Increasing demand, low cost structure and strong forecast returns - just some of the 7 reasons to invest in dairy

7 reasons to invest in dairy

1.      Demand.

The world wants more quality animal protein.  As a result of population growth and the dietary switch to animal proteins in emerging economies, demand for dairy products is growing faster than the output from farms.  It is estimated that by 2050 the one hectare of farmland that supported one person in the mid 1980s will be required to feed 1.8 people[1].  It is uncertain whether the global supply of suitable farmland and productivity improvements will satisfy this increased demand for food.

2.      Efficiency

New Zealand grass based dairy farming systems are sustainable, low cost and very productive.  This is in contrast to 90% of the world where cows are confined and are fed grain-based and other high cost rations.  This is borne out by the current milk price to feed cost ratio - on a typical New Zealand dairy farm this ratio is 3.7 times[2] versus 1.9 times[3] in US dairy confinement systems.  This trend won’t change soon as crops are also in demand to feed a growing human population and for biofuels production.

3.      Profitability

Pastoral dairy farms are and have been very profitable:  In the 10 years to 2010, New Zealand dairy farms made an average pre-tax rate of return of 11.8%[4] p.a.  On average, 37% of this annual return came from operating profits, and the other 63% came from land appreciation.  The capital appreciation in pastoral dairy farmland relates to increases in both productivity and milk prices.  Over the 15 years to 2010, on average per hectare milk production increased 44%, milk prices increased 87%, pre-tax operating profit per hectare grew by 339% and land grew in value by 119%[5].

4.      Success

The dairy industry is one of New Zealand’s business success stories - The NZ dairy industry is an integral part of the NZ economy, producing more than $NZ11.3billion of exports or 25% of NZ’s merchandise trade. The wholly farmer owned dairy cooperative, Fonterra is New Zealand’s biggest company and the world’s leading exporter of dairy products. Fonterra suppliers represent just 3% of the world milk supply, but nearly 35% of internationally traded dairy products. In its recently announced 2011 financial results, Fonterra noted an increase in their after-tax profit to $771 million and a 19 percent increase in revenue to $19.9 billion.

5.      Diversification

Dairy farm investments are different from other asset classes; farmland and dairy outputs are tangible, in increasing demand globally, and essential to life.  Dairy farm investments can enhance investment portfolios; over the past 10 years, returns from farmland internationally (operating profit and capital appreciation), have generally been superior to and only weakly correlated with returns from shares and bonds.  Farmland is a good hedge against inflation. 

6.      The future outlook

• Now is a good time to be investing in New Zealand dairy farms; farm profits are up, farm prices are down and the outlook for internationally traded milk products is positive.
• Pastoral dairy farms have historically sold at prices equivalent to a milk revenue multiple of 3.5 – 6.5 times, and are currently selling towards the bottom of this price range.  The current low milk price multiple is a consequence of a combination of high milk prices, increased productivity and reduced farm sale prices.
• Farmers are, in general, using these record profits to repay debt rather to than purchase more farm land, and both farm sale numbers and sale prices have dropped as a result of this drop in demand from incumbent farmers. 
• Estimates, based on FAPRI[6] projections of the global supply and demand for milk commodities, that the volume of milk needed to meet international demand, will need to increase by 41% in the 10 years to 2019. 

• The projected ‘unmet demand’ gap implies that there are opportunities for existing and new suppliers to increase their participation in a growing world market and that firm (upward) pressure on commodity prices will be maintained.

7.      MyFarm forecast returns

• Cash returns of 6 – 8% p.a. at a $6.50/kgMS milk price.  The milk price in 2010/11 was $7.60/kgMS and is forecast at $6.75/kgMS for the 2011/12 season.   
• Capital growth that is driven by productivity growth and dairy demand growth.
• Total returns of more than 10% p.a.