Fonterra sets pace with big China buy

Guy Cowan

Fonterra has jumped into the fast-growing Chinese consumer dairy market, signing a deal that will be the largest investment in China by a foreign dairy company.

After more than two years of negotiations, it has agreed to pay $153 million for a 43 per cent stake in the Shijiazhuang Sanlu dairy company.

Chief financial officer Guy Cowan said the partnership was "the next logical step" for Fonterra, which was already the biggest shipper of dairy products to China.

He said the partnership would give Fonterra a foot-hold in a consumer dairy market that was doubling in size every five years.

As the domestic Chinese market for consumer dairy goods grew, local milk supply would also increase and the opportunity for foreign companies to keep expanding exports to China would be limited, making it vital that Fonterra had a presence in the Chinese dairy industry.

Chief executive Andrew Ferrier signed the deal in Beijing yesterday. The agreement still requires final sign- off by the Chinese Government, but both parties are confident this will be largely a formality.

Sanlu is China's No 1 seller of nutritional milk powders but Fonterra hopes to significantly expand its market share in the more lucrative fresh milk and yoghurt sectors.

Sanlu has just a 5 per cent market share in the liquid milk market and a 9 per cent share in the yoghurt market.

But Cowan said that market was fragmented and the leading players in those categories had just 19 per cent and 25 per cent shares respectively.

That left plenty of scope for Fonterra to use its production and marketing skills to expand market share.

Potential existed to launch key Fonterra brands in China through the partnership.

It would also provide improved distribution channels for New Zealand dairy products from Fonterra's ingredients business.

Sanlu has established distribution channels in 600 cities in China.

Cowan said the key expectation was that the investment would return significant dividends to Fonterra shareholders.

Cowan was unable to provide any detailed breakdown of Sanlu's financial record.

While the Fonterra board was well aware of details around profit and debt levels, he said Sanlu was a private company so those figures could not be made public.

But the purchase would have no negative impact on Fonterra's payouts to its farmer shareholders and would be "payout positive" in about two years.

"We've made this investment on the basis that we want a return to our shareholders that exceeds our weighted average return on capital," Cowan said.

There were never any guarantees, with an investment like this.

"But we've gone into this with our eyes open and we're confident that it's a low-risk investment."

Cowan said Sanlu had a stated intention to list publicly on the Hong Kong stock exchange and this offered further opportunity for a substantial return on the investment.

Public listing in China still requires companies to go through a series of complicated regulatory hurdles so that could be several years away.

Although, per capita consumption of dairy in China has doubled in the past five years, it is still low even by Asian standards.

Chinese consumption is less than half that of more developed Asian nations such as Japan and South Korea.

Sanlu chairwoman Tian Wenhua heralded the deal as a big development for the Chinese dairy industry. 
 

The numbers

* Fonterra will pay $153 million for a 43 per cent stake in Chinese dairy company Sanlu.
* Sanlu has annual revenue of $1.3 billion.
* It is China's No 1 player in branded milk powders.
* It sells more than 170 consumer dairy products including yoghurts and fresh milk.
* Fonterra will have three of seven board members and will make one appointment to the senior executive team.