anz bullrush - 12pp

BULL RUSH China’s great beef challenge and the

golden opportunity for the Australian sector

INFOCUSEDITION 1 2014

anz.com/agri

420914_ANZ AGRI INFOCUS AUGUST BULL RUSH NEWSLETTER_91042.indd 1 27/11/2014 10:26 am

FOREWORD

The ‘opportunity’ word is used a lot when it comes to the soft commodity outlook for Australian agriculture. It is the right word to use, but there are plenty of producers wondering when this opportunity will translate to improved returns. Critically for the beef industry, positive global factors of demand (strong) and supply (low) have been negated by local conditions of drought and oversupply along with a consistently strong Australian dollar. However, the numbers for beef remain compelling.

As noted in the following report, China is playing an important and significant role in the Australian beef industry. The demand for imported chilled beef has risen exponentially and appears to be a medium to long term event, supported by the spending and consumer behaviour of the ever increasing middle class population. Australia has featured as the predominant source of this chilled beef. Whether we can ultimately hold onto our 57 per cent share remains to be seen, but any way you look at it, China is a big and fast growing market, and our industry should be looking to position itself to rise to the challenge of supplying it – not forgetting it is a competitive world. Obviously the beef market for Australia is not just about China, but its addition to the mix forces us to think about where our options are and where the best value can be gained through the supply chain. The productivity challenge is before us, but I can’t help but think that improved profit at the producer level, will be a key to investment in the productivity response that so many are looking for. Hope you enjoy this ANZ Focus publication.

Mark Bennett

Head of Corporate AgribusinessRegional Business BankingAustralia

T: +61 3 8655 4097E: [email protected]


1

IN FOCUS – EDITION 1 2014

OPPORTUNITIES – THE SIZE OF THE PRIZE

The next decade and a half marks a lifetime significant opportunity for the Australian beef sector, principally driven by China’s emerging appetite for beef. ANZ research forecasts China’s beef consumption could rise by more than 70 per cent, from 5.9 million tonnes (mt) in 2013 to 10.1 mt in 2030. For Australia, with its current, preferred beef trade partner status, the export potential is considerable as China’s beef imports could increase by almost 250 per cent to 3.8 mt.

Australian beef producers and processors could reap large benefits from this increased trade, but there are considerable challenges ahead, including: maintaining market share in the face of competition; raising domestic productivity; and finally, in identifying our target markets. For many, this will come down to a decision of focusing breeding efforts and or business strategies on either the quality or quantity ends of the market.

China’s changing demographicsChina’s rapid urbanisation and growing middle class are driving lifestyle changes that include increased consumption of alternative proteins such as beef

The story of China food consumption is well known…

A confluence of macro and micro eventsChina’s middle class boom At the heart of this trend is a seismic demographic shift of 27 million people entering China’s middle class each year. Many will continue the well worn path from rural to urban areas, with a projected 1.1 billion people living in Chinese cities by 2030, up from 900 million in 2012.

Armed with more spending power than ever before, the Chinese middle class’ consumption patterns will continue its current evolution. Beef consumption, which is already 40 per cent higher among middle and high income earners than their low income counterparts, will continue to climb higher.

Food safety becomes criticalAt the same time as this significant societal and dietary shift, Chinese consumers have never been more aware of food safety and provenance. This heightened awareness, within both the Chinese government and the mentality of consumers, stems directly from a series of domestic health incidents surrounding pork and poultry.

Poultry was affected by the avian influenza, known as H7N9, while domestic pork consumption versus beef slowed due to public outcry stemming from ‘The Floating Dead Pig’ incident, in which 16,000 dead pigs were found in a Shanghai river in March 2013. Since then, a number of similar cases in other rivers throughout China have been reported. Partly as a result of these controversies, there was a surge in demand for beef, with official Chinese beef import figures in 2013 growing four fold.

Influenced by recent health scares in other protein sources:

Beef Consumption On The Rise

Recent safety issues in other meat products have also contributed to a rise in demand for beef

Beef consumption in enjoying particularly strong growth in China ….

