Most agricultural businesses have taken a pummeling over the last year or two, but on the dairy farm, things are looking up. Milk prices have shot up as the domestic supply tightened and exports increased significantly – especially to China. Rising feed prices had been consuming the increased revenue, but they began dropping in late 2013 thanks to an improved corn crop and lower ethanol demand.
This improved margin permits dairy farmers to invest in repairs, better machinery, and larger herds to boost capacity. But should they? Milk prices are incredibly volatile, and dairy farmers have had the rug pulled out from under them in the past.
Right now, increased production seems likely. The USDA is predicting 28% higher earnings for dairy farmers in 2014, contrary to the predicted 21% earnings decrease for the average farm. In early 2014, milk futures on the Chicago Mercantile were up by around 24%.
Higher prices have not yet produced a disproportionate drop in domestic demand for dairy products, and the USDA expects the collective overseas demand to drive sales to $43.1 billion – a 7% increase over the previous year, and a new record. Dairy farmers are likely to take advantage, assuming the demand can handle higher production without prices falling too far.
Not so fast, say other analysts. Weather is a wild card, and the drought conditions in California will be watched closely. California produces around 20% of the nation's milk supply, and while spring conditions are favorable, another year of drought and extreme heat could send California milk production into a tailspin.
Global demand is still expected to be high, but New Zealand and other milk-producing regions are shaking off stagnant production and aggressively trying to fill the gap. It appears that the market expects prices to drop throughout 2014, as milk futures with December delivery closed at the beginning of April at 22 percent below the previous April's delivery contracts.
In the short term, that does not help industrial consumers of dairy products (not to mention households). Both Domino's (NYSE – DPZ) and Dean Foods (NYSE – DF) are warning about the effects on their margins, and while companies are trying to avoid raising prices hoping the effect is short term, they may not be able to hold out for long. Of course, restaurants will be taking another beating, just as they have with recent higher beef prices.
Analysts seem to agree that prices should stabilize by summer, and what happens after that is anybody's guess. Many believe prices will continue to fall.
The milk futures market indicates lower prices in the latter half of 2014, but not the typical larger drop that traditionally follows peaks in the market. Are people expecting another round of bad weather and higher feed prices, or are they just hedging?
Lurking in the background is the recent farm bill, which introduces the new Margin Protection Program for dairy farmers. The rules have not been established yet, and there is always the chance for detrimental supply effects in late 2014.
As an investor, what do you do? As with the effect from higher beef prices, expect restaurants/food service investments to suffer from lower margins – but there seems to be reason to expect this to turn around in the second half of 2014 if the industry can weather the current storm. Meanwhile, if you want to speculate on the stock of milk producers like Dean Foods (NYSE: DDF), which at $15.28 today is down 60% from its 52 week high of $42.12 – or dive into the milk futures market -- your success may depend on how well you can predict the weather. How confident do you feel about that?
To see how the price of milk affects you as a consumer, see "Milk Prices on the Rise."
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