Dairy Situation and Outlook. November 2014

Transcription

1 Dairy Situation and Outlook November 2014 A Situation and Outlook November 2014

2 Contents - November 2014: Situation and Outlook Australian Dairy value chain 2 Six key drivers of the Australian Dairy Industry 3 Executive summary 4 Key driver analysis 5 Global economy 5 Global demand 7 Australian market 9 Global supply 19 Input markets 20 Exchange rates 23 Policy updates 24 Front-of-pack labelling 24 Trade policy update /14 Dairy Farm Monitor Project /14 NSW Dairy Farm Monitor Project /14 SA Dairy Farm Monitor Project 26 > > B Situation and Outlook October 2014

3 Australian Dairy value chain Export Water, Grain & Hay Inputs Milk Production Manufacturing Marketing & Distribution Australia Retail & Food Service Imports Inputs > > Increased global market prices and reduced expectations for the Australian harvest are applying upward pressure on local prices. > > Hay yields are forecast to be down on last year for the 2014 season. > > International benchmark fertiliser prices remain below long-run averages. > > Temporary water prices remain significantly above year-earlier levels. > > Cull cow sales volumes are well above last year, while dairy breeding cattle exports are tracking lower than the same time last year. Milk Production > > Australian milk production is tracking 2.8% ahead of last season, at 2.34 billion litres to September. > > Weather conditions have been mixed, but a stronger production peak than last year is likely. > > However, accumulating moisture deficits are of increasing concern in a number of regions, particularly in southwest Victoria and southeast South Australia. > > Domestic-focused producers in the northern and western states continue to face challenges around weather and production margins. > > Dairy Australia s forecast for 2014/15 growth remains at around 2%, generating a production range of 9.35 to 9.45 billion litres. Manufacturing sector > > Ongoing investment in exportfocused capabilities concentrated in southeastern regions to capitalise on robust long-term demand outlook. > > Incumbent players investing in more export-focused infant formula capacity. > > Plus developments highlighting exportfocused powder and liquid milk investments. Export markets > > The signing of the China-Australia FTA should open further opportunities for Australian dairy exports. > > Despite some recovery in demand, global markets remain oversupplied and international commodity prices have continued to decline. > > The impact of lower commodity prices is beginning to be felt at the farmgate in many places around the world. With seasonal conditions continuing to support production, the current expansion phase has some months to run. > > Demand-side pressures such as the Russian import ban and the stillsubdued nature of Chinese purchasing activity are further preventing any significant short-term recovery in commodity prices. Domestic retail > > Most major dairy categories exhibiting positive retail volume growth. > > Cheese value moving up on higher average prices. > > Dairy spreads continuing to show strong volume and value growth. > > Marketers and retailers focusing more on origin-focused marketing of dairy products. 2 Situation and Outlook November 2014

4 Six key drivers of the Australian Dairy Industry Global economy Global demand Australian market Global supply Input markets Exchange rates Situation Outlook Situation Outlook Situation Outlook Situation Outlook Situation Outlook Situation Outlook Neutral Neutral Neutral Neutral Positive Neutral Negative Neutral Neutral Neutral Positive Neutral > > Global economic growth outlook exhibiting slower than anticipated growth in US and emerging economies. > > US economy nonetheless showing sustained signs of recovery and firm, although pre- GFC level growth, continuing in emerging markets. > > European economic recovery being challenged by low inflation and high unemployment. > > China s economic transition continues toward domestic consumption. > > Southeast Asian economies benefiting from domestic developments as well as improved conditions in some advanced economies. > > The signing of the China- Australia FTA should open further opportunities for Australian dairy exports. > > Attractive pricing has revived steady demand out of most markets, in the short term; this has been insufficient to absorb rapid growth in global milk supply. > > Chinese demand remains subdued, with the surge in purchasing that characterised the final months of 2013 considered unlikely to occur this year. > > Dairy exports to Russia appear to have dropped significantly, as the effect of bans on the country s key suppliers combine with a depreciating currency to make life difficult for users of imported dairy products. > > Consumer sentiment remaining subdued on budget and labour market outlook. > > However, consumers are spending, and café and restaurant sales nonetheless staying positive. > > Major retail dairy categories exhibiting overall improved performance in volume and value. > > Firming retail prices being reflected in CPI dairy subcomponent. > > Although lower real wages and underemployment potentially encouraging some trading down. > > Europe s milk supply continues to grow relative to 2013; the cycle of expansion expected to continue until at least the final months of > > The ongoing effects of the Russian import ban resulting in a significant increase in the share of EU-28 milk directed to butter and SMP production, rather than cheese. > > US milk production continues to grow, although falling domestic product prices are likely to reduce the incentive to grow in > > The New Zealand season has started well, but significantly lower farmgate prices may see a steep late-season decline if seasonal conditions deteriorate. > > Australian milk production is 2.8% ahead of last season to September at 2.34 billion litres. However rising moisture deficits in a number of regions particularly southwest Victoria and southeast South Australia are causing concern. > > The size of the Australian 2014/15 wheat crop has been downgraded several times: these concerns, and increased prices in global markets are putting upward pressure on local prices. > > The 2014 hay season is well underway. Production has been mixed, with average yields and good quality achieved in some regions. However, it is expected that yields will be down overall. > > International benchmark fertiliser prices remain below long run averages; but significant changes in the AUD/ USD exchange rate over recent months may reduce the benefit to Australian buyers. > > While high reliability allocations are good, temporary water prices remain significantly above year-earlier levels. > > Cull cow sales volumes are well above average year to date, with prices supported by strong manufacturing beef demand out of the US. Exports of dairy breeding cattle are down. > > AUD and other major currencies moving lower as US stops bond-buying, and investors purchasing USD in anticipation of higher returns. > > The yen falling as Japan increases bond-buying, triggering wider currency devaluation concerns potentially affecting purchasing power in other key export markets. > > Weaker dollar supporting higher exporter earnings and positive for farmgate prices though limited by lower commodity prices. > > Emerging markets seeing lower international prices and improved affordability despite exchange rate fluctuations. 3 Situation and Outlook November 2014

