Dairy Globalization Refresh: 2011 Update Summary Findings Conducted by Bain & Company Commissioned by Dairy Management Inc. & U.S. Dairy Export Council

Webinar Aug. 3, 2011

Welcome

Margaret Speich Vice President Communications and Membership U.S. Dairy Export Council

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Unveil findings of “Dairy Globalization Refresh: 2011 Update” Updated outlook of

import demand, export supply Factors such as production

costs, currency, etc. Summary, program update

and recommended actions Address your comments and questions

Today’s topics

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Webinar is being recorded Participants in listen-only mode except during Q&A To ask questions and/or pose comments By text, use on-screen Q&A panel By phone, press *1 to notify an operator

To print slides, click printer icon on bottom right of screen For technical difficulties, press *0 on telephone touchpad

Webinar guidelines

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Alex Menendez Counsel McLeod, Watkinson & Miller

Antitrust reminder

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Presenter and moderator

Tom Suber President U.S. Dairy Export Council

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One of six IC programs to protect, grow dairy Globalization presents challenges, opportunities Strong participation advancing industry toward Consistent Supplier status But multi-year effort to create structural changes and improve commercial focus Industry led, USDEC staffed

Innovation Center globalization background

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Opening remarks

Kevin Toland CEO & President Glanbia USA & Nutritionals Chair Innovation Center Globalization Operating Committee

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Initial study examined implications of globalization But since then, industry has endured rollercoaster of economic cycles So do basic conclusions of original study still hold true? Have supply/demand changed to shrink demand gap

identified in earlier study? Have new suppliers come on board and shortened U.S.

window of opportunity? Is program to assist U.S. industry to become a globally

consistent supplier still viable?

Study background, purpose

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Josh Chernoff Partner

Bain & Company

Principal presenter/commentators

Clinton Anderson Partner

Bain & Company

Brett Burgess Manager

Bain & Company

In 2009, we identified several trends impacting the outlook for global dairy…

Dairy demand will continue to grow rapidly in developing markets

Dairy supply will be challenged to keep pace

United States is positioned to become a much larger player, but must address weaknesses

A latent demand gap is developing, creating a sizeable, though finite, window of opportunity for the United States

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Reform U.S. pricing and risk management policies

1. Reform regulated milk pricing systems and price support mechanisms (IDFA, NMPF)

2. Better mechanisms for risk management, volatility reduction

Increase access to international markets

3. Trade treaties that provide net export benefits (IDFA, NMPF, USDEC)

Improve responsiveness to global demand

4. Pre-competitive sales and marketing investments and capabilities

5. Food safety assurances and traceability

6. Customer product specification requirements, globally

7. Product and technology innovation

…and recommended 7 industry and company-specific initiatives

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The chosen outcome was for U.S. dairy to pursue actions that would make us a more Consistent Supplier

“Fortress USA”

Status Quo

Commitment to global opportunities Improve commercial focus,

product portfolio Reform FMMO, price support Improve forward contracts,

futures markets Strong domestic market

as basis for global trade Build insight/capability

Consistent Supplier

Recommended by IC Board

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A refreshed view of dairy fundamentals shows export opportunity still exists

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Import demand Long-term demand will remain strong, driven by emerging markets

Export supply Traditional supply sources are constrained and will fall short of expected demand

Buyer feedback Have affirmed United States is well-positioned but improvements needed

Long-term outlook Demand gap wider than anticipated, window of opportunity

remains open with U.S. as the likely source

But efforts still necessary (pricing/supply flexibility, volatility, commercial focus)

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Forecasted growth remains strong in emerging markets

Source: Projected growth for India, Mena and SE Asia from FAPRI (2011); projected growth for China based on Bain analysis derived from OECD (2010) and GDP/consumption regression analysis

Dairy consumption is expected to grow quickly in key emerging markets…from which ~75% of new dairy consumption will come PROJECTED GROWTH IN WORLD NON-FLUID DAIRY CONSUMPTION (’2010-15)

China: Despite foreign investments, commercial dairy farms unlikely to overcome demand gap

At most, Fonterra farms will add a fraction of total production

Additionally, they are likely to price at a premium

FONTERRA EXPECTED PRICING SCHEME VS. AVERAGE MARKET PRICE ($/cwt)

