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Fonterra says China well-poised for growth

Thursday 22 September 2016 02:56 PM

Fonterra says China well-poised for growth, regulatory changes will see 1800 brands disappear

By Fiona Rotherham

Sept. 22 (BusinessDesk) - Fonterra Cooperative Group chief executive Theo Spierings says legislation will mean drastic changes in the Chinese infant formula market with the removal of between 1800 and 2000 brands in the next 15 to 18 months.

Regulatory changes require each entity to have only three brands and three different recipes of infant formula in a bid to crack down on the grey market and allay consumers’ food safety concerns by reducing fake formula.

Spierings said Fonterra was well-positioned in every segment in China where it is already the global market leader for ingredients such as whole milk powder but a lot of things have changed in the past few years including a shift to sales from mother and baby shops to e-commerce.

The dairy cooperative, which has raised its forecast milk payout twice in as many months, posted a 65 percent gain in full-year profit as cost-cutting and cheaper milk made up for a revenue decline.

Profit rose to $834 million in the 12 months ended July 31, from $506 a year earlier while revenue fell 9 percent to $17.9 billion. The overall result shows a big swing towards more value-add which saw its return on capital rise to 12.4 percent from 8.9 percent the previous year.

“Our strategy is about ensuring we do everything we can to minimise the volatility in earnings but it's not going to go away,” said chairman John Wilson. “There is no doubt to some extent profitability is positive because dairy prices are lower but you’ve seen us announce for next year a lift in our earnings forecast as milk prices are coming up.”

This week Fonterra raised its forecast payout for the current season by 50 cents/kgMS to $5.25/kgMS, for a total payout of $5.75-to-$5.85 including forecast earnings of 50 to 60 cents available for distribution.

Greater China, Fonterra’s key market, produced earnings before net finance costs and tax of $64 million through its China farm division, which includes two farming hubs, increased annual losses to $59 million, up from $44 million, due to weak global milk prices during the year.

There was a recovery in Chinese demand with dairy imports up 27 percent this year and Fonterra had 48 percent volume growth to 1 billion litres in its consumer and food service business there, which is continuing to expand in mainland China, Hong Kong and Taiwan.

Milk production from its 10 China farms hit 230 million litres and a third farming hub is now being developed under a joint venture with Abbott Laboratories, which will use some of the milk produced.

Wilson said the cooperative was satisfied with that level of farm development at this stage having revised its original intention to produce one billion litres of milk out of China.

“With these two hubs we will be producing between 300 and 400 million litres and we’re very comfortable with that which is at a critical mass that we can now make the right decision on what do with that fresh milk into our consumer and food service brands and products and key Chinese customers’ local businesses,” Wilson said. “We will make those decisions in coming months, rather than years, on what do with that.”

Integrating the Chinese fresh milk, currently sold on the spot market, into its other operations in China won’t necessarily mean Fonterra building a processing factory in that country as Wilson said it could be done by third-party manufacturers instead.

“The Chinese market is evolving so rapidly. That’s why ingredients out of New Zealand are so important and any manufacturing in China will be supplementing ingredients from New Zealand with a fresh dairy offering from China and we need both as that market evolves, particularly down the east coast of China,” he said.

Spierings said currently 100 percent of the milk used for its products in China is produced from New Zealand but over time he could see that shifting to 80 percent from New Zealand and 20 percent from its Chinese farms.

There were plenty of questions at today's results briefing on Fonterra's $747 million investment last year in Chinese infant formula maker Beingmate which warned investors it was anticipating a first-half loss of up to 230 million yuan. Its share price has dropped from the 18 yuan a share that Fonterra paid for its 18.8 percent stake to 11.67 yuan. The tie-up includes a distribution deal for Fonterra's Anmum infant formula brand.

This week Fonterra also got Australian and Chinese government approval for its joint venture with Beingmate to purchase Fonterra’s infant formula plant at Darnum in Australia, which Wilson said will mean product destined for Beingmate’s Chinese customer will now start rolling off the production line.

The Darnum joint venture is a key component of Fonterra’s partnership with Beingmate to create a fully integrated global supply chain from the farmgate direct to Chinese consumers using Fonterra’s milk pools and manufacturing sites.

Wilson said the Beingmate investment was part of a wider strategy in China that was now starting to come together.

“We’d like to see the Chinese infant formula business be far more in balance and we anticipate that happening in the next 12 months,” he said.

For the overall business, around 4000 “transformation” initiatives delivered $2.2 billion in free cash flow, of which $1.6 billion was used to reduce its debt to $5.5 billion, lowering its debt gearing ratio to 44.3 percent from a record high 49 percent the previous year.

Wilson said the debt gearing would have fallen to 42 percent if it hadn’t used the strength of its balance sheet to support its farmer shareholders through tough times after two years of low payouts, by advancing payments and a support loan.

“We have used the strength of the co-op paying down that debt to get cash flow flowing through to our farmers and still delivered a strong balance sheet for the co-op," he said. "That’s the important thing, getting the balance right.”

Fonterra also turned around its loss-making Australian operations, delivering a $63 million earnings before interest and taxation compared to a $92 million loss last year after what Spierings said was “big changes in milk prices which were not connected to what was being earned in market”.



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