5 Executive summary Prices on global markets have declined a further 2-9% since September from disruption by Russia s ongoing partial trade embargo and as Chinese buyers largely remain out of the market. The disruption to dairy demand has also combined with ongoing supply growth from key global dairy export regions to prevent any significant recovery in global commodity prices. At the farmgate, major Australian processors have cautioned suppliers not to expect further price rises for the balance of the season given market circumstances, and warned against aggressive capital investment on-farm given the weak short-term outlook for commodity prices. Processors have suggested suppliers manage costs carefully for the remainder of the season. Various global market indicators show pricing in international dairy markets is unlikely to increase significantly until at least the second quarter of Against this uncertain market backdrop, year-to-date national milk production has been robust with July to September milk production up 2.8% on last year to 2.34 billion litres. Growth is primarily driven by southern export regions as challenging production conditions and high input prices in fresh milk production regions have overshadowed the small upward adjustment in farmgate pricing for some suppliers. The Australian milk production forecast for the current season remains for 2% growth to billion litres assuming average seasonal conditions and the absence of any further reduction in the farmgate pricing outlook. Input markets are under pressure, with elevated pricing for grain and hay, particularly in northern regions and Western Australia where both prices and availability are challenging. Temporary water prices are up on last season, while lower fertiliser costs and higher cull cow prices (+2% on average) are providing some financial relief. Competition for milk supply in a number of Australian regions remains fierce. Some processors are adjusting payment and production systems to provide farmers additional flexibility around seasonal production volume requirements and also offering growth incentives to grow milk pools rather than acquire farmers from other companies. Talk of foreign investment in key production areas has many people wondering as to what the production capacity and competitive environment for milk will be in coming years should these investment plans fully materialise. A significant proportion of this pre- and post-farmgate investment in the Australian industry is focused on securing international market opportunities, despite the reduction in the exportable surplus since raw milk production peaked in 2001/02. At the same time, there is also some renewed interest in export opportunities from farmers outside southeast regions. Although in domestic drinking milk markets such as Western Australia, Queensland and New South Wales it is also clear that the local industry faces varying challenges in supplying domestic requirements within current farmgate price and production cost structures. The Australian domestic retail dairy market is largely steady, with positive volume growth in most major categories. Within total retail milk, UHT has grabbed a percentage point of share of total milk, now at 14% and private label modified milks have extended gains in share of total modified milks. Pricing has firmed for cheese, and deli continues to outperform chilled cheeses in both volume and value terms. Consumer sentiment has remained tilted towards pessimism for most of the year, affected largely by perceptions on budget and labour market developments. However retail sales data suggests that consumer spending at cafes and restaurants remains healthy. Still, rising underemployment and slightly higher unemployment in an environment in which prices are growing faster than wages could promote trading down or dampen spending in some households. The drop in the Australian dollar continues to depend on perceptions of strength of the US economic recovery. But while the Australian dollar is at more favourable levels for exporters than it had been over recent years, recent currency-related developments and expected movements are not in the short-term expected to offset the impact of lower international dairy commodity prices. Against the current challenges, a number of significant pre- and post-farmgate investments in the Australian dairy industry have been announced, or are underway. These investments do reflect confidence in Australian milk production and could prompt a step-change in industry profitability and production volumes should they realise their full potential. The recently signed China-Australia Free Trade Agreement (FTA) will ultimately see the total removal of all dairy export tariffs faced by Australian dairy exports to China and is a positive development for the Australian dairy industry. The FTA will also enable the Australian dairy industry to further develop its long-term relationship with China and to compete on a more level playing field in the Chinese market. As a result of the deal, the industry can expect positive flow-on effects throughout the supply chain, in particular through substantially reduced tariffs on dairy products such as infant formula, cheese, milk powders, butter and liquid milk. Despite very little market certainty emerging in recent weeks, a number of positive developments for the Australian industry have occurred. Regular farmgate pricing updates from processors have been well received by farmers, the Australian dollar has remained trading at lower levels and the retail domestic dairy market has held steady. Challenges associated with weather persist in many dairy production regions, but the strong appetite to invest in Australian dairy reflects underlying confidence in the future of the industry and future demand for Australian dairy exports. 4 Situation and Outlook November 2014

6 Key driver analysis Global economy On the back of weaker than expected growth in the first half of the year, the International Monetary Fund (IMF) in its latest World Economic Outlook (WEO) trimmed its 2014 world economic growth forecast from 3.4% to 3.3% and reduced its 2015 forecast from 4.0% to 3.8%. FIgure 1: World Economic Outlook (WEO) projections 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% -1.0% -2.0% World Advanced United Euro Japan Emerging Economies States Area Market & Developing Economies 2012 Source: IMF (p) 2015 (p) China India ASEAN -5 MENA Global economic recovery is uneven, with greater risks potentially stemming from geopolitical tensions, stagnation and low growth in advanced economies and weaker growth in emerging markets, according to the IMF. Lower than expected growth in both the United States and emerging markets underpins the revised forecasts. Yet the US Federal Reserve in October announced it was concluding its quantitative easing (bond-buying) programme, given improved labour market conditions implying a brighter outlook for US economic prospects more broadly. Signs of the US economy s improved performance have been shining through: US GDP data released in late October suggests that the economy experienced its strongest six months of growth in over 10 years. Although that improvement represents potential risk to the extent it creates global over-reliance on US growth, which gives rise to potential shocks from funds flowing rapidly out of emerging markets and back into US assets, amongst other risks. Emerging market economies meanwhile continue to grow faster than advanced economies, although their growth rates have slowed to below pre-global financial crisis (GFC) levels. Continued growth in exports from, and imports into, emerging markets should therefore still support the relatively more favourable outlook into Higher growth is forecast especially for ASEAN-5 economies, the Middle East and North Africa (MENA), which contributes to the favourable long-term outlook of these areas as dairy export markets. Concerns remain around Europe s trajectory: the euro area is still forecast to achieve slight positive GDP growth in the medium term, but the situation and outlook for Europe remain challenged by persistently low inflation and stubbornly high unemployment. Major European dairy manufacturers continue to expand their activity and investment especially in China and more broadly in other Asian dairy export markets, given the far brighter prospects abroad. However, China s high growth period is showing stronger signs of having passed. The shift to a more consumption-oriented economy is progressing, but China over the September quarter recorded its slowest growth in five years and observers expect the country to record its lowest annual growth since 1990 (omitting the 6.8% recorded in 2008 around the GFC). Key growth drivers including fixed asset investment and industrial production have all been declining (see box: China economic activity slowing). China s policymakers are expected to continue supporting the economy s transition to more of a consumption-oriented model through the reform of the hukou system (China s household registration system which facilitates access to health, education and welfare system) and other measures designed to support urbanization and bolster the urban property and service sectors. But observers maintain that the debt build-up and overcapacity, particularly in property and heavy manufacturing sectors will inevitably result in business failures and thus dampen not only growth, but also employment and consumption. Yet fluctuations in domestic products and a growing middle-class population should continue supporting opportunity in daily consumption including dairy consumption. 5 Situation and Outlook November 2014

7 China: economic activity slowing but shifting more towards consumption Figure 2: China-economic activity slowing /1/2006 6/1/2006 9/1/ /1/2006 3/1/2007 6/1/2007 9/1/ /1/2007 3/1/2008 6/1/2008 9/1/ /1/2008 3/1/2009 6/1/2009 9/1/ /1/2009 3/1/2010 6/1/2010 9/1/ /1/2010 3/1/2011 6/1/2011 9/1/ /1/2011 3/1/2012 6/1/2012 9/1/ /1/2012 3/1/2013 6/1/2013 9/1/ /1/2013 3/1/2014 6/1/2014 9/1/2014 China Real Activity Index China Real Activity Index - New China Real Activity Index - Old Source: Bloomberg The chart above suggests that Chinese economic growth is slowing, although there is some pick up in New economic activity, assisted by policies aimed at shifting China more towards consumption and addressing pollution issues. The New reflects growth in activity related to consumption, advanced manufacturing, new energy, and the private sector. The Old reflects growth in real estate, low-end manufacturing, thermal energy and the state sector. Despite the slowdown in Chinese economic activity, the scale of the Chinese economy given the number of consumers, their continued urbanisation and income growth still suggests opportunities in dairy markets for some time into the future. New Old Figure 3: Key industrial drivers and retail sales trending down GFC 11/1/2004 2/1/2005 5/1/2005 8/1/ /1/2005 2/1/2006 5/1/2006 8/1/ /1/2006 2/1/2007 5/1/2007 8/1/ /1/2007 2/1/2008 5/1/2008 8/1/ /1/2008 2/1/2009 5/1/2009 8/1/ /1/2009 2/1/2010 5/1/2010 8/1/ /1/2010 2/1/2011 5/1/2011 8/1/ /1/2011 2/1/2012 5/1/2012 8/1/ /1/2012 2/1/2013 5/1/2013 8/1/ /1/2013 2/1/2014 5/1/2014 8/1/2014 China Value Added of Industry YoY China Retail Sales Value YoY China Fixed Assets Investment (Excluding Rural Households) Cumulative YoY Source: Bloomberg Pulling out key trends in activities reflected in both the New and the Old from the above: Government measures in response to the drop in industrial activity around the GFC drove the peak in fixed asset investment, and have been instrumental in supporting employment and retail sales. But while consumer prices have been growing around 2.5% recently, the trend in retail sales value, along with the declines in industry value added and fixed asset investment continue to trend down, and arouse concerns about a faster than expected slowdown. Nevertheless dairy import trends are expected to grow at higher rates particularly given consumer preferences in markets for infant formula and liquid milk. Hence the successful China-Australia FTA should be good for both Chinese consumers and Australian dairy exporters. 6 Situation and Outlook November 2014

