China Dairy: Downstream is key

China dairies in the downstream segment that have exposure to fast-growing product lines will be leading the industry’s growth. In this deep dive, we look at the industry’s dynamics, poten...
Group Research30 Nov 2017
  • China’s dairy sales could post a healthy 5.3% CAGR in 2016-2021F
  • Chinese dairy groups should speed up M&As to lift product quality and variety
  • The downstream segment has seen strong top-line and earnings growth
  • Better performance could be achieved by large players as the market firms up
Photo credit: AFP Photo

According to Euromonitor, China’s dairy sales, inclusive of alternative milk, could post a healthy 5.3% compound annual growth rate (CAGR) in 2016-2021F, driven by rising yogurt demand (15.6% CAGR). Ultra-high temperature (UHT) yogurt, in particular, should post the fastest CAGR of over 20%, as many Chinese consumers are lactose intolerant and avoid milk. This category does not need to be stored at low temperatures, allowing it to swiftly expand into more remote areas across China. Other products like cheese, butter and plant-based milk (e.g. walnut milk, coconut milk, soy milk, etc.) also see increasing customer demand. Some players are also looking for new opportunities to tap the high-end segment, e.g. organic products, goat milk, etc.

As households’ purchasing power continues to improve and Mainland Chinese travel more, consumers are trading up and demanding better quality and variety, including an increasing number of imported products. Diversification strategies on products, brands and distribution channels, as well as gradual premiumisation will be required to cater to changing consumer behaviour. As a classic example, Nestlé has evolved over time, from initially selling infant and dairy products to also offering ice-cream, beverages, nutritional products, pet foods, confectionery, etc., through M&As. It has also seen its share price surge over 14 times in the last 30 years, reaffirming the strong potential of well-executed acquisitions. As non-dairy companies continue to enter the dairy and plant-based segments – an example is soft-drink leader Coca-Cola, tapping the US premium milk category through a joint venture with Fairlife to produce milk with higher protein and no lactose, and spending US$575m on Unilever’s AdeS soy brand in Latin America – Chinese dairy groups should also speed up M&As to lift product quality and variety.

Since the 2008 melamine scandal, China’s dairy supply chain has been heavily scrutinised and hampered by stringent government policies. While significant improvement has been made along the supply chain, we believe there is further room for enhancement especially in food safety and cost competitiveness. Specifically, upstream players’ profitability is determined by raw milk prices, feed costs, productivity and overall efficiency. With a growing supply of low-price imported milk powder, it seems difficult to see an inflection point in China’s upstream sector. Further support by the downstream brand operators in the form of guaranteed volume commitment, capital investment or financial support may be required to help sustain upstream profitability.

The downstream segment has seen strong top line and earnings growth, supported by rising dairy consumption per capita thanks to consumers trading up and population growth. In terms of product category, yogurt (UHT yogurt, probiotic beverages), cheese, and butter should continue to see double-digit CAGRs in the range of 10.2-15.6% for 2016 to 2021F (source: Euromonitor), which should offset softening sales in basic UHT milk and flavoured milk beverages. While around a 50% y-o-y rise in the prices of whole-milk powder (WMP) as well as increases in sugar and packaging costs could lay pressure on gross margins, a cut in advertising and promotional spending post-2016 Olympics should offset rising raw material costs.

The IMF segment has been affected by more stringent regulations and players need to meet registration requirements before 2018. Volume growth should resume this year on the back of the revised tax regime for purchases via cross-border e-commerce. Euromonitor also projects the IMF segment to grow at a 6% CAGR in 2016 to 2021F, along with relaxation of the One-Child Policy and rising demand for higher quality brands. The Development Plan for China Milk Industry (2016-2020) promotes market consolidation, targeting for over 80% of domestic IMF sales to come from the top 10 players in China by 2020. Better performance could be achievable by large players as the market firms up.

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