Fonterra's China farms likely to be profitable in two years

Fonterra Cooperative Group's [NZX: FCG] Chinese dairy farms could take another two years to become profitable but their losses should be reduced this financial year, Fonterra's managing director, international farming, Alan van der Nagel, says.

The international farming division, which currently consists of two farming hubs in China and has no plans to own any elsewhere, posted a loss of $44 million in the 2015 financial year on revenue of $141 million. That was because of set up costs for new farms, livestock revaluation, and a 20% drop in the domestic milk price, and compares to a profit of $21 million in 2014 on $103 million in revenue.

Mr Van der Nagel told BusinessDesk the milk price in China is starting to return to the level needed for on-farm financial sustainability at near four renminbi per litre. However, the division was likely still to report a loss this financial year, owing to farm development costs, which will be a third lower than last year's capital expenditure of $364 million.

The cooperative has tightened its capital spend as declining global dairy prices hit revenue and to reduce borrowings to achieve a debt-equity ratio of 40-45% by the end of the 2016 financial year. Fonterra wouldn't provide a figure on how much it has invested in total since setting up its first farming operation in China in 2007, but has previously said each five-farm hub costs about $250 million, including livestock.

Fonterra is finalising Chinese regulatory approval for land for a third farming hub it's developing in a $US300 million joint venture with New York Stock Exchange-listed Abbott Laboratories.

The joint venture had chosen a preferred site along with a number of alternative choices it was still negotiating on, van der Nagel said. Fonterra holds a 51% stake in the joint venture and will be liable for that portion of the costs of setting up the hub, which will have five farms, 16,000 animals, and produce 160 million litres of milk annually.

The move is part of a change in direction for Fonterra, which has decided it's no longer strategically important to own its farms in China outright.

Mr Van der Nagel said that doesn't mean the farms themselves are no longer strategically important, with Fonterra committed to building an integrated dairy business in China. It's considering whether to set up manufacturing operations there again, supplied by its own milk, once it has established sufficient demand.

Fonterra's milk produced in China attracts a premium because it's considered safe and high quality, he said. It's currently sold into the fresh milk market primarily for use in yoghurts and UHT (ultra-heat treatment) milk whereas all Fonterra-branded product sold in China is sourced from outside the country.

Its two farming hubs in Ying county in Shanxi province and Yutian county in Hebei province currently employ more than 1000 predominantly Chinese staff and have 25,000 milking cows producing 12 million kilograms of milk solids annually. It also has 28,700 young stock and some 30% of its annual costs are for livestock brought in from New Zealand to improve the herd's genetics.

Mr Van der Nagel said he's pleased with production from the feedlot farms. Criticism of the production figures doesn't take into account that some of the farms are start-ups and three were operational for only part of the last financial year, he said. The Ying hub is yielding 28.5 litres per cow daily while the Yutian hub yields 29 litres per cow daily. He said production from Yutian was cut back last year due to over-supply within the Chinese market.

Mr van der Nagel said that when the third farming hub is completed by the end of 2017,  the farms will have the capacity to produce about 600 million litres of milk annually. To put that in perspective, that's still only 1-2% of China's total milk market, although Fonterra already ranks ninth out of the top 10 largescale producers.

The original target of one billion litres of milk from its China farms by 2018 has now been extended to 2022/23, Mr van der Nagel said.

Fonterra is seeking other "strategic partnerships" to develop farms and is also considering whether to sell down part of its existing hubs, he said. It's also offering a pipeline of livestock and to manage the Chinese farms owned by Beingmate in which Fonterra has taken an 18.8% stake. A further possibility is developing new farms jointly with the Chinese infant food manufacturer, he said.

(BusinessDesk)