FONTERRA SHARE OF CHINA DAIRY HERD / RAW MILK PRODUCTION

Source: “Fonterra benefits from Chinese dairy market”, stuff.co.nz (4/14/2011); “Fonterra to invest in two more farms”. Fonterra media release (2/2/2010); Bain analysis; Expert interviews

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China: Even with production growth, likely to rely on imports to meet growing demand

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Source: “Fonterra benefits from Chinese dairy market”, stuff.co.nz (4/14/2011); “Fonterra to invest in two more farms”. Fonterra media release (2/2/2010); Bain analysis; expert interviews

CHINESE NON-FLUID DAIRY CONSUMPTION CHINESE NON-FLUID DAIRY CONSUMPTION (FORECASTED)

5%

7%

Average 6%

CAGR 2010-19

Import markets What has changed since 2009

Est. impact, 2013 demand gap

China Net imports: 486K MT, 11% of global

• Dairy consumption growth has increased and promises sustained growth over the longer term as economic development moves inland and 200M more Chinese join the middle class

• Production took a big hit from melamine crisis in ‘08-’09, widening China’s demand gap. Current industry structure makes large production increases unlikely without major investments in large, industrial farms

• Ongoing quality issues and lack of trust in domestically produced products create near-term opportunities to boost imports

• China will continue to be a net importer over the long term, but government tightening of import documentation requirements may create difficulty for U.S. imports

SE Asia Net imports: 777K MT, 17% of global

Although milk production increased faster than expected, local production still covers <10% of consumption

SE Asia remains a sizeable importer of dairy products with strong potential for consumption growth

Russia Net imports: 658K MT, 14% of global

Production dipped during 07-10 due to droughts, high temperature and high-feed prices, widening demand gap

Future production unclear due to recent instability in milk production and shifting government policies

Consumption growth slow due to a declining population

Russia expected to remain major dairy importer despite government efforts to encourage domestic production and stricter documentation requirements (effectively blocking Ukrainian and U.S. imports)

Legend Impact on demand gap: Bigger gap Small change Smaller gap

More on demand and other import markets (1)

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Note: Net import figures as of 2010

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Import markets What has changed since 2009

Est. impact, 2013 demand gap

Mexico Net imports: 299K MT, 7% of global

Consumption still growing,and expected to continue with stable economic growth. However, rising concerns over obesity may shift consumption toward lower-fat products

Despite faster production growth, Mexico projected to remain a significant importer through 2015 and beyond

Mexico extended retaliatory duties to U.S. cheese in late 2010 but recent progress on trucking dispute may restore trade levels

MENA Net imports: 519K MT, 11% of global

As a group, Algeria, Egypt and Saudi Arabia are significant dairy import markets, collectively importing more than China in 2010

Production growing slowly, but not sufficient to cover domestic needs, and water/ forage limitations will constrain future growth

Unrest across the region threatens near-term economic growth, though political reforms may also lead to significant long-term upside for economic (and therefore, dairy) growth

India Net imports: 20K MT, 0.4% of global

Supply has failed to keep up with domestic demand due to bad weather hampering production and continued growth in consumption

Near-term consumption expected to outpace production despite government’s encouragement of self-sufficiency

Imports have increased by small amount to fill demand-supply gap, with similar opportunities expected in near term

Production has large potential to improve and should grow with government’s National Dairy Plan

Although currently inaccessible to U.S. exporters, India’s growing imports will create opportunities for the US elsewhere in the world

Legend Impact on demand gap: Bigger gap Small change Smaller gap

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Note: Net import figures as of 2010

More on demand and other import markets (2)

New Zealand: Constrained by several factors, dairy land growth should reach peak by 2020

Source: LIC Dec 2010, Dairy NZ, USDA GAIN Nov 2010; Lit. search, Bain analysis

0.8% CAGR 1.2%

CAGR 2.1% CAGR

Most dairy land growth/ conversion on South Island, where good land in demand

Environmental regs expected, limited land/herd growth

Irrigation of marginal land on South Island also limited due to regs and water supplies

Dairy land likely to grow slowly beyond 2015 and peak around 2020

Several factors are expected to constrain further land growth beyond 2020

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it

it

it

DAIRY LAND (M Hectares)

PROJECTED GROWTH (2010-20) Bar width proportional to country’s share of EU production

Some countries will expand production, while others will be flat to down

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Source: European Commission, “Economic Impact of the Abolition of the Milk Quota Regime” (2/2009); Eurostat (for 2010 country-level production)

Countries most frequently mentioned by experts as likely to experience strong growth

