Even though some key issues remain to be resolved, the overall industry tone is much more positive than at this time last year.
Vast improvements at farm level
One of the ways this positivity is manifesting is through increased milk production.
After many consecutive months of year over year contraction, milk production has recently been growing steadily across most of Latin America.
Brazilian milk volumes are up just over 4% for the collective first half of the year, while gains have been even more substantial in countries like Chile and Uruguay. In Argentina, arguably the country that suffered the most during 2016, year to date milk production is edging toward parity with prior year volumes.
A key driver behind the increased milk production is vastly improved climatic conditions. Last year, drought plagued some South American agricultural regions, while torrential rains pounded others.
Generally speaking, weather this year has been much more agreeable across the region with reasonable precipitation accompanying mild temperatures. However, climatic forecasts indicate some possibility of a La Niña weather effect developing over the coming months, which would result in an uncharacteristically dry spring and early summer, as of now the impact is not expected to be too severe.
In addition to better weather, farm economics have also dramatically improved compared to last year. Milk prices in most places have risen steadily, finding support at current levels. One exception is Brazil, where farmgate prices have softened last year – nevertheless, they remain the highest in the region.
Operating costs have also declined as improved weather resulted in a bumper grain crop that put downward pressure on concentrate prices. In addition, general economic conditions in the region are improving which has helped to reduce inflation, easing financial strain.
Overall, the relationship between milk prices and input costs is favorable to dairy farmers, leaving them with enough margin to encourage expansion.
Consolidation amongst processors
As the production sector strengthens, some of the sector’s stress has been shifted to processors, who are now adjusting to a new reality by creating scale.
Consolidation amongst processors, a trend that has been active in the region’s dairy industry over the last few years, continues to intensify – accelerated by economic challenges in individual countries.
Some of this consolidation is taking place across borders as regional dairy companies battle to raise their international profile. For example, in August of this year, a deal was confirmed that will result in the sale of more than 90% of the shares of Vigor, a Brazilian dairy company, to Mexican dairy firm Lala for nearly $2bn.
In other cases, consolidation is domestic in nature. In early February of this year, Chilean dairy firm Watt’s vocalized their decision to purchase Danone Chile for a sum of about $21m. The decision will give Watt’s a greater presence in its own, local market, elevating market share to an estimated 14%.
Not all of the consolidation within the processing sector has been so defined.
One of the largest outstanding questions within the region’s dairy industry is what the future has in store for Argentina’s largest milk cooperative SanCor. SanCor, which at one time processed nearly 20% of Argentina’s milk, has battled bankruptcy for years and in May agreed to sell a majority share of the firm in exchange for government financial assistance.
Although there have been many rumors about potential suitors for the company, there has been no official indication about who the ‘strategic partner’ may be. The industry waits with baited breath to see who will take control of this iconic Argentine dairy company and brand.
Lethargic demand and trade
As producers and processors accommodate themselves, consumers are demonstrating a bit of resistance. In general, higher milk prices have meant higher dairy product prices at the grocery store shelf with many consumers responding by backing off dairy purchases.
The situation is further complicated in some countries by poor economic performance, high unemployment, and flagging consumer confidence. While the situation is not dismal, it is working to keep a ceiling on the industry’s recovery.
Light demand is also slowing intraregional dairy trade, especially with respect to Brazilian imports. Reaching a value of just $48.3m in August, Brazilian imports are down 27.6% year over year.
The volume drops are even more significant, as increases in dairy commodity prices are helping to offset some of the impact in value terms. The drop has been the most severe with respect to milk powders, which cheese has fared better.
A decrease in dairy demand from Brazil is most fundamentally felt by Argentina and especially Uruguay, who have seen their exports decline as a result.
Trade issues within the region are taking the spotlight in several respects. As uncertainty circulates around the outcome of NAFTA, there is speculation that the Mercosur countries could become key dairy providers to Mexico should their ties to the US be cut.
In addition, at a local level, tensions are mounting around a recent decision to remover quotas that have governed milk powder imports from Argentina into Brazil over the last few years. While Brazilian dairymen are concerned about the impact this will have on their own production, the impact of the decision is not likely to be material, at least in the short term.
While South America’s dairy sector has gone through some tough times, evidence is mounting that the industry has turned the corner and is currently strengthening. If this trend continues, and is not undermined by weak demand, the regional dairy sector should be looking toward a bright future.
Monica Ganley is the principal of Quarterra, a boutique strategy consulting firm dedicated to helping their clients understand and unlock the food and agriculture industries of Latin America. To learn more, visit their website and blog at www.quarterra.com or get in touch directly at monica.ganley@quarterra.com