August 30, 2013 12:01 pm

China dairy: of milk and money

If industry can shed the scandals, it is worth investors taking a look

Fancy a splash of milk with that? In China’s case the country does not have nearly enough to offer. Small dairy farms with low production yields are failing to meet demand. Distrust of scandal-hit local brands has driven parents as far as the UK and Australia in search of foreign-made baby milk. And to top it off, one of those foreign producers has been caught up in its own scare.

Still, the share prices of China Mengniu, the domestic industry’s biggest dairy processor, and China Modern Dairy, the top supplier, just jumped after Mengniu’s tie-up with Danone, among others, boosted first-half sales. If China’s milk industry can shed the scandals, it is worth investors taking a look.

Over the past seven years, China’s milk consumption has doubled but raw production has been growing at less than 2 per cent a year. The country’s dairy farms are mostly small operators, and the top five producers hold a mere 5 per cent of the total market, according to Macquarie research. For example, Modern Dairy, at number one, has only a 1.3 per cent share. And its average milk yield per cow, at 5 tonnes a year, is a sixth below more developed producers such as Australia and half that of the US.

Chnia’s domestic production already falls 30 per cent short of demand, which is expected to grow by more than 10 per cent a year for the foreseeable future. That will almost double milk consumption from about a pint, or half a litre, per person each week by 2018.

Beijing officials are trying hard to get the milk industry in order. The government took an 18 per cent stake in Mengniu in 2009 after the company was laid low by the melamine scandal. This year, Mengniu bought a 28 per cent stake in Modern Dairy, among other deals. Having a number of larger-scale milk suppliers would make it easier to control quality; a big factor in the recent contamination scandals was the myriad of small producers that failed to meet onerous rules.

Meanwhile, China’s number two supplier, Liaoning Huishan Dairy, is readying a Hong Kong stock market listing to raise about $1bn to fund more cows and improve yields. Investors should consider more than a splash.

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