Is China Sick of Australia Dairy?

Think back to 2015, what was a defining industry within equities? Dairy. And even though it sounds silly, baby formula was on top. Of course, it doesn’t sound silly when you factor in demand. And not to mention constant profit increases for various companies within the industry.

While many analysts believed baby formula wouldn’t be a topic for 2016, it’s still persisting. Super star of 2015, Blackmores [ASX:BKL], are only just starting their baby formula debut. Blackmores and Bega Cheese [ASX:BGA] decided last year that it was their turn. And they intend to capitalise on this explosive market.

Where is this market? Of course it is in China. Demanding Chinese parents want the best for their children. So that’s why they buy from the best producers. And they are Australia and New Zealand. They’re better not only because of perceived quality. Aussie and NZ dairy products don’t harm infants.

It seems like the Chinese dairy industry will never live their 2008 scandal down. The scandal involved tainted milk and infant formula. The contents of which had toxic doses of melamine. The end result was six infant deaths. Thousands more across China had to be hospitalised because of the tainted dairy products.

But this incident was nothing new. Four years prior, 13 infants died because of watered down milk. The cause of these deaths was malnutrition. The two events are now just sad reminders. And more importantly, lessons of why many Chinese don’t trust domestic dairy.

Fonterra increases profits a staggering 123%

Who do you think supplies a lot of Australia companies with milk and other dairy products/facilities? If you don’t know that’s OK, because I’m going to tell you. It’s Fonterra Co-operative Group [NZE:FCG]. In fact, Fonterra can be associated with Western Star butter, Perfect Italiano cheese, Mainland cheese and Ski yoghurt.

Fonterra is also a huge supplier to infant formula company Bellamy’s Australia [ASX:BAL]. And they are now even supplying Chinese infant formula company Beingmate with their products. Even more recently, this morning, Fonterra reported a 123% profit increase for the first half of the 2016 financial year.

But while net profits were on a high, totalling $409 million, the price of milk has dropped. Chairman John Wilson said the supply and demand imbalance has brought the price down to unstable levels. And particularly in New Zealand, as the strong NZD has also had a negative impact on milk prices.

The low prices have placed a great deal of pressure on incomes, farm budgets, and our framing families,’ said Wilson. ‘Our priority is to generate more value out of every drop of our farmers’ milk by focusing on the areas within our control. We aim to efficiently convert as much milk as possible into the highest-returning products.

The low dairy prices are representing a mixed sentiment. Low prices have reduced the cost of ingredients for consumers. And they’ve boosted Fonterra’s profits. But lower milk prices are weighing heavily on farmer-shareholders. Their collective incomes have been cut by billions in the last two years.

This has prompted Fonterra to announce early dividend payouts. Yet it might just be a quick fix to ease farmer’s cash flow problems. Nevertheless, Fonterra said it would pay an interim dividend of 20 cents in April. This will then be followed by two dividends of 10 cents each in May and August.

Earlier this month Fonterra reduced its forecasted milk price by 6% to $3.90 per kilo. You might be thinking why milk isn’t measured in litres. But Fonterra is measured in milk solids. Ok now back to China.

So does this mean China no longer craves Fonterra’s products? A likely answer to this questions is that current supply has saturated the market.

But this may not be true. The US Department of Agriculture’s (USDA) Beijing bureau saw 2016 milk powder stockpiles at 89,000 tons. It’s the lowest level in four years. And the USDA is also forecasting China’s whole milk powder imports to increase to 400,000 tons. A 50,000 ton increase from last year.

However sometimes even compelling figures wont sway investors. Instead, pessimism coming out of China will dictate the herd’s mentality. Yet this could be a good thing. While companies like Fonterra and others are neglected by investors, you might have a better chance to buy a cheap dairy related company.

Härje Ronngard,

Junior Analyst, Money Morning

PS: Investing in dairy related companies for 2015 was a great idea. Investors could have made triple digit returns easily. And just because of Asian demand. The USDA believes this demand will continue into 2016. But there are also other investments that were great in 2015 and have carried over to this year.

Money Morning’s Publisher, Kris Sayce, has been scouring the market and looking over price action to come up with great investments still relevant right now. In Kris’s report ‘The Three Best Investments in Australia for 2015 and Beyond’ he’ll tell you where to start looking.

Through Kris’s report you’ll understand why it’s time to load up on Australia’s most hated sector. Kris will teach you in on how you can buy property on the Aussie stock market. To get your free copy of Kris’s report, click here.

Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

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