8 Global demand Map figure 4: International dairy market, global dairy exports to select markets. Changes for 2014, 8 months to August Greater China: Volume: +24% Value: +43% Chinese buyers are yet to fully return to global dairy markets. Although some increase in purchasing activity is possible as the safeguard volumes associated with the NZ- China FTA roll over into a new quota year, expectations remain modest as to the market impact this will have. Russia: Volume: -14% Value: -9% The Russian market remains closed to sellers from the European Union, US, Canada, Australia, Norway and Ukraine. Early indications suggest Belarussian, Turkish and South American exporters are helping fill the gap; however a depreciating rouble and difficulties in sourcing replacement product have seen total dairy exports to Russia plummet, down 71% for August, relative to August Middle East: Volume: +9% Value: +19% Milk powders and fats continue to drive growth in 2014 as buyers capitalise on greatly improved affordability, relative to SMP and butter saw particular gains, up 35% and 26% respectively. Cheese volumes are down sharply, 17% lower than 2013 to date. Figure 5: International dairy demand, 12 months to August. 2,500 Southeast Asia: Value: +18% The ASEAN-6 (Indonesia, Malaysia, Philippines, Singapore, Thailand and Vietnam) continue to lead demand growth in the region. The slowdown in exports to China has increased access to product, and lower pricing has improved wholesale and retail margins while stimulating demand. Core powder and fat products are driving both volume and value increases. Japan: Volume: +1% Value: +7% While cheese volumes are down 1% in the year to August, butter and SMP are up significantly. This trend may continue, with reports of a growing butter shortage in Japan. The Ministry of Agriculture, Forestry and Fisheries (MAFF) is reportedly planning emergency imports of 3,000 tonnes of butter and 10,000 tonnes of SMP to cover anticipated shortfalls towards the end of the calendar year. 7 Situation and Outlook November ,500 1,000 thousand tonnes Volume: +5% 2, South East Asia 2010 Africa 2011 Middle East Greater China Japan 2014 Source: GTIS, Dairy Australia Note: Chart figures represent totals for 12 months to August of respective year Russia Mexico

9 Dairy affordability Figure 6: Dairy Affordability Index (SMP Base) More expensive Less expensive The benchmark SMP per tonne price in Dairy Australia s Affordability Index is around 48% lower than where it was in January and 17% below where it was in August, the reference month for the October Situation & Outlook report. Against the backdrop of the low price environment resulting from strong milk production growth and relatively sluggish aggregate demand, the Affordability Index suggests that prices remain significantly lower (from 10% to 30%) against 5-year averages in local currency terms across major importing nations. Lower commodity prices are offsetting the less favourable (for purchasers) impacts of slightly weaker currencies against the US dollar, although it is the Russian currency that has seen the only significant decline, around 13%, given the strengthening of the USD in October and early November. Buyers continue to have the upper hand while the global supply-demand balance is tilted in their favour. With prices heading in the direction of GFC lows, and no signals of an impending shock to supply on the near-term horizon, the period of sustained affordability continues. However, stronger global trade flows and domestic growth in emerging markets needs to be sustained over the medium term to support affordability on the demand side where it could otherwise be eroded by materially weaker currencies. Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 SMP benchmark China Japan Indonesia Russia Thailand Source: Bloomberg, Dairy Australia 8 Situation and Outlook November 2014

10 Australian market Consumer sentiment Figure 7: Consumer sentiment - remaining at lower levels Unemployment Figure 8: Edging up - employment and underemployment Inflation Figure 9: Prices outpacing wages- year-on-year changes in wage price index /2/2009 Pessimists outweighing optimists (below the line when index < 100) 1/2/2010 3/2/2010 5/2/2010 7/2/2010 9/2/ /2/2010 1/2/2011 3/2/2011 5/2/2011 7/2/2011 9/2/ /2/2011 1/2/2012 3/2/2012 5/2/2012 7/2/2012 9/2/ /2/2012 1/2/2013 3/2/2013 5/2/2013 7/2/2013 9/2/ /2/2013 1/2/2014 3/2/2014 5/2/2014 7/2/2014 9/2/2014 Source: ABS, Westpac-Melbourne Institute Consumer Confidence Consumer Sentiment SA % Nov-2007 Jan-2008 Mar-2008 May-2008 Jul-2008 Sep-2008 Nov-2008 Jan-2009 Mar-2009 May-2009 Jul-2009 Sep-2009 Nov-2009 Jan-2010 Mar-2010 May-2010 Jul-2010 Sep-2010 Nov-2010 Jan-2011 Mar-2011 May-2011 Jul-2011 Sep-2011 Nov-2011 Jan-2012 Mar-2012 May-2012 Jul-2012 Sep-2012 Nov-2012 Jan-2013 Mar-2013 May-2013 Jul-2013 Sep-2013 Nov-2013 Jan-2014 Mar-2014 May-2014 Jul-2014 Unemployment rate Source: ABS Underemployment rate 5.0% 4.5% 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Jan-2007 Wage price index Jan-2008 CPI Jan-2009 Jan-2010 Source: ABS: Consumer Price Index, Australia, Wage Price Index, Australia, Jan-2011 Jan-2012 Jan-2013 Jan-2014 > > Weaker consumer sentiment over last 8 months: below 100 indicates pessimists outweigh optimists. > > Households could be more inclined to trade down from more decadent dairy items. Pessimists continue to outweigh optimists (a reading of less than 100) according to the Westpac-Melbourne Institute Consumer Sentiment Index. The 94.8 reading in October was up marginally on September s This weighting towards pessimistic sentiment has held sway since February, though there has been no prolonged, further deterioration. In fact, the October survey actually indicated slightly brighter household sentiment on their shortand mid-term financial outlooks. This was attributed chiefly to delays in implementation of budget measures. > > Employment data from the ABS suggests that underemployment (now at 8.5%) has grown steadily although unemployment has remained relatively stable (now around 6.1%). > > More data that suggests that at least some households could be under pressure to trade down. Unemployment has remained steady at 6.2% according to the ABS (Oct 2014). Unemployment rates by state are highest in Tasmania (7.2%), Victoria (6.8%), Queensland (6.7%) and South Australia (6.6%). Structural changes have been affecting employment numbers across these states. Tasmania and South Australia have been experiencing net losses in population while Victoria and Queensland have been experiencing net gains and higher population growth. 1 Labour markets appear firmer in New South Wales, the ACT and Western Australia. Households in relatively weaker labour markets may be under more pressure to trade down or reduce purchases where they are seeing costs of living pressures but lower wages growth. > > Inflation remains within RBA target range. > > But CPI index suggests prices growing faster than wages. > > If the trend persists it could be less positive for spending generally. Inflation (per the ABS consumer price index) was up 2.3% through the year to September. Significant increases in fruit (+14.7%), property-related charges (6.3%) and motor vehicles (5.8%) offset declines in electricity (-5.1%) and fuel (-2.5%). Dairy CPI was up 0.9 (from 100.1, June qtr.) to in the September quarter. This growth in the dairy sub-component of the index was driven by increases in both cheese (+3) and ice cream and other dairy products (+0.2), which offset the fall in milk (-0.2). This is the second consecutive quarter in which dairy CPI has seen positive growth. Prices for services in particular have increased in recent years. Dairy prices have been constrained by supermarket pricing strategies, although cheese and other dairy product prices are firming. 1 The most recent ABS figures (looking at year-on-year growth to March 2014) identify WA (2.5%) as the fastest-growing, followed by VIC (1.9%) NSW (1.6%) and QLD (1.6%) (ABS Australian Demographic Statistics March 2014). 9 Situation and Outlook November 2014