NOTE: There was apparently no huge impact on pork consumption, although beef consumption grew more strongly in 2013 and 2014.

464,000 cwt

100,000 cwt

China beef imports increased from:

increase in 20134 fold

In�uenced by recent health scares in other protein sources:

‘Floating Dead Pig’ Incident

H7N9 in poultry

Beef Consumption On The Rise

Recent safety issues in other meat products have also contributed to a rise in demand for beef

Beef consumption in enjoying particularly strong growth in China ….


464,000 cwt

100,000 cwt

China beef imports increased from:

increase in 20134 fold

In�uenced by recent health scares in other protein sources:

‘Floating Dead Pig’ Incident

H7N9 in poultry

NOTE: Forward projections based on estimates and data from: ANZ, USDA, UN, World Bank, BMI, MLA (Meat & Livestock Australia), ABARES


High incomeLow income

40% beef

In urban areas, Upper Middle – High Income consume 40% more beef than low income families

people entering middle class status in China every year

27 million

Urbanisation

900 million1.1 billion

2012 2030

$$$$


2


Supermarkets and cold chain logisticsAs shopping and consumption habits change and China’s cities continue to evolve, so too do the buying patterns of consumers. While in the past food products were purchased in traditional ‘wet’ or farmers markets, urban dwellers are fast adopting Western style consumption habits. This is evident in the fast adoption of shopping in supermarkets. The urban trend towards supermarkets, known as “hyper markets” has seen the numbers grow from approximately 16,073 stores to 42,963 between 2004 and 2012. This is expected to propel the amount of beef sold through retail channels from 2 per cent in 2010 to 40 per cent in 2020.

While historically China’s supply chains have lacked sophistication, they are now being reengineered from supporting traditional wet markets to organised retail. Chilled and frozen beef sold through the supermarket channel require cold chain logistics, and consumer demand is driving widespread infrastructure upgrades. Evidencing this, while live cattle imports have stagnated over the last ten years chilled beef imports have skyrocketed, realising 40.5 per cent growth rates, and growing from 3,863 carcase weight (cwt) to 54,709 cwt between 2012 and 2013.

The importance of this trend should not be lost on Australian processors and producers, as the development of a ‘mid and high value’ beef market will become increasingly critical to meet growing and more discerning consumer demand.

Local production challengeChinese domestic beef currently provides for 81 per cent or 4.8 mt of domestic demand and in 2008 a prolonged national and government effort saw local production ramp up substantially. However, since then, it has stagnated as the Chinese government switched its focus from growing supply to emphasising efficiency, quality and food safety. In addition, China’s beef production industry remains highly fragmented, with 90 per cent of domestic cattle supplied by small operators. Added to this, 85-90 per cent of China’s production is processed in small local slaughter houses, while China’s domestic cattle herd remains relatively low yield compared to major beef exporters. Together, these factors make greater domestic scale relatively difficult to achieve.

As a result, ANZ forecasts that by 2030 the country’s beef producers will be able to account for only 62 per cent of demand, leaving a substantial gap to fill through imports. ANZ anticipates this gap will necessitate an increase of almost 250 per cent in beef imports, to 3.8 mt, by 2030.

China’s Domestic Beef Production IndustryChina’s beef production industry is fragmented and of relatively low yield compared to other major beef exporters

Looking ahead, China would need major change to be vaguely beef self-sufficient …

0 20 40 60 80 100

44% (82kgs)

30% (31kgs)Australia USA Canada China

0

100

200

300

400

5001986 2030

82kgs

270kgs 352kgs

77kgs 92kgs 31kgs

341kgs

137kgs

Since 1986:

Aust cattle yield has grown by:

Chinese cattle yield has grown by:

43.6% 28.1% 36.8% 29%Australia USA Canada China

Yield by Growth

China's Beef Production Industry Yield Growth Comparative Yield

85-90%of China’s beef production is processed in small,local slaughter houses

90%of cattle supply is supplied by small operators


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Organised retail: Number of retail super/hyper markets is growing dramatically

“Grey trade” versus official importsTo date, 12 per cent of beef imports into China have been via ‘unofficial’ trade routes know as “grey trades” via Hong Kong, Vietnam, Thailand and Bangladesh, however, this market could significantly decrease over the medium term, as food safety continues to play a critical role in public policy and health risks from unregulated markets become more closely scrutinised.

