Fonterra chairman appeals for patience on Beingmate formula

Fonterra chairman John Wilson expects it will take another one to two years before there's clarity on how its Chinese partner Beingmate will fare under new regulations governing infant formula in China.

The so-called Article 81 regulatory change means each legal entity will only be allowed to have three brands with three recipes for infant formula and that's expected to decimate the number of brands and labels on supermarket shelves in China from more than 2000 to about 200.

The Shenzen-listed Beingmate, in which Fonterra has invested about $754 million, recently reported further operating losses for the third quarter of 2016.

Following a dismal half-year performance where it reported a 214 million yuan loss, Beingmate has reported negative earnings of 195 million yuan for the quarter ending September 2016 and a net margin of negative 42%. Its share price is trading at 12.58 yuan, well down on the 18 yuan per share Fonterra paid for its 18.8% stake. Beingmate hasn't paid dividends for some time.

Many of the infant formula producers who are expected to be forced to exit the Chinese market have been clearing inventory which has had a substantial impact on market prices and net margins in the past and current financial year.

A shareholder in Fonterra's unit fund asked for more information on the dairy co-operative's China strategy at Monday's annual fund meeting while the annual Fonterra Shareholders' Council report has in-depth commentary on Beingmate which it says has "quite rightly been of great interest to shareholders".

Mr Wilson says the regulatory changes are challenging for all entities operating in China's infant formula market but Fonterra has confidence Beingmate will come through the changes well and the board is monitoring it closely.

"Historically it has operated well and every participant in that sector is under the sort of pressure Beingmate is under," Mr Wilson says. "Beingmate has to grab the opportunities that present themselves because of that and that is our expectation of it."

Fonterra's China strategy involves $1.6 billion of total capital investment in farms in China and the Beingmate partnership. Mr Wilson says it is important to remember the investment in Beingmate is just one component of the partnership.

There has been a 78% uplift in sales of Fonterra's Anmum infant formula brand, a latecomer to the Chinese market, through Beingmate's distribution network while production is starting to flow into Beingmate's consumer businesses from its joint venture Darnum plant in Australia following a lengthy delay in getting regulatory approvals.

Fonterra is also starting to do some work with Beingmate to help make its own farms more efficient, using its capability to drive high-quality fresh milk for the Chinese company's own business.

The Chinese farms were the only negative result in an otherwise positive annual result for Fonterra in the 2016 financial year. The 10 farms in two hubs produced an increased annual loss of $59 million, up from $44 million the year before.

Its level of milk production hit 230 million litres, the level required to sustain a processing factory in China but  since the deal with Beingmate Fonterra has cut back on its original plan to produce 1 billion litres of milk from its own Chinese farms.

Long-term investment
The Fonterra Shareholders' Council annual report says it is important for Fonterra shareholder suppliers to view the investments in China as a whole, rather than as separate initiatives,although each investment must deliver returns to the co-op per its business case.

Council chairman Duncan Coull says while it is understandable shareholders are concerned about some issues of late in China such as the stockmarket and regulatory changes, Beingmate is a long-term investment and China a market that Fonterra has to be in.

One in four litres of Fonterra milk now ends up in China and Coull says it would be difficult to sell that amount anywhere else in the world.

But the council is expecting to see significant returns on that investment over time, he says.

It is also critical that Beingmate adapted to the fast-paced shift to e-commerce that's occurring in China, the report says, and that it is allocating "significant resource into fast-tracking its ability in this area."

Mr Coull says the council is also concerned about the downward trend in Fonterra's share of the New Zealand milk market which has dropped in the past year to 84.1% from 85.4%, although overall milk volumes have grown.

He says Fonterra and the council have strategies they are working on to try to shore up its share of the local milk pool, particularly given production is down an estimated 7% this season.

"We don't want to base our loyalty on the last payout because that leads us down a slippery slope. We have to develop deeper connections," he says.

(BusinessDesk)