11 Supermarket sales of major dairy products (2013/14) Major dairy products Milk Cheese Dairy Spreads Yogurts & D/Desserts Source: IRI-Aztec Volume (m. litres) Retail Value ($ m) Volume (kt) Retail Value ($m.) Volume (kt) Retail Value ($ m.) Volume (kt) Retail Value ($ m.) 1,306 2, , ,358 Year-on-year growth +1.2% +0.6% - 1.8% +2.0% +6.9% +6.7% n/c +2.9% Growth rates of supermarket sales were generally positive in the year to June Both butter and dairy blends volumes are growing strongly; fresh and UHT milks both showing positive growth; steady growth in yogurt volumes is offsetting falling dairy desserts volumes; although cheese volumes contracted following the heavy price discounting in the previous year. With milk sales volumes increasing 1.2% and sales value marginally increasing just 0.6% in the last twelve months, the average retail milk price has decreased by 1 cpl to $1.56 per litre. Fresh milk growth in the year was 0.6% for volume and just 0.2% for value, with average prices down 1 cpl to $1.58 per litre. The fresh milk share of the total milk market has slipped to 86%. Branded fresh milk volumes fell 3.0% in the year, down 1.6 share points for a share of 38% of total milk, with average prices up 4 cpl to $2.30 per litre. In the same period, private label fresh milk volume increased by 3.6%, for a share of 48% of total milk, with average prices steady at $1.02 per litre. The branded/private label split of fresh milk was 44%/56% volume and 64%/36% value for MAT June UHT milk volume grew by 5.0%, with value up just 3.6% in the last twelve months, therefore average prices are down 2 cpl to $1.38 per litre. The UHT milk share of the total milk market is up to 14%. The branded/private label split of UHT was 57%/43% volume and 61%/39% value for MAT June Figure 10: Drinking milk sales channel volumes (m. litres) 1,600 1,400 1,200 1, % 47.8% 49.5% 50.2% 51.2% 52.5% 52.7% 53.0% 53.3% 2005/ / / / / / / / /14 Supermarkets Other retail & foodservice supermarket channel share Source: DA milk sales collection and IRI-Aztec Supermarket milk sales continue to marginally increase their share of all drinking milk sales across Australia in 2013/14. 60% 50% 40% 30% 20% 10% 0% 10 Situation and Outlook November 2014

12 Fresh White milk segment trends The fresh white milk segment shares of full cream and modified milks have changed little over recent years; with volumes split about 55%/45% and values about 50%/50% over the past two years. However, the share split between branded and private label milks within the regular and modified segments has continued to steadily change since the supermarket milk wars broke out in early-2011 as shown in the following charts. Figure 11: Fresh White full cream segment mix - volumes 100% 80% 60% 40% 20% 0% Source: IRI-Aztec 71% 71% 70% 67% 68% 29% 29% 30% 33% 32% 2009/ / / / /14 branded private label Figure 12: Fresh White modified segment mix - volumes 100% 80% 60% 40% 20% 0% Source: IRI-Aztec 43% 49% 52% 51% 53% 57% 51% 48% 49% 47% 2009/ / / / /14 branded private label These changes have had significant implications for the profitability of those companies marketing branded fresh white milk products; with the lower margin branded full cream milks gaining share of the fresh white milk segment while, at the same time, losing significant share of the higher margin modified milk segment. Figure 13: Fresh White branded segment mix - values 100% 80% 60% 40% 20% 0% Source: IRI-Aztec 65% 63% 61% 58% 57% 35% 37% 39% 42% 43% 2009/ / / / /14 branded full cream branded modified Nevertheless, the price premium of branded over private label prices has increased significantly as the retailers moved to align full cream and modified milk prices. Figure 14: Fresh White % price premiums - branded over private label 100% 90% 80% 70% 60% 50% 2009/ / / / /14 full cream modified total Source: IRI-Aztec 11 Situation and Outlook November 2014

13 Cheese Supermarket cheese sales volume decreased by 1.8%, while retail sales value increased 2.0%, in the last twelve months. Consequently, the average price is up 54 cents per kg to $14.73 per kg. Chilled cheese and deli cheese volumes have both experienced quite different growth patterns over the past twelve months: chilled cheese volumes down by 2.7% and deli cheese volumes up by 3.7%. Figure 15: Supermarket Cheese price trends - $/kg $25.00 $20.00 $15.00 $10.00 Source: IRI-Aztec $23.08 $23.72 $23.94 $14.50 $13.09 $14.19 $14.73 $12.63 $ / / /14 Chilled cheese Deli cheese All cheese Chilled cheese prices have lifted 49 cents per kg to $13.12 per kg, delivering segment value growth of 1.2%. Deli cheese prices have lifted 22 cents per kg to $23.94 per kg and delivering a 4.7% increase in segment value. Heavy discounting of block cheeses in particular last year actually served to lower the segment average price. This has been reversed in the last year. Consequently, the volume growth patterns are quite different across the two segments. Figure 16: Supermarket Cheese segment growth trends - volume 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% -2.0% -4.0% -0.2% 9.2% 1.8% 1.4% 1.7% 1.0% -2.7% 3.7% Chilled cheese Deli cheese All cheese -1.8% Source: IRI-Aztec 2011/ / /14 12 Situation and Outlook November 2014

14 Dairy spreads Dairy spread sales volume increased strongly by 6.9%, while retail sales value increased 6.7%, in the last twelve months. Consequently, the average price is marginally down 2 cents per kg to $8.82 per kg. Butter and dairy blends volumes have both experienced quite healthy growth patterns over the past twelve months butter volumes up by 5.1% and dairy blend volumes up by 9.1%. Figure 17: Dairy Spreads segment price trends - $/kg $10.00 $9.50 $9.00 $8.50 $8.00 $7.50 $7.00 Source: IRI-Aztec $8.16 $8.24 $8.11 $9.01 $9.13 $9.18 $9.34 $8.60 $8.46 $ / / / / /14 butter blends Butter prices have slipped 5 cents per kg to $8.45 per kg, delivering segment value growth of 4.5%. Dairy blend prices have increased 2 cents per kg to $9.22 per kg and delivering a 9.3% rise in segment value. Prices have increased much more strongly in the dairy blends segment over the last five years than for butter. Nevertheless, apart from the jump in 2010/11, growth rates have been equally strong across both segments, although butter volume growth has been much more consistent. Figure 18: Dairy Spreads segment growth trends - volume 15% 10% 5% 0% -5% -10% 2.3% -6.1% 4.3% 4.9% 2.6% -0.1% 10.5% 4.9% 2009/ / / / /14 butter blends Source: IRI-Aztec 13 Situation and Outlook November 2014

