A Guide to Dairy Investment in Latin America
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A Guide to Dairy Investment in Latin America
With an average growth rate of 5% a year, South American dairy production appears to be a strong market for investment, despite a certain degree of price and political instability.
According to a Food and Agriculture Organization (FAO) report, rising incomes and firm regional and international demand have favored dairy production growth in Latin America and the Caribbean. South American milk production expanded by over 5% in 2011 and a similar rate of increase was expected for 2012, with an output of 71 million tons.
The FAO report points to favorable pasture production and an optimistic outlook on the international market for dairy products as factors that led to increased investment in new technology and improved animal genetics.
“Agribusiness is made up of three major sectors: crops, cattle/meat and dairy,” notes Richard Peña, area manager, Latin America and the Caribbean (LAC) at dairy equipment provider Paul Mueller. “Dairy is a key component and in certain countries, the highest per hectare revenue producer. As an example, Uruguay dairy produces US$900 of revenue per hectare, and this is compared to about US$700 for soybeans and about US$150 for cattle/meat production. Now, there are different production costs associated with this revenue stream. But dairy is usually the highest revenue producer in the Southern Cone countries per hectare.”
• 20% returns
He explains that there are two types of dairy production companies in Latin America: listed food companies that sell dairy products as part of their consumer products portfolio; and private, mostly family-owned companies with a focus on dairy products, which are “ripe for private equity investors that can offer value added.”
“In the Southern Cone countries of Argentina, Brazil, Chile, and Uruguay you have a number of private equity investors from Oceania and Europe investing significant funds into the dairy processing and dairy farming sectors,” Mr. Peña says.
“Olam from Singapore is present in the Southern Cone region, and their investment started at the dairy farm level with outside management running the farms. There are challenges to this type of investment, as Olam has found, and you need to understand the dairy business and the production cycle to make your investment profitable. But well managed dairy farms are seeing about 20% returns without land appreciation, and this is appealing to investors. And the processors are seeing even better returns than the farms.”
• Price slump
Investors should be aware that global dairy prices have reached their lowest level since 2011. Rabobank recently cut its dairy commodity price forecast by as much as US$950 a ton, pointing out that the slump in prices since February had taken values below levels it saw as “sustainable in the long term.”
But despite forecasting price recovery to take a long time, the bank expects world milk output to remain strong, with producer margins protected by low feed prices. “All signs suggest that a prolonged period of low prices will be required in order to clear the international market. Market rebalancing will be a slow process,” Rabobank said.
Mr. Peña agrees that, as in any international agribusiness endeavor, weather and pricing are risk factors. He explains that in South America dairy farming is directly correlated to the crop sector, and in particular to the soybean market.
“As soybeans continue to plunge in price, dairy becomes more attractive,”
he says. “The barrier to entry for dairy is that it takes more investment in equipment, dairy cows, and personnel to enter the space. But the difference in revenue per hectare with soybeans below US$350 a ton is quite attractive for farmers and investors alike. The other limiting factor is that dairy takes more hands-on effort to manage the business than crops.”
Global demand for dairy grows more and more each year, boosted by population growth, rising incomes, urbanization, and westernization of diets, particularly in developing countries such as China and India.
And while India recently overtook the European Union as the largest milk producer in the world (OECD), milk supply in China, as well as regions in Southeast Asia and Africa, is not keeping pace with this growth, leaving other milk producing regions – including South America – with the opportunity to meet increased demand.
Asia accounted for 34% of all dairy imports in 2011 – 53% of the world’s skim milk powder and 40% of the world’s whole milk powder imports. China alone reached 25% of the world’s milk demand by February 2014. But demand is also growing within Latin America, which bodes well for the future of the regional sector.
“Per capita consumption numbers are key to local production, which is the reason Argentina and Uruguay are the leading dairy producers in LAC,” Mr. Peña says. “You have over 200 kilos per capita of dairy consumption in Argentina and Uruguay. The average for the rest of the region is about 10-15 kilos per capita.”
“The good news is that as per capita income increases, more dairy consumption will follow as we have seen in the Central America and Caribbean region. In the entire LAC area, dairy is a well received and a desired food choice seen by many emerging middle class consumers as healthy and an excellent value proposition. Today, dairy consumption is growing at about 2% over per capita GDP growth. And the consumption patterns are influenced by local tastes, with cheese being the most consumed followed by ice cream in the region. Brazil and Mexico are major cheese buyers and are also large consumers of ice cream,” says Mr. Peña.
• Political uncertainty
Another factor influencing the dairy market in South America is political uncertainty in Brazil, Argentina, and Uruguay, three of the largest dairy producers in the region. Brazil’s presidential election is moving into a runoff on October 26 after incumbent president Dilma Rousseff failed to win the majority she needed to secure a second term against Aecio Neves on October 5.
According to Mr. Peña, neither candidate really knows how to lead Brazil out of recession. “Today, Neves is up by 10% over Rousseff. This lead is about the same as Brazil’s inflation rate year-to-date 2014, and neither Rousseff nor Neves has plans on how to contain it.”
“I was visiting with a very large farmer from the Rio Grande de Sul province last week and he told me that he is uncertain about future investment plans to keep growing. I asked him who he was going to vote for, and he said neither because they both had no idea of what it takes to manage an economy that is struggling. Now that is devastating,” he says on his website agribusinesslac.com.
October 26 will also be election day in Uruguay, with former president Tabare Vasquez, as well as Luis Lacalle and Pedro Bordaberry all hoping to take over from current President Pepe Mujica. According to Mr. Peña, a victory for Vasquez would be the most negative result for the country’s agribusiness.
“The last two Frente Amplio (Vasquez’s party) governments did not create the needed policies to keep agribusiness growing. Currently, Uruguay finds itself becoming a developed economy but a very expensive place to invest and do business. All three candidates are facing a slowing economy after 10 years of incredible GDP growth fueled by the agribusiness sector. This strong financial performance is possible due to strong agribusiness exports, but soybean will be US$350 a ton by November. The question now is will the lower commodities prices slow GDP growth? Or will it be the Frente Amplio’s higher land tax proposal?” he asks.
Meanwhile, Argentina’s inflation rate just hit 41%, and most of the country’s economic sectors are in distress, but dairy re- mains an attractive investment. According to the USDA foreign agricultural service, despite the domestic economic uncertainties, Argentina’s well-known natural conditions for dairy production make it very attractive for local and foreign investment. Argentine milk output for 2014 is expected to reach 12.2 million tons, and investment is forecast at US$221 million over the next two years, providing additional capacity to process 6.8 million liters a day.
By Emerging Market Investors Association (EMIA)
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Post available in: English