ANZ analysis forecasts China’s per capita beef consumption is set to rise dramatically over the next 16 years, driving significant increases in beef imports through official channels. ANZ predicts that due to demographic shifts and the reduction of grey channels total beef consumption in China is likely to almost double over this period, from 5.851 mt cwt in 2013 to 10.1 mt cwt.

At present levels, that rate of demand will significantly outstrip domestic production growth, which may only be capable of supplying 6.3 cwt or 62 per cent of demand according to ANZ modelling. Official channels import figures will climb from 400,000 tonnes cwt in 2013 to 3.8 mt cwt, representing a 950 per cent rise.

Ultimately, this means imports as a per cent of China’s total beef consumption will need to increase from 6.8 per cent in 2013 to 38 per cent by 2030.

Import volumes could rise 250% from current levels by 2030

2004 2010 20202013

2%

42,963 stores

16,073 stores

expected rise in retail beef sales

of all beef in China sold

through retail channels

40%

Domestic production will only be capable of supplying 6.3m cwt (62%)Estimated China production

had declined in 2003-2013 by:

2003 20300

2000

4000

6000

4,76

2cw

t

5,18

7 cw

t

O�cial channels import �gure will climb from:

2013 2030 2013 20300.0

1.0

2.0

3.0

3.3m cwt

400k cwt

Import as % of all China consumption will rise from:

% demand growth signi�cantly outstrips % domestic productiongrowth (capability):

Of the 2030 China consumption demand �gure (10.1 m cwt) it is expected:

6.8%

33%834%


FAST FACTSAustralia produces 4% of global beef supply, but exports 65% of domestic production, accounting for 17% of global beef exports.

CHALLENGES

Australia’s productivity challengeWhile the numbers are compelling, Australia faces a significant and somewhat unrealistic challenge in order to maintain its current market share, amounting to 57 per cent of China’s beef imports. Domestic productivity levels will need to rise sharply from current levels and the total volume of Australia’s beef exports would need to almost double over the next 16 years, from 1.6mt cwt in 2013 to 3mt cwt in 2030. In effect, this would translate to annual productivity growth of 2.9 per cent year on year. This is akin to the productivity rates achieved in the 1980’s and 1990’s, and is more than the long term annual productivity growth rate across the period back to 1970. Given Australia’s mature sector it’s unlikely to be achieved.

However, ANZ has created a lower case export scenario that is considered achievable and is also based on the current beef industry productivity growth figures, but which still requires annual productivity growth of between 0.9 per cent and 1.2 per cent. The high side of this growth rate band is twice the annual productivity growth since 2000 but less than the long term annual productivity growth rate across the period back to 1970.

If Australia maintains this, our market share will shrink but China will remain a significant export market. Moreover, this could result in a total export value of between $6.8 billion and $7.1 billion in 2030, and from now to 2030 it could amount to $102.9 billion. Put another way, if no productivity gains are achieved across the sector from now to 2030, an extra $14.2 billion in export revenue could be lost.


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5


Competition intensifyingChina currently relies predominantly on Australia, New Zealand and Uruguay for its official beef imports, with smaller volumes being sourced from Canada, Argentina and only recently from Brazil, which had been suspended from exporting to China for a two year period to July 2014.

Australia and New Zealand are particularly well placed to capitalise on demand growth thanks to early adopter statuses, respective geographies and high food and animal health standards. However, given the size of the market, competition is rapidly ramping up, particularly from Brazil, currently the world’s second largest producer and exporter. Since being suspended from exporting beef to China in 2012 after an outbreak of foot-and-mouth disease, the Brazilian government and domestic operators have nonetheless expanded their production and export facilities. With its recent ‘approved’ status for exporting beef to China, this is expected to intensify. India is also emerging as a dominant player in the export market, through its supply of buffalo meat into China, culminating in a memorandum of understanding signed by both countries in 2013 for direct export.

