By David Jones and Silke Koltrowitz

LONDON/ZURICH, Aug 26 (Reuters) - Price increases in
emerging markets and cost-cutting will help Europe's biggest
food groups avoid a profit hit similar to that of the last milk
crisis of 2007 when their dairy costs soared.

Swiss Nestle and Paris-based Danone are more exposed to milk
costs than to other commodities, and prices have been rising
this year due to strong emerging market demand and lower
production in Europe and North America.

Nestle is the world's biggest milk buyer for its products
such as Nido milk powder, Coffee-Mate and Cailler chocolate,
while Danone has nearly two-thirds of its sales in dairy
products such as Activia yoghurt and Actimel drinks.

There are also some fears that rising grain prices due
largely to drought and an export ban in Russia will add to the
pressure on milk prices as European farmers feed more grains to
dairy cattle during the colder winter months.

But analysts say the rise in milk prices is showing sign of
cooling and the highest prices this year were well below 2007's
peaks, even if it pays to keep a careful eye on Danone as milk
accounts for more of its input costs than in the case of rivals.

"In terms of size Nestle has most exposure to milk. However,
given the concentration of its portfolio Danone will be impacted
most from higher milk prices," said analyst Jon Cox at Kepler
Capital Markets in Zurich.

Danone has recognised the rise in milk prices by raising its
forecast of milk cost inflation in July to 10 percent for 2010
from 5-7 percent previously, but has also added that prices had
peaked in the early summer and were now trending down.

Analysts say milk accounts for 38 percent of Danone's raw
material costs, 23 percent at Nestle and 6 percent at Unilever
Plc/NV, and buying forward is quite difficult for liquid milk
and companies often buy directly from farmers.

This means liquid milk prices can be more volatile than the
more widely traded skimmed milk powder, and here Danone is the
most exposed as the need for fresh milk is greater at the French
yoghurt group, while Nestle is able to buy half of its
requirement as milk powder for its milk drinks and chocolates.

Nestle, the world's biggest food group, spent 5 billion
Swiss francs on milk in 2009.

"Dairy is one of the areas where we are seeing an escalation
in costs and therefore it's one of the areas where you are
likely to see some pricing action," Nestle finance director Jim
Singh told an investor roadshow this month.

European Union milk powder prices peaked at around $5,500 a
tonne in 2007 falling to around $1,700 in early 2009 before
edging back to just below $3,000 currently, and analysts say
milk powder does give a pointer to future liquid prices.

"On the whole, milk prices have become much more volatile
over the last two years which is due to the fact that the
European Union intervenes less on milk prices," said Dieter
Mirbach, manager of industry group European Dairy Farmers.

NOT SUCH A BIG ASK

Danone raised its prices following the 2007 milk price
surge, only to cut them in the middle of 2009 when costs fell,
so analysts say investors are right to be wary when Danone
starts raising prices in such a volatile market.

Analyst Alex Molloy at Credit Suisse said 40 percent of
Danone's dairy sales are in emerging markets where general
inflation runs at around 5 percent and so pushing up price is
not such a big ask.

Analyst Pablo Zuanic at Liberum Capital said United States
liquid milk prices are starting to come down and West European
prices are also peaking, and an LTO Nederland survey of European
milk prices for July due on Sept 3 may confirm this.

The survey showed average European milk prices in June were
up 23 percent year-on-year at 30.26 euros per 100 litres to
reach an 18-month high. However, if prices have peaked then
Zuanic says a Danone price rise of just 2 percent in Western
Europe in the second half of 2010 will be needed.

"We continue to argue the price increase "needed" by Danone
in Western Europe for the second half is quite manageable," he
said.

Pressure on Danone may intensify if grain prices continue to
rise with Orianne Segaud at Natixis saying, "If wheat prices
continue to rise, Danone has the least protection as it is the
most exposed to liquid milk prices with no hedging mechanism".

But New Zealand, the world's largest milk exporter largely
through butter and milk powder trade, produces its milk from
grass-fed livestock without any cereal-based supplement so any
grain price rise will not affect production costs.

Barry Callebaut, the world's largest chocolate maker which
counts Nestle and Hershey among its clients, is one of the top
three users of milk powder in Europe but has been relatively
insulated from price rises as it uses no fresh liquid milk in
its chocolate production.

Anglo-Dutch Unilever's main milk usage is at its world
leading Cornetto, Magnum and Ben & Jerry's ice cream operation
but it is a smaller milk buyer compared to Nestle and Danone.
(Editing by Sitaraman Shankar)