Cloud over Fonterra’s China farms as losses deepen

Fonterra’s China Farms business remains a strong candidate for the chop after posting a 43 per cent increase in direct loss to $17 million in the first half of the year.

The total loss from the seven farms was $21m.

This was made up of the direct loss of $17m, a $5m loss for Fonterra’s ingredients business in China which buys the farms’ milk at an inflated price, and a $1m profit in the consumer and foodservice business.

Fonterra has spent $788m establishing the farms which have been loss-making for at least five years.

New Zealand’s biggest business is reviewing all its operations and strategy as it struggles with debt and a capital squeeze and new chief executive Miles Hurrell said in December the farms were “getting a heightened focus” in the shakeup.

Farmer-owned Fonterra last year posted a historic first net annual loss of $196m and debt of $6.2 billion. It has pledged to reduce debt by $800m this financial year.

The China farms, which make up two hub operations, produce fresh milk for the Chinese ingredients, foodservice and consumer markets.

Fonterra said in the first six months of the 2019 financial year, domestic milk prices had improved with 40 per cent of milk production selling for more than 4RMB per kilogram against 17 per cent in 2018, when the average milk price was 3.56RMB/kg.

This is a positive because Fonterra’s ingredients business buys raw milk at a higher-than-market price from the farms and sells it for the highest possible price. This transfer pricing practice saw the China ingredients business post a $30m loss for the full 2018 financial year, on top of the farms’ own direct $9m EBIT loss.

Fonterra said rainstorms and floods in the Yutian region, home to one of the hubs, had reduced half year milk production and as a result, sale volumes, and pushed up feed costs. Sales volumes were down 15 per cent in the first half compared to the same period last year.

Revenue from the farms was $108m, compared to $123m the previous half year. Fonterra began building the farms after the collapse of its joint venture with China’s San Lu company after the 2008 melamine milk poisoning scandal.

The goal was for the China farms to produce up to one billion litres of milk a year by 2020.

In the first six months of this financial year, the farms produced 113m litres of milk compared to 132m in the comparable previous period.

In the 2018 financial year total production was 273m litres, compared to 355m in 2017.

In its interim report, the company said its plan was to shift more milk from the China farms into higher value products. The farms’ second half performance was predicted to improve through cost efficiencies and controls and feed procurement efficiencies in combination with a seasonal lift in production.

“Having farms in China means we can supply premium fresh milk to customers like Alibaba’s Hema Fresh which stocks our Daily Fresh milk range,” said the report.

Fonterra Shareholders’ Council chairman Duncan Coull said the watchdog was waiting until the strategic business review of Fonterra was finished before further addressing the issue of the loss-making farms.

After watching the farms go from producing milk for powder, then UHT, to providing fresh milk for the Chinese, Coull said personally he wasn’t sure quitting the operation was the best option. But the capital expenditure that had been involved was concerning.