These emerging producers have made large inroads in a market that was once dominated by the US; historically the world’s biggest beef producer, which due to recent droughts and reduced profitability versus other farming, such as grains for biofuels, has flat lined in terms of production.

Low Case – 2030 based on Australia’s current productivity growth

ANZ modelled a ‘low case’ scenario – based on Australia’s current productivity growth – to forecast the likely size and value of China as a beef export market by 2030

At Australia’s current rate of productivity growth, our market share will shrink...

Australia’s forward productivity growth is expected to be 0.4 % pa (based on historical average). If Australia continues at this rate:

High Case – The golden opportunity

ANZ also modelled a ‘high case’ scenario – where productivity growth targets are met and market share maintained – revealing the potential size and importance of China as a beef export market by 2030

However, if Australia can rise to the productivity challenge, the size of the opportunity is outstanding.

Challenges in maintaining our current market share in China, given anticipated China demand increases

2.9%annual productivity

0500

1000150020002500300035004000

China 2030China 2013

3.0mt cwt

1.6mt cwt

Australia currently generates:

3.8mt cwt

2.4mt cwt

=100k cwt

Total 2,363k cwt beef of which 1,624 cwt exportsof which 229k cwt export is to China

To maintain our 57% market share in China, given anticipated China demand increases:

Total volume Australian beef exports and Australian total beef production (domestic consumption + export) would need to rise from:

Exports Production

9.2% 14% 2.1%$AUD 88.6bn$AUD 5,359m

1,523k cwt Representing

export value total between 2013-2030

$AUD 11.2bn$AUD 679m214k cwt Representing


Australia’s market share of China’s imports would drop from:

57%

Australian Beef total exports by 2030 would be:

Exports to China would represent (of this total)

Assuming Australia maintains its share of exports to the traditional markets, in 2030 China would represent:

of overall Australian

beef production

of overall Australian

beef exports

of all beef consumption

in China

=200cwtMarket Share

(%)

0

10

20

30

40

50

60

6%

57% 21%72%$AUD 130bn$AUD 10.7bn

3,041k cwt Representing


$AUD 80bn$AUD 7.7bn2,178k cwt Representing


In 2030, Australian beef would represent:

20132030

In 2030 China export market would represent:

Australian Beef total exports by 2030 would be:

Exports to China would represent (of this total)

of overall Australian beef

production

of all beef consumption in China

of overall Australian beef exports

=200cwt

14%


SOLUTIONS

The Australian beef sector is well placed to potentially provide China with a range of cattle and beef products through business strategies that range from trade and country-specific branding to partnerships. The Chinese are particularly relationship driven, and there are a number of potential business partnerships to consider.

KEY TAKEOUTS > Beef marketing and packaging that plays on the themes of ‘clean and green’ will become increasingly more important to middle and upper income Chinese consumers.

> As Brazil continues to take advantage of China lifting its beef export ban in July 2014, competition for the quantitative, mass beef market will intensify.

> Australian producers and processors may find a natural point of focus is playing to our existing competitive strengths in high quality genetics and animal husbandry, resulting in a more premium product.


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Partnership possibilitiesAustralian beef processors/exporters + Chinese restaurateurs

Australian beef processors/exporters + luxury hotels and high-end restaurants

Australian beef exporters + Chinese beef processors

Australian beef producers + Chinese offtake providers

Joint venture agreements In addition to supermarkets, other distribution channels are opening up, including luxury hotels, fast food restaurants and a growing number of hot pot restaurants in Chinese urban areas, as Western style habits of eating out gain popularity. Joint ventures that partner Chinese retailers or restaurant chains with Australian producers or meat processors and exporters present a compelling opportunity for all parties. However, on the part of the domestic producer, exporter or processor, it requires highly structured agreements and a level of comfort with offshore partnerships. But, these challenges are offset by additional capital expenditure to expand exports, grow herd sizes and move Australian produce into the Chinese market.