15 Yogurts and dairy desserts Supermarket yogurt and dairy dessert sales volume was unchanged, while retail sales value increased 2.9%, in the last twelve months. Consequently, the average price is up 18 cents per kg to $6.56 per kg. Yogurt and dairy dessert volumes have both experienced quite different growth patterns over the past twelve months: yogurt volumes up by 1.1% and dairy dessert volumes down by 3.2% Figure 19: Fresh Dairy segment growth trends - volume 6.0% 4.0% 2.0% 0.0% -2.0% -4.0% -6.0% 3.9% Source: IRI-Aztec 1.4% 1.1% -3.0% -3.2% -3.7% -3.7% Yogurts Dairy Desserts Fresh Dairy 2011/ / /14 Figure 20: Fresh Dairy price trends - $/kg. $7.50 $7.00 $6.50 $6.00 $5.50 $5.00 Source: IRI-Aztec $6.92 $7.07 $6.24 $6.00 $6.38 $ % $7.23 $6.56 $ / / /14 Yogurts Dairy Desserts Fresh Dairy n/c Yogurt prices have lifted 21 cents per kg to $6.35 per kg, delivering segment value growth of 4.4% Dairy dessert prices have lifted 16 cents per kg to $7.23 per kg and delivering a 1.0% fall in segment value. Dairy dessert volumes have been steadily declining for a number of years now. Nevertheless, the segment has continued to deliver steady increases in average prices. Manufacturing sector developments Milk from the majority of dairy farmers outside Australia s southeastern dairying regions now goes mainly into local drinking milk markets. Where milk production is more heavily concentrated in the country s southeast, and total production volume far exceeds local drinking milk, as well as local manufactured product market requirements so a significant exportable surplus is converted into product which comprises the bulk of Australia s dairy exports. In light of an impending free trade agreement with China, many dairy farmers across the eastern seaboard s dairying regions have a renewed interest in export opportunities, notwithstanding logistics, regulatory, competitive financial and other challenges. After all, the Chinese market represents growth opportunities due to the current inability of the country s domestic industry to meet internal demand and ongoing urbanization (from 53% in 2012 to 60% in 2020) driving income growth (with disposable incomes expected to grow 11% by 2020) and westernization of diets, including a taste for dairy (per capita consumption of dairy products growing in rural areas at 15% and consumption of fresh milk in urban areas at 3% off a low base, according to the OECD-FAO), and strong consumer preferences for imported dairy goods with high food safety credentials. Against that background, three themes have emerged within the manufacturing sector in 2014 that reflect the Australian industry s continued export ambitions: 1. changing ownership rather than increasing (ownership) concentration 2. developing export-focused infant formula capacity 3. growing export-focused liquid milk capacity 14 Situation and Outlook November 2014

16 Key developments in connection with these themes are highlighted below. Changing ownership rather than increasing (ownership) concentration Changes of ownership have been more prevalent than significant concentration of industry through reduction in number of processors in recent years. Saputo takes Warrnambool Cheese & Butter (WCB) MG picks up larger share of Tasmanian Dairy Products (TDP) Parmalat snaps up Harvey Fresh R&R Ice Cream purchases Peters Ice Cream from Pacific Equity Partners (PEP) PG Cussons acquires 5am Saputo s takeover bid for WCB ended with the Canadian major acquiring an 87.92% interest in the Western Victoria-based manufacturer in mid-february Saputo had taken control of WCB earlier, around mid-january after picking up a greater than 50% interest, soon after Bega (BGA) sold its 18.8% stake in WCB. Shortly after, Murray Goulburn (MG) withdrew its bid and subsequently sold its 17.7% stake to Saputo. Due to Lion retaining a 9.9% holding, Saputo failed to achieve the greater than 90% interest that would have triggered a compulsory acquisition under the Corporations Act. WCB consequently remains listed on the ASX, pending any changes in listing eligibility per the ASX Listing Rules (for example, a reduction in the number of shareholders below the 400 threshold). The Chairman has outlined a vision for WCB to accelerate its growth activities, invest in capital projects, increase manufacturing capacity, grow milk intake and create new opportunities. Tasmanian Dairy Products (TDP) was established in 2011 as a joint venture between MG, local interests Little Lion, and Mitsubishi. MG earlier this year acquired the local party s interest taking the co-op s share of the joint venture from 56.1 to 76% Mitsubishi retains the remaining 24%. TDP specialises in bulk commodity milk powders. TDP s establishment has brought greater choice in prospective suppliers for Tasmanian farmers and the operation s continued growth should support farm gate price competition. Parmalat acquired West Australian dairy producer Harvey Fresh for a reported $120 million. Harvey Fresh owns two production facilities (Harvey and Griffith) with approximately 250 employees. Parmalat described the purchase as broadening its geographic footprint in that country [Australia] and becomes a fully national player. This acquisition improves the Group s export capability to [Asian] markets. Harvey Fresh has a well-established position in WA s drinking milk market and an established export business, shipping mainly bulk milk to Singapore and other countries including Hong Kong, the Philippines, China, Malaysia and Indonesia. WA s drinking milk market faces challenges in keeping up with population growth (up 2.9% year on year from 2012 to 2013) and WA farmers have a limited number of prospective supply options (Lion, Parmalat, Brownes); while the acquisition does reduce the number of players at a national level, consumers and farmers stand to benefit from a committed manufacturing sector. Europe s second largest ice cream manufacturer R&R Ice Cream purchased Peters Ice Cream from Pacific Equity Partners (PEP). Peters last changed hands when acquired by PEP from Nestle in 2012 for some $245 million. Local media suggested that R&R paid close to $450 million [nine times forecast earnings before interest tax, depreciation and amortisation (EBITDA)] for Peters, which accounts for just under 30% of the value of the $992 million supermarket retail ice cream market according to Nielsen. R&R indicated it intends to maintain Peters operations at Mulgrave. PZ Cussons local unit acquired Melbourne-based organic yoghurt manufacturer 5am for just under $80m (reportedly 12.8 times EBITDA). Cussons is looking to build on its growing local range of food brands. Established in 2011, 5am s expansion of distribution into the major supermarkets helped make the yoghurt maker the fastest growing manufacturer across all supermarket categories nationally, according to available IRI-Aztec data (for the 12 months ended 29/06/14). 15 Situation and Outlook November 2014

17 Developing export-focused infant formula capacity Australian dairy manufacturers of infant formula are focused on export markets, primarily China and other Asian destinations. ABS data does not capture Australian exports of infant formula. However, based on data from GTIS, the chart below captures the total of traceable imports from all origins into both China (including Hong Kong) and key ASEAN markets (Thailand, Indonesia, Malaysia, Philippines and Singapore). Based on 12-month rolling totals up to the end of September, imports into China have grown at an average annual rate of 18%; although some recent disruption to trade occured as the number of infant formula brands sold in China was rationalised. Excluding the latest 12 month period for imports into the ASEAN-5, which understates volumes due to lags in data collection, the southeast Asian economies still represent a significant market, albeit one experiencing a lower growth rate of 1%. Figure 21: Infant formula import (volumes) into China and ASEAN markets 140, , ,000 80,000 60,000 40,000 20, * China (inc Hong Kong) Source: GTIS, Dairy Australia Selected ASEAN (TIMPS) Rapid volume growth in China s infant formula market have slowed, but reasonable growth is nonetheless still expected over the medium term. According to outlooks on infant formula consumption in China forecasting average annual growth rates from 5% to 8% through to Yet ongoing moves by China s administration to promote the consolidation and growth of major domestic dairy manufacturers, as well as growing investments and collaboration by major global companies such as Danone (amongst others) with local companies, reflect the intensifying competition in that market. But accredited Australian manufacturers are still seizing opportunities in the China market, with the cachet of Australian origin and associated food safety and quality credentials providing a competitive advantage. 16 Situation and Outlook November 2014

