Sunday, July 3, 2022

Fonterra plays waiting game

Fonterra Shareholders’ Council (FSC) chair Ian Brown has shied away from being drawn into a debate on Fonterra’s refreshed strategy, which has come after recent announcements that two Chinese companies intend to set up infant formula plants in this country. Business commentators have asked why Fonterra has not invested in such a plant and branding in New Zealand. Chinese firms Yashili and Yili announced plans to build one plant in the South Island and another most likely in Waikato. These come as Chinese-funded Synlait expands its infant formula business and other Chinese companies circle the NZ milk supply market.

Buying into the value-add infant formula market was identified by researcher Tim Morris, of Coriolis Research, in 2010 as one of five strategies Fonterra could pursue to grow business value.

Last year’s strategy announcement from Fonterra listed a renewed focus on maternal and paediatric formulations as one of its seven key areas of focus. This included an aim to enhance the cooperative’s position in selected Asian markets and to have a continued investment in supply innovation.

Fonterra processes powder for formula and has its own brand, Anmum, in some markets.

Brown said the strategy, less than a year old, was still in its early days and he would prefer to give it time to play out.

Coriolis also completed a food and beverage report in 2010 focussing on four food areas, including infant formula. This revealed NZ could easily export four to five times more infant formula globally than it is now, making it a $4 billion industry. Challenges for that occurring included Fonterra’s “disinterest”  and capital constraints.

More recently, Morris said globally China offered the only real potential for growth in the infant formula market. Global market share was tightly consolidated among some big players, with the top six firms controlling 66% of global sales. The bulk of that is captured by only three companies, Nestlé (25%), Danone (14%) and BMS (11%).

For Fonterra to go beyond the sales it makes with its Anmum range of powders for children aged from one to six could require significant investment in a brand, Morris said.

“A number of brands have changed hands but for really big numbers, the sort where you risk the company totally and borrow 50% again on it. It is not like the wine industry.”
Strongest growth in the US$34 billion market has come in the Asia-Pacific region, which has averaged 15% annual growth and now accounts for US$11 billion of the total. China accounts for half that.


As a market China has experienced 24% pa growth over the past 10 years.

Yashili, one of the companies wanting to set up here, is ranked among the top secondary Asian companies and the other company, Yili, was ranked in the top 20 global dairy companies.

Morris said the early arrival of some “cowboy” operators had possibly tainted the view on Chinese operators but the latest players like Yashili were not to be underestimated. The Dairy Board had considered infant formula production in the 1980s, he said.

“But the issue was, do we want to compete with our own customers?”

He believed this view remained, an opinion supported by industry analyst Peter Fraser.

Morris also said tariff constraints could determine exactly what was simply milk powder and what was infant formula.

“They may make powder that is just about infant formula but can’t be completely for tariff reasons.”

Despite the scale of the infant-formula market, Morris believes “all the interesting stuff” is happening at the opposite life stage in human nutrition, as the global population ages and birth rates fall.

Fonterra’s focus on bulk powder was also criticised recently by Morningstar Research analyst Nachiket Moghe. He pointed out the co-op was just covering its cost of capital, which was largely a result of processing lower-margin commodity powder.

Morningstar believed as a result the Fonterra unit price of $7.31 was overvalued. The company has set a price range from $5.50-$6.10/unit, based on earnings.
The current market price put Fonterra’s price to earnings ratio at 17 times, ahead of established massive value-add players like Nestlé, with share valuations at 15 times earnings.

Compared to similar food company Dean Foods in the United States, which runs similar margins and products, Morningstar valued Fonterra’s units at 12 times earnings.

“Fonterra does already have Anmum brand, but the key reason Nestlé is so successful is a phenomenal distribution network into every nook and cranny. That can’t happen overnight,” Moghe said.

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