Elimination of quota will lead to modest expansion of ~5%

% of total EU cow milk production

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Export markets What has changed since 2009 Est. impact,

2013 demand gap

New Zealand Net exports: 1997K MT, 41% of global

• Production grew faster than expected during 2007-10 due to cow population growth. Consumption slumped in 2006-08 due to soaring prices, adding to export growth

• Future production growth expected to slow; could reach peak level of 23M MT by 2020

• Despite higher production, will not produce enough milk to close latent demand gap

Australia Net exports: 390K MT, 8% of global

Production took a hit due to droughts, floods. Water table has improved, should spur limited production growth

Consumption growth will remain flat, will remain a large exporter, albeit with slow production growth and limited ability to expand

EU Net exports: 1419K MT, 29% of global

• Consumption slumped in 2006-10 as high prices were followed by recession and added to export growth; consumption growth expected to remain low

• Quotas increasing 1% annually 2009-15; aggregate EU-27 production could increase by 5-8% from 2010 to 2020

• Production growth most likely result of a step change in output at 2015 by some countries as they expand production to use the full potential capacity of existing farms

• After 2015, further growth will be constrained by environmental regulations and the steep incremental investments required to expand the industry

Ukraine Net exports: 64K MT, 1% of global

Production lower in 2007-10 than previously projected due to financial, policy and quality issues; future export growth dependent on addressing these issues

Consumption growth also slowed due to high prices and a weak economy

Growth still possible, though unlikely to be a major exporter in the near term

Legend Impact on demand gap: Bigger gap Small change Smaller gap

More on supply and other export markets (1)

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Note: Net export figures as of 2010

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Export markets What has changed since 2009

Est. impact, 2013 demand gap

Brazil Net imports: 48K MT, 1% of global

Brazil became a net importer as production fell mainly due to poor profitability and bad weather

Consumption continued to increase, spurred by income and population growth

Should return to small net exporter by 2015. Still has strong exporter potential in the long term

Argentina Net exports: 247K MT, 5% of global

Downturn saw production and consumption growth, but exports continued to grow off a small base. Still a relatively small exporter with decent growth potential, despite protectionist policies

Improved dairy-grain price ratio should encourage use of feed and improve cow yields

Belarus Net exports: 312K MT, 6% of global

Industry dependent on demand from Russia, but exports have grown at a very strong pace

Poor economic situation will limit consumption growth and limit government ability to invest in production, though production has shown strong potential

Exports are starting to diversify to markets other than Russia

U.S. Net exports: 322K MT, 7% of global

Global recession, slow reaction of U.S. trade policy and period of high-feed prices could lead to a less competitive U.S. dairy industry

Production and consumption trends remain steady with slow growth expected through 2015

Legend Impact on demand gap: Bigger gap Small change Smaller gap

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Note: Net export figures as of 2010

More on supply and other export markets (2)

Dairy producers will almost certainly face high feed costs (relative to the previous 20 year average)

Producers and processors should reassess their cost structures to ensure competitiveness over the longer term

Source: EIU (2011), Bloomberg (2011); Bain analysis

Sustained high commodity prices also likely

AVERAGE COMMODITY PRICES (cents/bu)

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New Zealand marginal costs include cost of shifting to 100% feed after peak production is reached under grazing model

Range of potential marginal commercial costs

Netherlands China New Zealand U.S.

High feed prices not likely to shift U.S. cost position; major expansion will be costly for most competitors

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Source: IFCN 2010; USDA 2009; China Dairy 2010; Teagasc Ireland Dairy 2010; “The Wealth Report” (2011); Eurostat (2011); expert interviews

Despite higher feed prices, the U.S. should maintain its cost position. And, even for traditionally lower-cost producers, major commercial growth will be costly.

RAW MILK ESTIMATED MARGINAL PRODUCTION COSTS ($/MT) Costs based on IFCN large-sized farms

Currency was also considered as a wildcard, but it is unlikely to have a near-term impact on U.S. dairy

Source: EIU (2011), Bloomberg (2011); Bain analysis

PROJECTED USD APPRECIATION/DEPRECIATION VS. KEY IMPORT CURRENCIES (10-13F)

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Currency trends may influence long-term cost position of suppliers boosting purchasing power for importers

However, currency fluctuations unlikely to drive purchases in the short-term because buyers more likely to manage through hedging

Even with strong U.S. dollar, latent demand gap will still exist, making export pricing levels more attractive

By text, type in using on-screen Q&A panel By phone, press *1 to notify an operator For technical difficulties, press *0 on telephone touchpad

Comments, questions from participants?

