The outbreak of coronavirus is disrupting the entire dairy supply chain in China. Although, for now, we have only limited information and anecdotal evidence, Rabobank assesses the impact on the Chinese dairy market because the potential effects on the global dairy commodities market should not be ignored. The situation remains fluid, and Rabobank is monitoring the developments closely.
Disruption to the Entire Supply Chain
While the impact of the epidemic on the demand for dairy should be short term, the uncertainty over the actual duration of the impact and the lingering psychological impact could potentially bring meaningful damage to consumption, which then affects processing, production and import.
What a 30-Day Disruption Could Bring to Dairy Consumption
Retail outlet closures, falling foot traffic at grocery retailers (partially offset by online retailers) had a material effect on retail sales during the Chinese New Year holiday. As a result, retail inventories which were well-stocked before the Chinese New Year, continue to build. There has been some recovery of delivery capacity of online retailers post-holiday, but mobility remains an issue in many places.
Based on industry interviews with Chinese sources regarding retail performance, Rabobank initially estimates a 30-day impact could reduce liquid milk consumption by 2%–4% YOY for the full calendar year, assuming part of the retail loss is compensated by online sales.
During Chinese New Year, premium liquid milk products, traditionally purchased for gifting purposes, were severely impacted, although this was potentially offset by higher sales of more basic products for drinking at home. If the situation is prolonged, this could mean a process of de-premiumization, at least during Q1 2020, negatively impacting retail sales value.
As food service is among the hardest-hit sectors, consumption through this channel is likely to suffer the greatest year-on-year percentage change.
Cheese consumption in China is heavily tilted toward food service channels. Rabobank initially estimates that a 30-day impact could potentially reduce Chinese cheese import by at least 5% YOY for the full calendar year, or over 6,000 tonnes (consumption estimated based on 2019 import of nearly 115,000 tonnes).
Distributors have experienced a slower movement of inventory through retail channels. As a result, they are delaying restocking from processors. Restocking is also impacted by road traffic control and a shortage of labor post-Chinese New Year, as a result of reduced mobility. If it takes an extended period of time for restocking to resume, retail inventory will start to erode through the remainder of Q1.
Production and Processing Largely Disrupted by Road Traffic Control and Lower Consumption
Tighter road traffic controls are being used in an attempt to contain the epidemic. This is causing disruptions to inter-provincial logistics around China and even within provinces, affecting raw milk shipments in various regions. Small and medium-sized farms appear to be more impacted than large farms, leading to some milk dumping. The central government issued circulars at the end of January 2020 and the beginning of February 2020, stating the importance of a stable food supply, in terms of production, distribution and logistics, but it may take time at the grass-roots level to help with this. This could put more pressure than usual on milk prices, which generally trend lower after the Chinese New Year. Rabobank is aware that milk supply contracts have generally been honored between large processors and large farms which have been able to deliver milk. However, prices for deliverable raw milk outside the contracts tend to be sold at a much lower price than the contracted price. In some regions, farms have encountered tight feed supplies due to an extended Chinese New Year holiday and partly due to the road traffic controls. Any persistence of the situation could have a further negative effect on milk production.
News reports and cross checks with industry contacts suggest that dry spraying of raw milk has started in a number of regions in China, and drying capacity utilization has been fairly high even before the new milk flush comes on stream, due to reduced retail end-demand and disrupted distribution.
What it Could Mean for China’s Dairy Imports in 2020
China imported a total of almost 670,000 metric tons of WMP in 2019 (+30% YOY), second only to 2014, and a record high SMP of 340,000 metric tons (+23% YOY). Rabobank was expecting China’s 1H 2020 import to fall by 3% YOY and to grow by only 1% YOY for the full year. However, the coronavirus situation is very likely to change this forecast significantly. At least in the near term, this should reduce China’s appetite for dairy ingredients, following abundant arrivals of December 2019 and January 2020 shipments, slow-moving inventory, ongoing higher levels of dry spraying of milk and with carryover of inventory from last year.
Rabobank’s sensitivity analysis shows that, for the full year of 2020,1% YOY decline in total dairy demand (LME) would potentially lead to a reduction in import (LME) by 11% YOY for the year, whereas a 5% YOY reduction in total dairy demand (LME) would lead to import (LME) falling 25% YOY in 2020.
Given the major impact on food service, the knock-on effects could prompt exporters that service that segment to shift some production from cheese, butter and cream into WMP and SMP over time, resulting in more milk powder on the global market, especially if China goes into destocking mode.