18 This year has seen several existing or prospective infant formula manufacturers in Australia expanding capacity for export, as outlined below: Bega Group s Tatura canning at Derrimut Burra expanding in Gippsland ViPlus canning at Toora Camperdown Dairy International (CDI) establishing at Camperdown Midfield founder proposing dryer for Warrnambool Gina Rinehart venturing into dairy Fonterra partnering with Beingmate: Darnum-centred joint venture Bega s Northern Victorian-based Tatura subsidiary has historically manufactured infant formula for Snow Brand other major companies as well as local brands such as Bellamy s. Tatura s Derrimut (Western Melbourne) blending and canning facility commenced production in April The facility gained the requisite infant formulaspecific approvals to supply China in July 2014, with a reported capacity of up to 16,000 metric tonnes. Bega has invested in incentive payments to grow milk supply and is expected to grow its infant formula business, having highlighted it as one of the group s strategic priorities. Burra CEO Grant Crothers confirmed around mid-august that the Gippsland-based company s new infant formula capability is fully operational with production at capacity. Burra s plant and many of the company s key customers have obtained the required accreditation from the Certification and Accreditation Administration of the People s Republic of China (CNCA) to market infant formula in the Chinese market. Burra has previously indicated it expects to export up to 10,000 tonnes of infant formula product. Continued growth and expansion of local manufacturing supports dairy farmers in Gippsland. ViPlus has established a blending and canning capability at the previously disused Toora Bonlac facility. The CNCA-accredited company is reportedly sourcing inputs from major manufacturers. Longer term, however, ViPlus also reportedly plans to establish its own manufacturing capabilities. New entrants support favourable dairy farmgate price dynamics and can contribute to local communities. Camperdown Dairy International (CDI), like ViPlus, is an aspiring new entrant with export ambitions. Backed by mining services company MCG Group, the Eat Groupmanaged CDI enterprise aims to establish a vertically integrated operation spanning pre-farmgate production through to post-farmgate manufacturing and export marketing. CDI purchased its proposed manufacturing site (a former Bonlac facility at Camperdown) from Camperdown Dairy (the recently rebranded and unrelated dairy business unit of Aussie Farmers Direct), which will continue operations at the same site. CDI has indicated that it aims to establish export-focused powder and infant formula manufacturing at the site to fulfil contracts with Asian customers. CDI does not yet have full manufacturing capabilities established; however the company is reportedly working on arrangements with local dairy farms to acquire supply for the planned operations. The company has also acquired some capabilities through the acquisition of a local Melbourne-based blending and canning operation. New entrants are presenting opportunities and challenges for growth, potentially bringing options for dairy farmers and local communities, but also raising hopes for growing the domestic milk pool. Midfield Meats founder Colin McKenna is reportedly proposing the establishment of a milk powder plant in Warrnambool. Mr McKenna confirmed he had been looking for a site within Warrnambool and that although details were not yet finalised he aimed to have the plant up and running in 12 to 18 months. The emergence of another manufacturer in the Warrnambool area is likely to further intensify competition for milk supply in Western Victoria, particularly given the strong pricing offers from newcomers such as the Australian Dairy Farmers Cooperative in Gina Rinehart, chairwoman of Hancock Prospecting Pty, is planning to invest up to $500 million in a dairy farm-to-factory venture via a Hancock Prospecting-controlled company called Hope Dairies which will combine farm and factory assets in Queensland. Hope Dairies is reportedly looking to purchase over 12,000 acres to establish a 10,000 milking cow farm in Queensland s South Burnett region and construct infant formula (up to 30,000 tonnes per annum) and UHT manufacturing capability in the Mary Valley. Local industry has been encouraged by initial statements from Hope spokespeople suggesting that the venture could also use local suppliers milk. China National Machinery Industry Corporation (Sinomach), a state-owned enterprise, is reportedly partnering with Hope Dairies in establishing the venture, which is aiming to commence production from the second half of calendar Fonterra late in August announced it was entering into a partnership with China s Beingmate that would see the NZ co-op draw on its milk pools and manufacturing sites to supply infant formula to China. The initial stage of the partnership involves Fonterra taking up to a 20% stake (valued at over US$500 million) in subsidiary Beingmate Baby and Child Food. Pending regulatory approvals, the key components of the partnership s second stage are expected to involve (i) the formation of a joint venture company that will purchase Fonterra s Darnum facility from Fonterra and (ii) an agreement to distribute Fonterra s branded infant formula in China. 17 Situation and Outlook November 2014

19 Growing export-focused liquid milk capacity Manufactured products still utilise the majority of Australia s raw milk production (less than 30% goes into liquid drinking milk, most of which is consumed locally). And bulk commodity exports such as cheese and milk powders (which require much greater volumes of milk to produce) remain the mainstays of Australia s exports in dairy. Yet there is conspicuous growth in liquid milk exports, off a low base, and a story about niche opportunities with companies seeking to capitalise on premium prices for Australian product, at least in the short term. Australian dairy manufacturers of liquid milks including ESL and UHT milk have historically focused on a combination of domestic and export markets, particularly southeast Asian destinations, and more recently China has become a significant destination: (China, Hong Kong and Singapore collectively accounted for 60% of the liquid milk volume exported from Australia in 2013/14). Available ABS data in the chart below shows the steady growth especially since 2011 in exports of liquid milk from Australia (to all destinations). Manufacturers from Victoria and Western Australia have been growing the trade over recent years. Norco, the northern dairy industry co-operative, began contributing to that growth with the launch of its export of fresh milk to China, which commenced in May. The available ABS data does not reveal the type of milk exported (that is, whether it is UHT or ESL), since the bureau categorises it instead by fat content in line with tariff codes. Most of the volume exported, however, is assumed to be either UHT or extended shelf life (ESL). Around 95% of the liquid milk exported comes from Victoria and Western Australia. Australian exports of liquid milk have grown in both volume and value at an average annual rate of 11% since Increased volumes to Singapore (a hub for trans-shipment to other southeast Asian destinations) and significant growth in exports to China have been the drivers: shares of total volume exported for Singapore have grown from around 50% to 60% while those for China have leapt from 1% to 21% between 2007/08 and 2013/14. Figure 22: Australian liquid milk exports (volume and value) Existing and prospective liquid milk exporters have been expanding their activities, as the publically announced examples outlined briefly below attest: Bega Group sign deal with major Western China retailer Pactum Dairy Group expanding business via Bright deal Bega has signed a deal to supply Chongqing General Trading Group (CGTG) with Bega-branded milk, expected to generate revenue of $100 million over five years. Bega is reportedly having the product contract manufactured by Pactum Dairy Group. Freedom Foods-Australian Consolidated Milk joint venture Pactum Dairy Group (PDG) has opened its northern Victorian plant, where it expects to initially produce 100 million litres per year of UHT. China s Bright Foods is expected to take one quarter of Pactum s production volume in the first year under a strategic supply agreement. PDG is a joint venture between Kyabram-based Australian Consolidated Milk (ACM) and ASX-listed Freedom Foods Group. PDG s plant has initial capacity for 100 million litres of milk production, with capacity of up 300 million litres long term. Figure 23: China liquid milk imports (from all origins volume and value) Source: GTIS Volume ('000 tonnes) Value ($ USD m) MAT Aug 2008 MAT Aug 2009 MAT Aug 2010 MAT Aug 2011 MAT Aug 2012 MAT Aug 2013 MAT Aug 2014 Source: GTIS Volume ('000 tonnes) Value ($ m) 18 Situation and Outlook November 2014