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In summary, the window of opportunity remains open and appears to be expanding

IMPORTERS

China

Russia

Southeast Asia, Mexico, MENA, India

EXPORTERS

Brazil

Ukraine

New Zealand

European Union

Australia, Argentina, Belarus

China shows continued growth in demand

Russia production dipped

Potential low-cost producers such as Brazil, Ukraine recently stumbled

New Zealand and EU, despite modest increases, unable to fill demand gap

Other sources—Argentina and Belarus—have good potential, but still relatively small

Net 2013 demand gap widened during the global economic downturn

Latent demand gap of 6.5-7B lbs. still exists, may be larger than estimated

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Though the window of opportunity will remain open, the U.S. must take action in near-term

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TIME HORIZON

High

Low

U.S

. DAI

RY

CO

MPE

TITI

VEN

ESS

NEAR-TERM Dairy trade continuously

attractive

Buyers seek to rely more upon United States as an alternative supplier

MID-TERM Growth markets continue to import

New Zealand approaches peak production levels, inducing a need for alternative suppliers

Low-cost suppliers emerge

LONG-TERM Today’s emerging

markets see slower growth rates

Low-cost exporters expand capacity

POTENTIAL LONG-TERM U.S. TRAJECTORY

And buyers have clearly affirmed that the U.S. is well-positioned to play a greater role

“The United States has one very big strength. They have a lot of milk with no seasonality.”

“We desire to open our portfolio and expand our supplier base beyond Fonterra. I would like to have the United States as a supplier and they are a natural choice.”

Source: Innovation Center for U.S. Dairy “Global Dairy Buyer Survey,” conducted in September 2010

“Supply is uncertain – they want to play when price works but we can’t be sure they will be there. It works for spot buys, but not for consistent, twice-monthly deliveries. We need suppliers who are committed.”

“We are afraid to contract with the United States because we can’t ensure that they will meet the commitment. That means I have to bear the risk.”

Buyers view the United States as an important source of future supply…

…but want the United States to commit to the global market

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However, there are reminders that the window of opportunity won’t remain open indefinitely

Import demand

1. Major importers have renewed investments in domestic production

2. Recent willingness to protect local producers may give domestic producers time to increase their competitiveness

Export supply

3. Oceania and EU aggressively pursuing FTAs with developing countries

4. Long-term growth likely for some EU producers such as Ireland and Netherlands

5. Brazil, Argentina, Ukraine and Belarus hold potential

Policy reforms 6. The United States has yet to make key reforms

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Policy reform should seek to accelerate achieving critical outcomes

U.S. dairy is uniquely positioned to seize on long-term export growth

Updated dairy policies are needed before the U.S. can fully benefit

Global dairy demand continues to outstrip supply due to growth in developing markets

Export markets are the strongest source for future U.S. growth

The U.S. can become a sustainably larger player provided it can address capability gaps

Global buyers want a more diverse supply base

Yet, emerging suppliers make this a finite window

Flexible pricing to let milk flow to the best/ most profitable use

Achieve greater predictability of price thereby decreasing the cost of volatility

Reform milk pricing systems to improve the forward/ futures market to manage price volatility

Reform price support to remove the government as a “last resort” buyer and remove disincentives for product innovation

Develop better mechanisms for risk management to mitigate the impact of volatility

Modify standards of identity closer to global norms if commercially needed to meet customer needs

The reforms, whatever their details, must enable key outcomes

Let market incentives better align product portfolios

with customer needs Achieve value growth for producers and processors

by investment in innovation, safety and quality

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Failure to achieve needed policy change will weaken the U.S. industry and limit its higher value realization

The U.S. will miss out on sustainable volume and value growth

Limited opportunities for U.S. to grow milk supply and raise on-farm margins without global trade

Greater value and profits will be available as emerging markets expand consumption – capturing this value is a priority for every expanding industry

Stagnant industry will undermine competitiveness, investment and profit for entire sector

Unmet demand will accelerate the expansion of other producers

Failure to fulfill rising demand will incent investment in alternate areas of supply, accelerating their emergence as global competitors

Without the U.S., investors and buyers must turn to higher-cost sources such as the EU – and contribute to closing the window of opportunity

