Bellamy's to pay Fonterra $29.2 million to change supply contract as it struggles to crack China

China is the largest global market for infant formula at US$20 billion (NZ$27.98b) and is experiencing the fastest growth at around 15 per cent a year. Photo / Getty

ASX-listed Bellamy's Australia plans to raise AU$60.4 million (NZ$63m) from shareholders and will pay nearly half of that to New Zealand's Fonterra Cooperative Group in order to change their milk supply contract in its quest to comply with Chinese import regulations.

The two companies have been in negotiations this year after announcing changes to their take-or-pay organic powder contract.

Fonterra and Bellamy's first entered into a five-year, multi-million dollar deal to manufacture a range of baby nutritional powders at the Darnum infant formula plant in south-east Victoria in November 2015.

The Australian company then ran into trouble in China in 2016 when that country tightened its infant formula regulation, allowing each legal entity just three brands with three recipes for infant formula. A further challenge came from a regulatory requirement that any Chinese labelled product will require registration from the China Food and Drug Administration (CFDA) from 2018.

In a release to the Australian Securities Exchange today, Bellamy's announced a five-for-38 entitlement offer at A$4.75 per share, allowing it to raise A$60.4 million. That's a discount to the A$5.76 price the shares were halted at pending the announcement.

Bellamy's said the net proceeds of the offer would be used to "further reset the company's supply agreement with Fonterra", including an A$27.5 million payment to Fonterra in exchange for it removing projected shortfall payments over the life of the supply agreement. A$28.5 million will be used to buy most of Camperdown Powder, a canning facility with a record of compliance with Chinese regulations.

"It is important to note that the agreement still includes minimum annual volume commitments that are subject to shortfall payments, however the level of these commitments is now aligned with growth and production forecasts," Bellamy's said.

Earlier this year, Bellamy's announced the term of the Fonterra contract would be extended to eight years, with the minimum volume commitments kept the same but spread over a longer time.

The revised supply agreement also introduces volume-based rebates and a modified bulk formula price which will "improve Bellamy's cost position as the business grows" and ensures Fonterra will provide technical support for the company's research and development, it said.

Bellamy's said the Camperdown acquisition would secure a critical aspect of its supply chain by providing a "clear path to achieve CFDA registration of 'Chinese labelled' product", allowing it to keep selling into the world's second-biggest economy.

The company maintained previous guidance for second-half sales between A$105 million and A$120 million, and said second-half earnings before interest and tax (ebit) would be between A$16.5 million and A$20 million. Given its first-half sales of A$118.3 million and ebit of A$10.1 million, the 2017 results would be below its 2016 full-year earnings of A$244.6 million and ebit of A$54.3 million.