Dairy ingredients outlook

by Keith Nunes
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What a difference a year makes. Last year, during the Annual Dairy Ingredients Symposium, speakers focused on the unprecedented run-up in dairy ingredient prices and the impact they were having on the market. At this year’s event, which was organized by Dairy Management, Inc., Rosemont, Ill., and the California Polytechnic State University-San Luis Obispo Dairy Products Technology Center, the situation was completely different when speakers discussed the outlook for ingredient prices and changing consumer purchasing patterns.

William A. Schiek, an economist with the Dairy Institute of California, spoke at the meetings, held March 10–11 in San Francisco, and said many dairy-based ingredient prices appear to have reached the bottom.

"We are seeing life in some of these markets where there was not a lot of interest from buyers before," he said. "We are starting to see more sales of dairy ingredients and prices seem to have stabilized, which is good. You have to see some stability in price levels before you see a turn around in demand."

Mr. Schiek emphasized that international demand and market volatility played key roles in the eventual slowing of dairy ingredient sales.

"Supply interruptions in Australia and New Zealand were the key igniters of the run up in prices in 2007 and 2008," he said. "But what had really been going on for a number of years was growing global demand. Prices had been kept low because there were such high inventory levels globally of dairy products. Those had been worked down over time through 2003, 2004, 2005 and 2006. We had a period of low prices in the U.S. during ‘06 and that led to lower growth and production in the U.S. in ’07. European production also had some fallback in milk production at the same time so we had some contraction in global milk production."

Mr. Schiek noted that the record high prices led to what he described as demand destruction for dairy ingredients.

"We saw purchases of dairy products and dairy ingredients drop off and there are a couple of reasons for that," he said. "First is ingredient substitution as food manufacturers began to look for alternative ingredients.

"The other thing is with actual finished dairy products. We began to see consumers buying less. One of the key examples was in the pizza industry as pizza makersbegan putting less mozzarella on their pizza pie. They still delivered their product to their customer, but they cut back on their use of the dairy ingredient."

But Mr. Schiek did not completely lay the blame for dairy ingredient demand destruction on the run-up in dairy ingredient prices.

"We saw record prices for a lot of commodities, some of which were substituted for dairy commodities," he said. "One of the key differences though is many other commodities that drive ingredients can be adequately hedged in an effort to protect against price volatility. A food manufacturer can do it for corn, beef, soy and fat substitutes. It is a lot more difficult to do that for dairy.

"So food manufacturers were faced with a choice. Corn prices were as high as dairy, and they had to decide which one they were going to work with. They decided they can manage their risk better with corn than they could with dairy."

Working through inventories

For non-fat dry milk, skim milk powder and whole milk powder, Mr. Schiek said inventories have grown significantly during the past year and that is going to limit price recovery going forward, but "there are some encouraging signs in terms of pricing," he said. "The bottom has been reached. Fonterra’s (the New Zealand-based dairy cooperative) auction system recently saw an uptick in prices and folks believe that indicates things have flattened out or turned the corner."

However, he added that competition from high-protein grains in some product development applications, the drop in cheese prices, and the use of export subsidies in the European Union and the United States were all reasons additional price increases may be delayed.

With regard to whey, it is starting to look a little better, Mr. Schiek said.

"We have seen prices turn around for a few weeks now," he said. "It looks like because whey prices fell more quickly, (processors) have had more time to recover some momentum and get back into people’s formulations and lure customers back. The idea is that prices have reached as low as they are going to go and food processors can come back to the market as a buyer with some confidence."

Mr. Schiek’s outlook is for gradually increasing whey prices for the rest of the year, but it will not be anything particularly special in terms of pricing, he said.

"We’ve got heavy inventories of lactose, especially in the U.S.," he said. "That price had been edging down, but just like whole milk powder and skim milk powder in Oceania, the U.S. price seems to be edging up. We may have found the bottom of the lactose market in terms of prices. Buyers seem to be coming back in greater volumes. I expect lactose to continue to move steadily forward."

For milk protein concentrates and whey protein concentrates, Mr. Schiek believes the lower prices will benefit ingredient suppliers who have lost market share to other ingredients such as soy, but, he added, it is going to be challenging.

"I’ve talked to food manufacturers and they say the soy industry has done a good job of closing the gap on some of the flavor issues they historically have had," he said. "For some applications, soy is a viable alternative and customers have accepted it. It will take a considerable marketing effort to get some of those markets back.

"But, broadly, M.P.C. and W.P.C. seem to have an expanding application because of their flexibility of functionality, and I think we may see more whey products showing up in a variety of food products. I think that will continue. Again, the long-term outlook on dairy proteins is good, but we are just hitting a rough patch. It will be tough going forward this year."

Consumer purchasing patterns

David Henkes, vice-president of Technomic, Inc., Chicago, shed some light on how consumer purchasing patterns are changing in the midst of the current economic downturn and attempted to dispel the notion that the issue is a benefit for retailers and a problem for food service operators.

"People are definitely cutting back," he said. "When we looked at the food industry and saw people cutting back on the food service side, we thought we would see a pick up on the retail side. And we haven’t seen that. We have seen people cut back on both channels.

"Food service only represents about one in four meals so it is certainly declining, but you are not seeing a similar pick up at retail. All things being equal, people are just purchasing less. They are eating out less and they are purchasing less regardless of where it is."

Mr. Henkes described the situation as a triple stage trade down.

"The first stage of trading down involves cutting back on eating out," he said. "Stage 2 is a shifting of product mix purchased. People are buying more private label and using more coupons. Then stage 3 is the shifting of channels. If you live in Chicago, you may not be shopping at Jewel anymore. You are maybe shifting to Wal-Mart or Aldi."

Mr. Henkes attempted to put into context how changes in consumer purchasing patterns may be affecting various dairy product categories.

"For cheese, you are still seeing strong demand through L.S.R. (limited service restaurant) sandwiches on the food service side, but not so much in pizza, which is a big driver for cheese," he said. "Retail cheese we think will perform at the industry average."

For indulgent products such as ice cream and novelties, Mr. Henkes sees consumers pulling back and being more selective. He predicted the category will probably underperform historical trends.

"Nutritional products are one of those things that are a little high-priced but part of the trend toward health and wellness that we think is still there," he said.

He said demand is anticipated to remain steady, but he is not "super optimistic it will over perform."

Nine emerging consumer behavior patterns

1. Frugal rich: Affluent consumers turning to private label and

bargain shopping.

2. Lessons learned: Re-evaluation of spending habits after

overextending using credit.

3. Conscientious deliberation: Consumers are making fewer

impulse purchases.

4. Back to basics: A renewed focus on practicality.

5. Timelessness as opposed to instant gratification: Choosing

quality and durability over disposable products.

6. A sure thing: Reduced experimentation among shoppers

is an emerging trend.

7. Selective indulgence: Choosing small rewards instead of

larger rewards.

8. Treasure hunting: Seeking new venues for better deals.

9. Bang for the buck: Evolution of value and new approaches

to finding it.

 Source: David Henkes, Technomic, Inc.

This article can also be found in the digital edition of Dairy Business News, April 2009, starting on Page 1. Click here to search that archive.

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