Dairy stocks: milk, but no honey

The ads with Rihanna and David Beckham showing white moustaches are not working. Milk drinking in the west is on the wane.

Between 2000 and 2013, US per capita consumption of milk dropped by a tenth, according to the US Department of Agriculture. Dairy in total is up 3 per cent (Americans are cramming down ever more butter and yoghurt, thank goodness). But US dairy production has grown by a fifth and the UK looks similarly lopsided. Given the imbalance, farmers have welcomed the emergence a new market: China.

Goldman Sachs forecasts that dairy consumption in China between 2013 and 2018 will grow at a compound annual rate of 7 per cent, well ahead of the average 2 per cent for the biggest-consuming countries. International dairy companies have been piling in. A wobbly domestic supply chain has led to safety concerns, so foreign brands have appeal. Still, as the market has grown imports have remained a fraction of domestic production, at 2.4 per cent of the total, Bernstein says. Foreign companies have also partnered with local brands. French Danone is tied up with Hong Kong-listed Mengniu Dairy and Yashili while New Zealand's Fonterra (often touted as a play on Chinese demand) is tied to Beingmate.

Despite bullish long-term prospects, the near-term outlook for milk looks to be turning. Inventory build-up in China last year has removed a big component of global demand. This March, the removal of EU production caps will add to supply, even as Russia's ban on buying EU dairy products in retaliation for Ukraine-related sanctions continues. On Wednesday, Yashili warned on profits, guiding that 2014 earnings would fall around two-fifths.

Given what looks like a serious supply glut, Chinese dairy stocks do not look cheap: Mengniu and Yashili trade at nearly 20 times forward earnings (and estimates are likely to come down). Fonterra is no bargain at 15. We're going to need some new advertisements.

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