of sucrose and fructose. It is possible that if as predicted 10-15% of the formula market is opened up due to the removal to the smaller players then further opportunities open for New Zealand exporters.

In the meantime population growth in China’s major cities has slowed to below 10% for the first time in 42 years (to 6.5%). This is largely attributed to the exodus of foreign workers during the covid pandemic. However, the disposable income of residents in six major Chinese cities has risen above US$10,240 (The cities are led by Shanghai followed by Beijing and Shenzhen, Guangzhou, Suzhou and Hangzhou).

Reports are also saying the population is becoming more discerning in its spending habits, buying less but of higher quality. This seems to be spread across both food and other items such as tech etc. This trend should ensure New Zealand products remain sought after.

There has also been a change in China’s attitude to GMO products with them tentatively opening up its lucrative corn market to genetically modified (GM) varieties. Only about 267,000 ha or 1% of the corn growing area is approved for planting at this stage but pundits are expecting more to come. While China has invested heavily into researching gene-edited and GM food crops for decades, it has rarely allowed them to be planted and restricted their importation because of biosecurity risks and pervasive public fears about such technologies. Although China does allow some GM imports, such as corn and soybeans for use in animal feed and food processing, no staple GM food crops have been granted a license for commercial planting until now.