Fonterra is putting its China investment setbacks behind it, writes Fran O'Sullivan.

Fonterra chief executive Miles Hurrell acknowledges talk of tension at a geopolitical level and at the most senior level between China and New Zealand. "But from a Fonterra perspective we are seeing it as a completely business as usual.

"We're still getting very good support out of our customers and consumers in those markets and while we watch with interest to see how the relationship goes there's nothing to concern us in the immediate term," explains Hurrell. "We obviously watch, at a bigger level the China-US relationship, and though that may open short-term opportunities there are no long-term winners in trade wars.

"Given the importance of that market — Fonterra has 25 per cent of its business with China — we just need to stay close to it and understand how China works more."

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Hurrell says Fonterra needs to be seen as an investor in the Chinese dairy market. The question the company is pondering — as part of a strategic review — is whether that investment needs to be in nutrition companies and online developments and whether it needs to be investing upstream — like farms and processing.

"Investment doesn't need to be cash," explains Hurrell. "But I think the relationships we've developed with some of the large digital companies up there now, through online and with e-commerce solutions also hold a significant weight as investment — in inverted commas — in China."

In April 2018, Alibaba and founding partners, including Fonterra and NZ Post, announced a project to use blockchain technology to improve supply chain traceability for Chinese customers, who are increasingly focused on the quality and safety of what they buy.

"In Fonterra's case that might involve the NZ dairy company selling product on to Alibaba's growing platforms in South Asia, and ultimately India, as Alibaba begins building an e-commerce platform with its partner there." visiting Alibaba CEO Daniel Zhang told the Herald.

To help build that vital trust among Chinese consumers, Fonterra has developed Trace — a system that can track the company's products back to the daily farm milk collection.

Strategic reset

Fonterra is actively considering how to ensure it is a globally competitive New Zealand dairy co-operative. Hurrell says the company's belief is that China will remain a key market — if not the key market — for "us into the long term".

Fonterra's focus is now on value rather than volume as it plans to prioritise its NZ milk supply and earn a premium from its heritage and provenance. Its global portfolio will be refocused to concentrate on where it has a competitive advantage, and there will also be an increased focus on return on capital.

The results of the strategic reset will be announced with the 2019 annual results. There have been challenges in China but the key short-term decisions from an investment perspective relate to its loss-making China farms and its 18.8 per cent stake in Beingmate.

China Farms: sell or hold?

Fonterra's China Farms business is a strong candidate for the axe 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.

There are two farming hub operations producing fresh milk for Fonterra's Chinese ingredients, food service and consumer markets.

The decision is a tough one.

Retaining the farms means Fonterra can continue to supply premium fresh milk to customers like Alibaba's Hema Fresh, which stocks its Daily Fresh milk range. A new Anchor co-branded fresh milk product with Carrefour has also been launched which rated as the number two fresh milk in the last quarter in Shanghai.

"The trajectory is heading in the right direction," says Hurrell.

"The question we now need to ask ourselves is how important are the farms to our long-term strategy in China, and that is the focus for the short-term thinking right now."

"Do we go for an integrated play in China in which the farms become critical, or do we become more of a finished play? But we haven't made that determination just yet."

Critical to this decision is Fonterra's decision to play up the New Zealand provenance story, the pasture-based system and animal welfare standards. Hurrell expects as that evolves there will be a heightened interest in NZ-sourced product.

Fonterra is not actively looking for buyers for the farms. If the call is made to maintain the farming operations a key pillar of that would need to be a downstream investment in processing, Hurrell says.

Beingmate: buy, sell or hold?

Fonterra's $775m investment in Chinese infant formula maker Beingmate has been written down to just $204m.

Fonterra has officially unwound its joint venture arrangement with Beingmate, taking back full ownership of the Darnum manufacturing plant in Australia and the marketing of its Anmum brand in China. Beingmate paid A$102m for a 51 per cent stake in the Darnum plant but the unwinding was done at no cost to Fonterra.

Fonterra's head of greater China operations Christina Zhu has also resigned from the Beingmate board.

Hurrell says the Anmum brand has grown significantly since it was taken back under Fonterra's direct control.

"China is a very important market to us and the performance of our consumer and food service business deserves local senior management's singular focus," he says. "With the untangling, it really does lead to a very simple decision because it's only an equity stake... that can be done at pace should that be the decision."

Fonterra faces key strategic decisions

China Farms:

sell or hold?

Volume LME:

113m down 15%

Gross margin:

$(10m) up $6m; (7.8%) up from (13%)

EBIT:

$(21m) — no change

Source: Fonterra's interim results presentation.

On the block?

Fonterra's 18.8% stake in Beingmate

Invest further?

Digital and e-commerce relationships and/or downstream manufacturing.