20 Global supply Overview With farmgate milk prices beginning to fall, margins are likely to tighten for farmers in key international exporting regions over the coming months. However, milk production remains strong, supported by broadly favourable weather conditions, and is likely to continue to grow into early Figure 24: Milk production. Major dairy producers % milk production growth vs prior year 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% YTD 2014: 9% Fcst 2015: 2% YTD 2014: 5% Fcst 2015: 2% Fcst 2015: 3% Fcst 2015: 2% YTD 2014: 2% NZ EU-28 US Aust Source: DCANZ, EU commissioner, USDA, Dairy Australia Note: Columns denote YTD growth, points projected growth. Width of column represents export share in MEQ Farmgate price movements 4 largest exporters Change in indicative farmgate price YTD 2014: 0.4% NZ EU-28 US Australia Compared to prior month -12% Steady -2% Steady Compared to prior year -37% +1% +21% -13% Northern Hemisphere European milk production is now expected to reach a record 151 billion litres in 2014 (up nearly 4%), despite the impact of falling dairy commodity markets beginning to reach the farmgate. Some EU member states (including Ireland, Germany, the Netherlands and the Baltics) have already seen prices dip below 2013 levels in data to August. Others (including France, Spain and the UK) are seeing prices holding up for longer.the possibility of quota overrun and superlevy penalties are also likely to weigh on producers in some member states. However, falling feed prices are helping cushion margins, and in its most recent Short Term Outlook the European Commission suggests milk deliveries may only begin to trail 2013 monthly volumes in November and December. The impact of Russia s import ban continues to be felt, with significantly larger volumes of milk directed to products other than cheese in particular SMP and butter; both being eligible for intervention and private storage aid (PSA). A strengthening supply response is being observed in the US, with September data from the USDA indicating milk production 4% higher than September 2013; bringing the year-to-date growth to 2%. The US market has held its ground for much longer than international prices; however recent weeks have seen prices begin to converge with world levels. This has been driven by slower exports, the arrival of import shipments, (primarily from Oceania) and the effects of high pricing reducing demand. At the same time, growing milk supply has tested capacity for some processors, leading to spot trades of milk and, for some, opportunities to make cheaper product. US milk production is expected to remain strong well into the first half of 2015, but as margins tighten, headwinds will intensify later in the year. Southern Hemisphere Milk production growth in New Zealand has outpaced earlier expectations, with Fonterra s collection volumes up 4.5% to September. The current Farmgate Milk Price forecast of NZ$5.30/kg MS assumes a late season price recovery that is increasingly seen as unlikely, leading banks and other analysts to predict a sub-$5.00/kg MS outcome. With some farmers hard-pressed to remain profitable at such prices, much will depend on late season weather conditions. Unfavourable weather is likely to trigger early dry-off of herds, where purchases of supplementary feed are uneconomic. Current forecasts anticipate 3-4% full season growth. After a marked slowdown in growth as the new season commenced, Australian milk production has steadily pushed ahead of last season. Driven by favourable weather conditions in most major production regions, growth reached 4% in September, equating to 2.8% (2.34 billion litres) for the season to date. Given the lower and flatter peak seen in 2013/14, a comparatively strong October is possible; however deteriorating seasonal conditions are increasingly likely to weigh on production heading into summer. Of particular concern is an accumulating moisture deficit (particularly in rain-fed areas such as southwest Victoria and southeast South Australia). Dairy Australia s national milk production forecast range for 2014/15 remains 9.35 to 9.45 billion litres; around 2% growth on 2013/14. Uruguay and Argentina are experiencing a return to year-on-year production growth (2% and 3% respectively in September) after excessive rains slowed output through autumn and winter. Additionally, the Argentinean government has relaxed export restrictions that hampered shipments earlier in the year; however it has signalled that it will intervene further if deemed necessary to control food price inflation. 19 Situation and Outlook November 2014

21 Input Markets Fertiliser Urea DAP MOP N 7 P 15 Source: Bloomberg K 19 (granular Middle East) (US Gulf) (granular Vancouver) US$/t 375-6% US$/t % US$/t % Cows Cull cows Live exports Dairy Australia Export Region Weighted Cost and Income Indices The weighted cost and income indices consider the near-term outlook and highlight the net impact of market changes. The latest update to the indices suggests: > > The outlook for margins remains challenging relative to 2013/14; however the analysis suggests a more favourable operating environment than the difficult 2012/13 season. > > The announced freeze by many processors of farmgate milk prices at current levels confirms the limited upside potential for incomes, with a substantial recovery in commodity prices unlikely in time for a significant impact during the current season. > > Firmer grain and hay prices are expected to pressure margins from a cost perspective, although weaker fertiliser prices provide a small offset even after adjusting for the depreciating AUD. Figure 24, shows the Export Region Weighted Cost and Income Indices with seasonal averages of the cost and income lines plotted. Figure 25: Export Region Weighted Cost and Income Indices 283 c/kg +2% 25,140 head +9% 13,231 head -20% 140 Source: NLRS and ABS 120 Water Temporary water price Northern Victoria Murray Irrigation System Source: Victorian Water Register and Murray Irrigation Ltd 114 $/ML +44% 672,790 ML +47% 118 $/ML +102% Prices are averages for October % change compares to the 5-year average. Number of head of cattle, or volume of water traded, is YTD ,192 ML +5% Index value Apr-08 Jun-08 Aug-08 Oct-08 Dec-08 Feb-09 Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10 Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 Feb-13 Apr-13 Jun-13 Aug-13 Oct-13 Dec-13 Feb-14 Apr-14 Jun-14 Aug-14 Oct-14 Dec-14 Feb-15 Apr-15 Cost index Income index Cost index (season avg) Income index (season avg) Note: The size of the shaded area provides a whole season perspective, indicating how relatively good (blue) or bad (green) a year was (or is expected to be). 20 Situation and Outlook November 2014

22 Fertiliser Fertiliser remains a significant cost item for dairy farmers, representing 8% of average cash costs in 2013/14, according to Dairy Farm Monitor Project data. International benchmark fertiliser prices remain below 5-year averages; however significant changes in the AUD/USD exchange rate over recent months may reduce the benefit to Australian buyers. While reduced production and strong demand contributed to an increase in international benchmark urea values in recent months, prices remain 6% (or US$26/t) below average: but 4% ($15/t) above average in AUD terms. DAP is up on year earlier levels, but sitting 14% (US$72/t) below average: exchange rates make this 5% ($26/t) in AUD terms. Continued oversupply contributed to potash prices remaining relatively unchanged at US$128/t (A$108/t) below year-earlier levels, 27% below average; or 19% in AUD terms. Looking forward, if international grain prices continue to be relatively week, this could reduce fertiliser demand in the coming season. Water The average temporary water price for both northern Victoria ($114/ML in October) and the Murray Irrigation system ($118/ML in October) remains significantly above both year-earlier levels and the 5-year average; 63% and 44% for Northern Victoria, and 79% and 102% for Murray Irrigation system. Demand was down in northern Victoria, with the volume traded 29% below year earlier levels (but 49% above average), but remained strong for Murray Irrigation system, up 14% on year earlier levels, and 61% above average. As of November 17th, seasonal determinations for all northern Victoria river systems regulated by Goulburn Murray Water had 100% allocation against High Reliability Water Share (HRWS). The Bullarook Creek and Broken systems also have 100% and 95% LRWS allocation, respectively. Murray Irrigation Ltd. general security (Class C) allocations are at 45%. Water levels are lower than 12 months previously for the Dartmouth (8%), Hume (17%), Eildon (12%), Waranga Basin (8%), Eppalock (27%) and Glenmaggie (2%) storages. The Bureau of Meteorology s ENSO (El Niño-Southern Oscillation) tracker was raised to ALERT level on November 18th, indicating a 70% or greater chance of El Niño occurring. The Southern Oscillation Index (SOI) has exceeded El Niño thresholds for most of the last three months, and the Tropical Pacific Ocean has been warmer than average. Further warming has occurred in the past fortnight, and international climate models predict that conditions will continue or strengthen in the next two to three months. Such events are generally linked to warm, dry weather in many parts of the country. Cows Cull cow sales volumes are up 22% on year earlier levels for 2014/15 (to end October), totalling 25,140 head. This is 20% above the 5-year average. The average price is up 6% (288c/kg) and 2% above normal: prices have been supported in recent months by strong demand for manufacturing beef out of the US. According to Meat and Livestock Australia, Australian beef cattle production is expected to dip in US beef production is also expected to continue declining next year. This could support cull cow values in the near future. Live dairy cattle export volumes were down 52% on year-earlier levels in September: 34% below the 5-year average. Financial year-to-date exports are 11% below 2013/14; discussions with exporters suggest the drop in exports may be associated with difficulties accessing supply. China remains the major buyer so far this financial year, being the destination for 95% of stock exported. Feed Grains and Hay Victorian Dairy Farm Monitor Project data shows average expenditure on grains, concentrates and other feeds accounted for 29% of cash costs during 2013/14, demonstrating the potential for grain market movements to impact on margins. After several downgrades throughout the year, the most recent USDA estimate puts the Australian 2014/15 wheat crop at 24 million metric tonnes (MMT): 1 MMT down on the previous month, and compared to an estimated 27 MMT last year. The increased pressures on the domestic crop, and increases in global markets, are impacting local prices. Prices were above the average in October across all but three of the dairying areas regularly surveyed in the Dairy Australia Grain & Hay Report. While wheat crops are looking reasonable within the trading range of dairying areas such as the Bega and Goulburn/Murray valleys, dry conditions in southwest Victoria are cutting into crop yield potential. Feed prices remain a challenge in northern Australia, however yields and quality of early harvested grains have generally been acceptable. Barley is coming under pressure from exporters. International benchmark grain prices fell through September, recovered ground in October, and fell again through the start of November. Prices gained ground as the market developed nerves about the central US wheat crop, and following release of the November USDA WASDE (World Agricultural Supply and Demand Estimates) report, which revised 2014/15 global wheat supplies down by 1.1MMT. The report revised the EU production estimate up by 1.4MMT. The estimate for global supplies of course grains was raised 1.6MMT, despite a small decrease in US corn production. The Australian 2014 hay season is well underway, with consequent fluctuations in hay prices as the market tries to establish a clearer outlook for the season. Production has been mixed, with later winter rains assisting reasonable yields on the NSW north coast, and large quantities of cereal hay being cut in southern NSW and northern Victoria. However, it is expected that yields will be down overall, with factors such as the dry finish in the Wimmera/Mallee and parts of the Riverina contributing to this outcome. The WA cereal hay harvest is coming to a close, with average yields and good quality achieved in some regions, and others suffering quality downgrades after heavy rains. This downgraded hay may present opportunities for domestic purchasers. 21 Situation and Outlook November 2014