BenefitsA good joint venture offers Australian beef producers, exporters and processors additional benefits, including:

> Direct distribution > Proven experience in logistics and offshore freight > Shared shelf space via established distribution networks

> Professional and locally relevant marketing > Intellectual property > Chinese consumer insights.

Similarly, for Australian beef producers benefits passed on from joint ventures between domestic meat processors or exporters and Chinese distributors can include:

> Growth and capital – passed on revenues from China’s expanding consumption

> Distribution channels and local support to move product to retail markets

> Local (in country) representation > Contacts – an introduction to key business relationships

> Chinese consumer insights > An indirect presence in Asia – being part of China’s growth story

> Dual marketing efforts.


TOP FIVE RESOURCE CONSIDERATIONS

> Time: Chinese relationships are resource intensive

> Capital: Is an equity partner a viable solution?

> Focus: What breeds and cuts will you provide, for what kind of consumer?

> Supply: How much of your herd is available for export now, and in future?

> Partnerships: Is there a shared vision?

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Focus pointsMarketingMeat processors and packagers will need to increasingly turn their attention to more professional beef marketing, focusing on product and meat traceability, health and safety and animal welfare. In doing so, they will continue to further Australia’s reputation for ‘clean and green’ food production, as New Zealand producers have successfully done in the dairy sector.

For individual producers, this generally translates to an opportunity in partnering with a local processor and packager, specifically those that have developed a strong and internationally recognised meat brand.

The advantages of doing so include leveraging existing marketing and communications strategies and networks. Other opportunities may lie with partnering directly with offshore packagers, wholesalers or retailers which not only have the aforementioned systems in place, but are also relevant and attractive to local Chinese consumers.

RelationshipsBeef cattle producers and packagers will need to place greater focus on driving relationships with Chinese trading partners and make it a central tenet of their mid to long term business strategies. Integral in this is the fact that the Chinese are culturally and historically relationship driven. As they increasingly look to not just secure the food chain through acquiring produce and agricultural land, but to partner with existing producers and secure long term offtake agreements, knowledge and appreciation of this facet is even more important.

Investing in time, travel and systemsTo move from purely processing or producing cattle domestically, to exporting or trading with an offshore partner is very resource-intensive and requires a tailored approach, specific for the Chinese market. Large investments in time, capital, people, travel, professional systems, networking and knowledge of the market are required.

Quantifying the viability of such a strategy will involve determining if it suits your end product, and ultimately the kind of end consumer you are targeting.

Strategy considerations > Appropriate cuts: dependent on a quality or quantity strategy

> Appropriate breed: varies widely depending on the China region and climate

> Chilled versus frozen meat > China’s geography relative to logistics, including ports and boning facilities.



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CHINA BEEF CASE STUDY

“I realised there’s a big misconception about what Chinese consumers want. Because of their hot pot culture, which itself varies between winter and summer months, they want more brisket and shin shank cuts that are deemed secondary quality in Australia and other export markets like Japan.

One day I was doing a cooking demonstration in a supermarket in China, showing you have to get the pan hot before cooking. One of the sales people explained a cultural issue, that there is a lot of fear associated with fire and cooking with heat. So, for Australian suppliers, there’s a big education piece we need to do before we see more middle class take up of better quality cuts of beef outside of affluent restaurants and hotels.”

❛❛ I realised after my trips there, if you stay here in Australia, you’ll never understand. It’s clear to me now that we’re not doing enough in marketing our produce in China. I visited supermarkets where our beef was in the back of the freezer and Argentinian beef at the front. The rest of the world is only going to increase their supply of beef to China, so we need to ask, ‘what more can Australia do to promote our beef in China?’ That includes starting at the beginning with introducing Chinese consumers to Western methods of cooking and preparing beef. ❜❜

“I understood it’s a price sensitive market, and I didn’t have a business case for what I could deliver at that lower price. We were on the same page in knowing we couldn’t and didn’t want to compete with cheaper beef from Mongolia and the United States. We had to differentiate, and we knew the key to doing that lay in marketing our product.”

