Dairy gets results
Fonterra’s rivals in China are making more money. How can the Kiwi co-op compete?
Rod Oram on Fonterra’s challenge
Fonterra is making good progress on its strategy, judging by its strong yearend results. Net profits were up 65 per cent to $834 million, the dividend paid to farmer-shareholders was up 60 per cent to 40 cents a share, free cash flow soared by $2.2 billion, debt fell by $1.6 b and return on capital hit a record 12.4 per cent.
But two very big questions arise: Can it hold on to the profit gains as milk prices rise from their abysmal lows? What is it up to in China?
The answer Theo Spierings, chief executive, gave to the first in the results briefing was positive but vague. His answer to the second was misleading and evasive.
Indeed, Fonterra is making progress on shifting more milk out of commodities and into consumer and food service products. Thankfully for farmers these are higher value and less price-volatile than commodities.
However, the gross margins on consumer products only edged ahead to 29 per cent from 27 per cent, and on food service to 27 per cent from 22 per cent. As the price of milk, its main raw material rises, profits will come under pressure.
The only hope is for Fonterra to keep growing its brand and market capabilities, so it can rival the much more resilient earnings of sector leaders such as Nestle´, Danone.
The outlook in China is even murkier. In his presentation, Mr Spierings said Fonterra’s sales reached 5 b litres of milk equivalent in the past financial year, making it ‘‘number 1 in China.’’ He added that the market was some 45 b LME.
This equates to a market share by volume of some 11 per cent; and Fonterra’s annual report shows its total China revenues at $2.4bn.
However, Yili and Mengniu, the two largest Chinese dairy companies, both have similar volume shares, according to data from Rabobank, the Dutch agribank, and IFCN, the global dairy industry’s highly respected research network based in Germany.
Far more crucially, Yili’s and Mengniu’s sales revenues are significantly higher than Fonterra’s Chinese sales. Simply, they’re making far more money per tonne of product in China than Fonterra is.
How might Fonterra catch up? Its two main strategic thrusts are its 18.8 per cent stake in Beingmate, a Chinese infant formula company, purchased last year; and its heavy investment in Chinese farming.
The presentation slide pack available on online had a single, simple strategy slide on the farms laying out a 10-year journey that began 2008. But it was devoid of explanation as to how losses can be turned into profits as the co-op keeps investing.
Mr Spierings presented a single slide on the ‘‘China opportunity’’. The only reference to Beingmate was a footnote showing how important it is to Fonterra. The coop’s sales of ‘‘advanced nutrition products’’ such as infant and adult formulas was a mere 0.02 b LME in 2013, equal to 1 per cent market share.
In the latest financial year, sales were 0.27 b, equal to a 9 per cent market share. But 0.25b had been via Beingmate. In other words, Fonterra on its own had achieved no volume growth in a market that had expanded by 50 per cent in three years.
When Mr Spierings was questioned about Beingmate, he talked very vaguely about deep disruptions in the Chinese infant formula market, such as new government regulations that would shake out small players.
Presumably this might benefit Beingmate. But Mr Spierings didn’t elucidate.
The simple facts are Fonterra paid 17.68 yuan per share for 192m Beingmate shares in March 2015.
In July, Beingmate warned Chinese investors of a hefty first half loss. Since Fonterra invested 18 months ago, Beingmate’s shares have fallen by 35 per cent, representing an unrealised loss of $250 m to Fonterra.
Shareholders deserve to know far more about their co-op’s investment in China.
As the price of milk rises, profits will come under pressure