Dairy giant Fonterra has plans to forge on in China despite being buffeted by a downturn, writes Fran O'Sullivan.

Fonterra chief executive Theo Spierings has revealed the NZ dairy company is "definitely" looking at developing another - and possibly its final - Chinese farming hub in Heilongjiang in partnership with Beingmate.

Fonterra unveiled a new global partnership with Beingmate, which is China's largest infant formula manufacturer, last August.

Beingmate already has 10 dairy farms in China's northeastern province of Heilongjiang. Spierings says Fonterra will definitely use its knowledge to help Beingmate - in which it has an 18.8 per cent stake - to improve the existing farms' effectiveness and efficiency to bring them to the same global standard as "we run them at".

"On top of that I have said to the Governor (of Heilongjiang) that with the partnership of Beingmate we should really consider a hub in Heilongjiang. And possibly that will be the last one."

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Spierings says if Fonterra establishes a new farming hub in Heilongjiang with Beingmate, it will be close to hitting its annual production target from China of 1 billion litres of milk when all of its hubs reach maximum production.

Last year, Fonterra also forged a strategic alliance with American pharmaceuticals and health care giant Abbott to develop a new $342 million dairy farm hub in China. Chicago-based Abbott is a big player in China's infant formula and nutrition market. The new hub was to be Fonterra's third in China and would complement its existing farming operations in Shanxi and Hebei Provinces.

But Spierings says though Fonterra has always spoken about building five hubs in China, they are now building double farms instead of single ones to achieve a better return on capital.

It is clear Spierings has taken a shine to Heilongjiang's Governor Lu Hao - widely tipped to be a major player in Beijing's "next generation" leadership - who singled out two-way investment as the key to ensuring the stability of bilateral trade between New Zealand and China during a recent visit to Auckland.

Heilongjiang is one of the strongest provinces of China in the farming, dairy and stockbreeding industries.

In Auckland Lu made the point to an industry briefing that the challenge to long-term trade is ensuring stability and reliability. Relying on price competitiveness for goods will not guarantee long-term trade, but two-way investment will guarantee trade in the long run.

Governor Lu also promoted the investment opportunities in his province during a meeting at Fonterra. "He is very brand-driven," says Spierings. "He is very active and energetic and a visionary man. I was very impressed."

Fonterra faced some criticism over its acquisition price for Beingmate. But Spierings says the company had taken a potential profit downturn into its valuation numbers. "We bought at a solid but not too high price."

Spierings has good connections with Beingmate founder Xie Hong. They both sit on the JV's strategic committee.

Fonterra is also open to partnerships in the food services area in China and is working on attracting a financial partner.

But its fortunes have been buffeted by the sharp and persistent downturn in commodity prices on the GlobalDairyTrade (GDT) auction platform since last year.

Spierings says recent movements on the GDT platform indicate China is back in the market.

"China was again more than 50 per cent of globally traded volumes and it is a long time ago that China took more than 50 per cent," says Spierings.

It's also significant that the producers are once again buying - not merely the traders - which indicates inventories are finally being run down.

He is confident in the long-term future for Fonterra in China given the inevitable demand for first-class proteins that will come as the Chinese middle-class grows.

"I can't change the ingoing assumption for the China Strategy as we wrote it three years ago," he says. "But it is terrible at the moment. It is the lowest milk price I have ever seen in China."

International factors have clearly been at play.

But for Fonterra the reality is that low dairy prices are making it difficult to farm in China.

"We continue, but it has a financial effect," says Spierings. "It hits us because the milk prices are putting pressure on us.

"We really have best-in-class farming but with the current milk price you can only operate cash - you can't think about Ebit and profit."

Despite the tough environment, Spierings says the company has a unique strategy and "we need to keep on driving it".

"We need to focus on initiatives. Last year we did so many deals in one year, we have enough on our plate."

Spierings has faced huge challenges since he became Fonterra's chief executive - almost all of them relating to China. Getting farmer-shareholder approval for "trading among farmers" (Taf) was a tough sell. But that was expected.

What wasn't expected was the impact of the DCD and WPC80 incidents and the false-positive botulism affair on the business. These incidents each took a lot of high-level management time - coupled with help from the New Zealand Government - to resolve. The malicious 1080 threat was yet another incident that could have - but didn't - take management's eye off the China ball.

But the Chinese and NZ authorities handled it with delicacy and the impact was transitory.

Spierings has put that behind him as he focuses on the Fonterra business. "We need to get faster because the geopolitical world changes so fast that we as management need to keep the metabolic rate up," he says.

The Chinese Government - like Fonterra - is now focused on the right partnerships and the right DNA for the future.

"With a 500 million strong middle-class which has money, I don't see why they would not buy good milk products."

Familiarity helps mould partnership

The Beijing Government-led consolidation of the Chinese dairy sector - which got strongly under way last year - left infant formula manufacturer Beingmate facing two options. Buy up a host of smaller producers or co-operate with a major international dairy player.

Beingmate Chairman Zhentai Wang told the Herald the company chose to work with foreign companies.

"Working with foreign companies is the most likely way we can help satisfy the tremendous needs of the Chinese market," he said. "Many Western countries have accumulated significant experience in their long history, developing their own dairy sectors. They also have a variety of resources, the price is more competitive and costs are relatively low.

"Based on prior experience working with Fonterra, we thought they were a desirable target in terms of scale, technology and integrity."

Wang said Beingmate's prior co-operation with Fonterra enabled the deal to be put through in a relatively short time. The formal negotiation process lasted only eight months, with familiarity between top executives cited as a reason for efficiency.

"Fonterra was motivated to find a partner to further develop their presence in this market. We have worked together for close to a decade, so when Fonterra raised the proposal with us, we naturally agreed this was a good direction for both of us to go."

The newfound co-operation will have a marked effect on the day-to-day operations for both companies due to the impact of regulatory requirements in China.

Says Wang: "Under Chinese law, Fonterra's product Anmum cannot be sold in competition with Beingmate as the two firms are a joint venture. Therefore, Fonterra authorised Beingmate to manage this product and be the distributor for the Anmum brand in China."

Beingmate sells into more than 80,000 outlets around China across a variety of markets, touching both high-tier and low-tier cities through a diverse network. Wang explains the most important issue is to study the Anmum products and their suitability in different Chinese markets. Once that research has been completed a marketing strategy will be forged.

"In the past, we studied the needs of the market first and then developed a product to fit that market," says Wang. "In the case of Anmum, it is already an established product, so the research is about finding suitable sales channels."

Wang hoped the current deal with Fonterra was the beginning of a longer partnership and further ventures, with both Australia, and children's food in his sights. "With Fonterra willing to expand their business into Australia, we see a lot of potential there. We would like to co-operate with Fonterra to explore this new market and develop new business.

Beingmate's focus is in food for children in their early childhoods.

"New Zealand and Australia have a huge resource base and variety of healthy foods, outside of dairy.

"These are all potential products for children's foods and if we could jointly develop in this area, it could be a big win-win situation."

Beingmate

Set up in 1992 to produce children's food

• Diversified into infant formula in 2002

• Produces 100,000 tonnes of baby formula annually

• Four production bases throughout China
• Alexander Speirs travelled to Hangzhou to meet with Beingmate Chairman Zhentai Wang to find out more about the global partnership his company has struck with Fonterra.