Fonterra is confident in its China strategy despite infant formula company Beingmate Baby & Child, in which it has an 18.8 per cent stake, saying losses for 2016 will be about double the previous forecast.
Shenzen-listed Beingmate said it its loss for the year was now expected to come in at 750-800 million yuan ($150.8m to $160.9m) because of accounting adjustments and provisions for bad debt arising from its subsidiaries.
Fonterra's chief financial officer, Lukas Paravicini, said Beingmate's recent performance reflected China's market conditions, "which remain challenging for all dairy players".
"The long-term outlook remains strong with disposable incomes in China growing by 11.5 per cent a year since 2006, the relaxation of the one child policy taking effect and tightening brand regulations leading to the exit of many smaller competitors from the marketplace," Paravicini said in a statement.
"We are confident in our overall China strategy, of which our Beingmate partnership continues to be an important part," he said.
"Our partnership with Beingmate is a long-term investment to grow in the domestic infant formula market," he said.
"It also supports future ingredient sales of our NZMP brand from New Zealand, and our whey products from Australia and Europe." Distribution of Fonterra's Anmum infant formula brand in China has grown from 60 cities in 2015 to more than 170 cities today.
Total sales were also ahead of projections, he said.
Beingmate last year forecast a loss of 380m yuan to 410 million yuan, compared with a profit of 103.6 million yuan in 2015.
In a translated statement, Beingmate said its fourth quarter revenue and profitability showed a slight improvement but that annual losses had become "more significant than previously expected".
Beingmate said that after discussions with its accounting firm, it had decided to reverse its cumulative deferred income tax assets of 300 million yuan. In addition, it had made a provision for bad debt of its subsidiaries that had suffered excess losses, to a total of 61 million yuan. "The performance forecast correction is the result of preliminary estimate by [the] company's financial department," Beingmate said.
No further details were available, but Beingmate last year said it faced a fake infant formula scandal, as well as "industry disorder" in the fast-changing Chinese infant formula sector and new regulation, including a requirement for brands to be registered with the China Food and Drug Administration.
Nine people were arrested in China in April after more than 22,000 cans of counterfeit infant formula were found being sold under the brands of Beingmate and Abbot Laboratories. Beingmate said further details about the loss will be revealed when the company releases its annual report in March.
Fonterra's tie-up with Beingmate, which operates four plants and 80,000 retail outlets across China, includes a distribution deal for Fonterra's Anmum infant formula brand and a joint venture manufacturing operation at Darnum, in Victoria.
The loss will not affect Fonterra's bottom line earnings but the company faces a loss on paper of $232.9m on original purchases price of $754m, based on Beingmate's decline in share price to 12.43 yuan from the purchase price of 18 yuan/share.
Fonterra said it would update farmer shareholders about Beingmate when the co-op releases its first half result in late March.
Harbour Asset Managements analyst and director Oyvinn Rimer said Beingmate's difficulties were not unique to the company.
"We have seen that other Chinese players are also facing some headwinds there as well," Rimer said.
"It is an industry phenomenon but you can't pinpoint exactly what is driving it because it differs from company to company," Rimer said.
Beingmate was always going to be "interesting" because it is a minority shareholding - that does not give Fonterra any leverage to direct its investment.
"It probably does not look like the best use of money, but hindsight is a wonderful thing," Rimer said.
"As it turns out, it doesn't look like the stars have aligned just yet," he said.
Fonterra NZX-listed units have been on a firming trend since November, trading today at $6.27 - up 1c from Tuesday's close and up from $5.80 last November.