China’s dairy industry is set to see further foreign investment this year, despite risks over poor food safety, leading Chinese analysts have predicted.

Confidence in domestic dairy brands plummeted last year after more than 20 companies were found selling milk contaminated with the chemical melamine. The adulterated milk powder was linked to the deaths of at least six infants.

Though dairy sales have since picked up, consumption is still only at about 70% of the level prior to the scandal, said Peter Zhao, chief of research and advisory at Rabobank’s north-east Asia office.

This creates a strong opportunity for foreign investors, he told just-food.

“I think this is one of the best times for foreign companies to come in. People trust imported products more.”

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Rabobank estimates that China’s consumption of fluid milk fell from 11.5m tonnes in 2007 to 8.05m tonnes in 2008, while milk powder was down to 1.7m tonnes from 2.8m in 2007. 

Some categories have been less affected by the scandal, such as yoghurt. “People believe that better milk is used to make yoghurt so it’s less likely to be exposed to risk incurred from raw material,” said Zhao.

He added that it could take one to two years before the market recovers fully. During this time, foreign brands could increase market shares. 

Others expect further equity investment in the sector. In December, the Wall Street Journal reported that private equity group KKR had invested in Mengniu Modern Dairy, a farm owned by leading producer Mengniu. KKR’s China spokesman declined to comment.

Benoit Rossignol, chief executive of Shiyao Investment, an advisory firm in Shanghai, said: “I think KKR has made a smart move. There are definitely opportunities to invest in milk production.”

China’s dairy processing industry has increased rapidly in recent years but production at the farm level has not been able to catch up with demand for quality milk supply, said Rossignol. This gap has led to suppliers cutting corners, using melamine to increase milk quantity, he believes.

“We need foreign investors in dairy farming. The challenges are that dairy policies need to be better developed. But the market is still extremely fragmented and privately-held farms are not yet that competitive.”

Heiner Braun, partner at Freshfields law firm in Shanghai, said foreign investors will be encouraged by recent Chinese government announcements urging consolidation in the dairy sector to raise quality.

He added that companies would need to take care in selecting acquisition targets.

Eric Xu at private equity group 3i agreed. His firm is considering investment in the food industry but “with a little more care and due diligence than before”.

Industry experts said most food investments were unlikely to be subject to the same level of scrutiny as Coca-Cola Co.’s bid for Chinese juice maker Huiyuan.

Rejection of the deal last week “may have a dampening effect on foreign investment in China”, said Braun. “But in reality, it will only affect larger deals. Remember that this case involved a brand that was known and loved by Chinese consumers. I’m not sure dairy brands can make that claim these days.”

Rabobank’s Zhao added that Huiyuan is a big player in its sector. “Such cases are less likely in sectors like dairy which is more fragmented. Foreign players are still quite small compared with the rest of the industry.”