23 Figure 26: Grain and Hay prices around Australian dairy regions > > The relevant stockfeed wheat available in a region (ASW, AGP, SFW1 or FED1). > > Shedded cereal hay; mid-range product without weather damage, of good quality and colour. Prices are estimates in $/t at 31/10/2014; GST exclusive but include delivery and (for grain) an allowance for storage and marketing costs. % price change compares to the 5-year average. Atherton Tablelands $363 +4% N/A Darling Downs $320 +9% $ % North Coast NSW Southwest WA Central Districts SA Central west NSW $323-3% $ % $291-4% $170 +2% $ % $ % $ % $ % The Grain & Hay Report provides a comprehensive overview of the market and indicative pricing by dairying region, and is published most weeks at: Supplements-and-nutrition/Supplementary-feeds-2/ National--Grain-Hay-summary.aspx The Production Inputs Monitor provides statistics and commentary for grain, hay, fertiliser, weather, water and cull cows on a monthly basis: Farm-inputs-and-costs/Production-Inputs-Monitor.aspx Source: AFIA, Profarmer Grain, Lachstock Consulting Southeast SA Goulburn/Murray Valley $272 +2% $275 +5% $ % $ % Southwest Victoria $277 +6% $ % Northwest Tasmania $326-4% $ % Bega Valley $ % $ % Gippsland $303 +4% $ % 22 Situation and Outlook November 2014

24 Exchange rates The Australian dollar (AUD) hit a four-year low and hovered between 86-87c for several days in early October, the currency has since trended back up against the US dollar (USD) and in early November was floating around USD 0.88c. With the US central bank announcing the completion of its quantitative easing (QE, or bond-buying) program, stronger purchasing of USD and USD-denominated assets is expected. The US currency is set to attract greater buying as purchasers pick up US dollars in anticipation of improved returns given the brighter economic outlook, and expectations of higher interest rates being realised in the US sometime in Hence the AUD and other major currencies, including the euro, are still expected to decline against the USD in Figure 27: Australian dollar and Euro against US dollar $1.40 $1.35 $1.30 $1.25 $1.20 $1.15 $1.10 Q3 13 Q4 13 Q1 14 Q2 14 Q3 14 Q4 14 Q1 15 Q2 15 Q3 15 $0.96 $0.94 $0.92 $0.90 $0.88 $0.86 $0.84 $0.82 $0.80 Over the September quarter, the AUD fell 6.4% against the USD, according to Bloomberg. The lower AUD continues to support the competitiveness of Australian exporters and should make some positive contribution to returns for Australian exporters, and by extension, local farmgate prices. Nevertheless, the extent of any boost from the currency is constrained by low international dairy commodity prices. After all, prices of major dairy commodities (such as milk powders and cheese) have continued to decline over recent months and are now between 20-50% down on January levels. October also saw some significant weakening of the yen against the USD: the Japanese currency reached a seven-year low against the USD in early November. The yen has over the last two years moved down about 35% against the USD. Japan s households have over the same period seen declining real wages, increasing import prices and the increase of the country s sales tax from 5% to 8% (and another rise to 10% anticipated): all in all, tougher conditions for customers in a key destination for Australian dairy exports. But as Japan s central bank relaunches its own assetpurchasing programme, designed to reinvigorate inflation and growth (at the same time as the US concludes its QE), the AUD is expected to receive some upward pressure. There are also concerns the move could spark efforts by competitors to devalue their currencies which could potentially reduce purchasing power across several dairy export markets. Historical EUR/USD (LHS) Major Euro Banks Forecast EUR/USD (LHS) Bloomberg Forecast AUD/USD (RHS) Forecast EUR/USD (LHS) Historical AUD/USD (RHS) Aus' Big 4 Banks Forecast AUD/USD (RHS) Source: Bloomberg 23 Situation and Outlook November 2014

25 Policy Updates Front-of-pack labelling The Health Star Rating The Health Star Rating (HSR) is a voluntary front-of-pack labelling scheme endorsed by the Australian and New Zealand Ministerial Forum on Food Regulation ( the Forum ). Developed by government in consultation with food industry, public health and consumer groups, the scheme uses a calculator based on five nutrients to rate the healthiness of the food, awarding stars from zero to five to help consumers make healthier food choices. In earlier iterations of the HSR, the nutrient-based approach was not favourable for dairy foods; particularly milk, cheese and yogurt; core foods recommended in the Australian Dietary Guidelines as foods to enjoy every day. Dairy industry groups including Dairy Australia, the Australian Dairy Industry Council and dairy manufacturers collaborated closely with HSR stakeholders to ensure these core dairy foods were rated in line with Australian Dietary Guidelines at three stars and above. As a result, separate calculator categories were developed for core dairy foods to align scores to be more in line with dietary recommendations, yet some anomalies persist. Dairy industry groups including Dairy Australia will continue to address anomalies with the Health Star Rating identified for milk, cheese and yogurt through the formal processes endorsed by the Forum to secure the minimum three stars for all core dairy foods and ensure consumers are informed of the nutritiousness of dairy foods The new Health Star Rating labelling is to be implemented voluntarily across Australia and New Zealand by manufacturers over a five-year period. It provides flexibility for manufacturers to choose to display just the star rating and energy icon, providing a better communication of the healthiness of core dairy products. Trade policy update China Australia Free Trade Agreement The Australian Dairy Industry Council (ADIC) has welcomed the signing of the China-Australia Free Trade Agreement (FTA), as an important moment for Australian dairy. The deal, which was signed on 17 November 2014, will ultimately see the total removal of all dairy export tariffs faced by Australian dairy exports to China. The FTA will also enable the Australian dairy industry to further develop its long-term relationship with China and to compete on a more level playing field in the Chinese market against key competitors such as New Zealand. As a result of the deal, the industry can expect positive flow on effects throughout the supply chain, in particular through substantially reduced tariffs on key dairy products such as infant formula, cheese, milk powders, butter and fresh milk. Item Current Tariff Tariff Phase out period 2014 Milk & Cream 15.0% 9 years SMP 10.0% 11 years WMP 10.0% 11 years Butter 10.0% 4-9 years Cheese 12.0% 4-9 years Infant Formula 15.0% 4 years NB: only major dairy product lines selected. Safeguard applies for WMP 24 Situation and Outlook November 2014