The U.S. industry will see lower competitiveness and less ability to meet market needs

Lack of higher growth outlets will dampen capital investment in the U.S. supply chain, leading to declining competitiveness

The impact of volatility will increase, further damaging the industry and encourage substitution by non-dairy alternatives in internal and external markets

Without a policy and economic environment that facilitates the growth and advancement of the U.S. dairy farmer, filling the latent demand gap could be out of reach

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The 2011 “refresh” confirmed the findings of the 2009 report—we’re on the right track Opportunity is still there, but we have a limited ability to control the “size of the prize” What we can control is time – how quickly we move into this space Window of opportunity won’t stay open indefinitely The U.S. has yet to make key reforms needed to fully capitalize

on the opportunity If the U.S. doesn’t make key reforms, we will miss out on

sustainable volume and value growth; unmet demand will accelerate the expansion of other producers; and the U.S. industry competitiveness will erode

Concluding thoughts and implications

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The same industry and company efforts will combine to make the U.S. a globally consistent supplier

Company specific Collective industry

Cross-border partnerships

Milk pricing reform

Risk Management,

Volatility

Quality-Traceability

(Safety)

Net benefit trade treaties

High

Low

Sales / marketing

capabilities

Customer Product

Specifications

Product & Technology Innovation

High-value products meeting

international standards

Export Marketing

Board

Prio

rity

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Structural Programs Goal Rationale Actions

Pricing Policy Reform (IDFA, NMPF) Revise regulatory milk pricing systems and price support

Accelerate consistent supplier outcome

Monitor IDFA and NMPF proposals

Volatility Risk Management (IC Work Team – Chair: S. Shelley, Schreiber) Develop better mechanisms to manage risk and moderate impact of volatility

Volatility to persist, impacting market strength, growth throughout supply chain

Work to increase liquidity by improving dairy futures contracts, and options

Trade Treaties (USDEC, IDFA, NMPF) Pursue trade treaties that provide net export benefits; counter arbitrary technical barriers

Greater and more expansive access to global markets

Korea, Panama and Colombia FTAs; include “Regulatory Coherence” in TPP

Program update

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Commercial Programs Goal Rationale Actions

Quality-Traceability (Safety) (IC Work Team – Chair: D. Carey, Darigold) Improve existing quality and traceability systems

Provide competitive advantage and proactive response to probable future mandates

Develop competitor bench-marking, business case, field trial, and technology review

Customer Product Specifications (IC Work Team – Chair: K. Murfield, UDA) Improve ability to deliver customer product specs

Limited product offerings disadvantage U.S. in internal and external markets

MPC GRAS efforts to better meet customer needs

Product and Technology Innovation (Dairy Research Institute) Improve development, utilization of market relevant innovation in product, nutritional and process applications

More sustainable market position with more value-added products

Identification of priority research (non-dairy threats, milkfat, proteins and lean body composition)

Program update

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Globalization assessment dashboard

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Goal Stakeholder performance indicator

Current assessment (based on data through first quarter of 2011) Positive Neutral Negative

Increase global competitiveness

Is U.S. becoming more competitive globally?

U.S. building on gains made before 2009 downturn

Is U.S. filling the latent demand gap?

U.S. capturing a growing share of larger market

Is U.S. moving beyond surplus disposal and “supplier of last resort” status?

U.S. NDM/SMP export quantities recovering, but competitors are gaining greater value Also unclear if growth will be sustained as the rate of import demand growth appears to be slowing

Strengthen domestic market

Is U.S. becoming more competitive domestically?

U.S. milk solids continue to displace imports in the domestic market

Provide value to producers

Is the global market contributing to higher returns to U.S. milk producers?

Increasing export share leads to greater market convergence of domestic and international commodity prices; lower, actual class III and Class IV prices converge with higher export equivalents

Improve commercial focus

Is U.S. better fulfilling increasingly demanding needs of global customers?

Buyers say they want U.S. supply option in market, but customer service improvements needed

By text, type in using on-screen Q&A panel By phone, press *1 to notify an operator For technical difficulties, press *0 on telephone touchpad

Comments from participants?

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Access on usdairy.com/globalization

Executive summary Factbase “White Paper” report (forthcoming late summer)

Final comments

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Dairy Globalization Refresh: 2011 Update Summary Findings Conducted by Bain & Company Commissioned by Dairy Management Inc. & U.S. Dairy Export Council

Thank you