A ANZ client recently attracted attention for his entrepreneurial approach, which has included vertically integrating his beef export business and directly targeting emerging Chinese beef consumers.

Relevant experienceThe client had previously managed a feedlot and had experience in abattoirs before moving into cattle farming. Then about four years ago he was contacted directly by a Hong Kong-based meat wholesaler who wanted to form a joint venture with an Australian beef producer. The business proposition was to raise an Australian grass fed and grain finished herd, killed, boxed and Australian branded and then exported onto Hong Kong and China, chilled or frozen. In his words, it was something that intrigued him more than the domestic market, but as an Australian farmer, seemed out of reach.

Structuring the business > The JV is a structured agreement, whereby the farmer is provided with funding to purchase cattle, and for inputs including vet bills and vaccinations.

> The Hong Kong-based partner put in 50 per cent of the up front capital to build the herd, thereafter they have been reared on land that was initially leased by the farmer.

> He established a trading company, which he is the sole director of, then drew up a shareholder’s agreement to support the joint venture.

> Local lawyers, accountants and designers were used to draw up all agreements and establish the brand, logo and copyright.

Controlling the supply chainThe preceding three and a half years brought about lengthy discussions over how the joint venture would work. In the end, the farmer’s responsibility was to establish and manage the production and export process, from buying and raising the herd, right up to the point that the boxed beef was packed into 40-foot freight containers and left Australian ports.

Even before trading began, the due diligence and strategy incumbent on the farmer was significant. He made several trips to Hong Kong and China to meet with his potential partners and understand their business, both of which were integral in establishing trust at both ends. A breakthrough came, he said, in visiting and talking to employees at their network of supermarkets.

Consumer insights

Key learningsCross cultural relationships


Mark BennettHead of Corporate AgribusinessT: +61 3 8655 4097E: [email protected]

James McKeefryState Agribusiness Manager – Victoria/TasmaniaT: +61 4 230 24503E: [email protected]

Alan ReadState Director – South Australia/Western AustraliaT: +61 8 7088 9053E: [email protected]

Jeffrey SchraleState Agribusiness ManagerT: +61 7 3947 5932E: [email protected]

Alanna BarrettState Agribusiness ManagerT: +61 2 5933 0209E: [email protected]

Or to find your local ANZ Agribusiness specialist go to anz.com/agri

CONTACTS

While our industry is fragmented, we clearly have a comparatively well developed, modern, and highly regarded beef industry in Australia. This is a global view and so we are in a strong position to leverage this reputation, especially into the China region where food safety is becoming paramount to consumers. So the productivity drive continues and the focus to improved efficiency in every part of the supply chain – controlling the controllables – will be critical in delivering ultimate reward to the industry.

CONCLUSION

Corporate governance offshore: Due to the fact that revenue was generated in Hong Kong and China, a Hong Kong trading company was established as well as the Australian trading company, to comply with offshore taxation regulations.

Labelling: The business established its own cryovac packaging with an Australian-centric logo, which is essential, because once produce arrives in China substitution branding and packaging is common.

Outsourcing: The farmer relies on a mid-tier regional abattoir to kill and box his beef, and then transport it to a major shipping company.

Resource intensive: Accurate completion of the shipping certifications and bill of lading documents are essential before the beef arrives at the Australian wharf, but the process is also very time intensive, requiring additional and experienced resourcing.

Financial reporting: In line with his reporting agreement, the farmer has installed and learnt to use a transparent cloud accounting system, which allows his partners to log in each day and track operational expenses and profits.

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Australia and N

ew Zealand Banking G

roup Limited (A

NZ) A

BN 11 005 357 522. Item

No. 91042 11.2014 W

420914

anz.com/agri

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anz bullrush - 12pp

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