Mood of the Boardroom: Fonterra keeps focus on China (2024)

Fonterra’s record $1.6 billion profit for the 2023 financial year goes someway to obscure the issues the giant dairy co-operative faced as the Chinese economy slowed earlier this year.

The 170 per cent lift in net profit was driven by strong margins on the co-op’s cheese and protein portfolios.

CEO Miles Hurrell says while it has been a strong year for Fonterra, the business has not been immune to the effects of the economic slowdown in China. He remains bullish on China. Immediately after announcing the result he said: “Our medium to long-term position on China hasn’t changed. It’s a market that we’ll continue to be focused on.”

Despite the financial success, the co-op’s dairy farmers shareholders remain concerned about the lower forecast farmgate milk price payout of between $6.00 to $7.50 per kilogram of milk solids for the 2023/24 season.

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There are signs of an upturn. The most recent Global Dairy Trade auction saw rising prices with anhydrous milk fat up 5.3 per cent and butter up 3.8 per cent. Skim milk powder and whole milk powder prices also climbed by 5.4 per cent and 4.6 per cent respectively.

To put it into perspective.

Before Covid, the co-op’s China business enjoyed double digit growth: “That was significant growth for us; significant growth for the dairy industry; and significant growth for the agricultural sector as a whole,” says Hurrell.

There were new pressures as China went through a series of severe lockdowns. From Fonterra’s perspective, demand changed quite significantly in the second half of 2022.

Explains Hurrell: “That played to our advantage. As out-of-home consumption reduced, we could move our products into other channels.

“We rode that wave. The strength of our business and the flexibility we had was helpful.

“Then, as we came out of 2022 into 2023 and the lockdown ended, we saw demand pick up. There was a rebound in our Foodservice business. We saw pent-up demand.”

During this period, China’s own milk production grew at a rapid pace. While demand was rising this had little impact on Fonterra which was able to maintain its import levels. When China went into lockdown there was a domestic surplus, which was dried into milk powder which is now being fed back into the market displacing product that would otherwise have come from businesses like Fonterra.

This lower demand is the main reason behind the revised milk price forecasts for the coming season.

The co-op expects demand to pick up in early 2024. Hurrell says: “We are starting to see consumers purchasing day-to-day products, which is good for an industry like ours where it’s seen as a daily consumable”.

Despite the overhang of surplus milk on the market. Fonterra’s other products continue to do well in China.

The co-op’s Foodservice business showed increased demand and fetched higher prices after the lockdown ended leading to Fonterra’s Greater China operation reporting a profit increase of $11 million to a total of $284 million.

Hurrell says Fonterra’s out-of-home and consumer business have become very strong in the last 12 months. “We don’t see that slowing down.”

Another growth area is the sports, healthy ageing and active living market. “It was a very small part of the Chinese market, but we see that growing significantly as the population ages”.

Fonterra has also had success targeting the sports and healthy lifestyle sector in the US. “We’ve seen good growth in the last couple of years. We don’t see that slowing down, but we need to keep watching that market because it is an important play for us”.

Another aspect of China’s changing demographics will impact demand in the coming decade. The nation’s middle class is set to rise from 400 million to nearly 800 million over the next ten years. Hurrell says this will mean there will be a place for imported milk products despite the growth in domestic milk production.

Fonterra has streamlined its China organisation in recent years. It no longer operates farms there. Today the focus is on the consumer food service and ingredients businesses. The business is simpler.

In recent months it has expanded its reach. While there is still plenty of growth to come from the large cities on China’s Eastern seaboard, Fonterra is moving into more of the tier four and five cities.

There has been a trend of people moving from the larger cities to the smaller ones and when they go back they take their taste for Fonterra’s products with them.

Hurrell says it is still early days, but there are positive signs from this.

Under the terms of New Zealand’s free trade agreement with China, the last of the tariffs affecting the milk industry will be lifted at the end of this year.

That currently sits at 10 per cent.

There’s potential for Fonterra to move into other Asian markets by forming joint ventures or other partnerships with China’s own dairy giants: Mengniu and Yili, which owns Westland. Hurrell says in the near term any partnerships will focus on China.

Away from China, Fonterra is making significant headway: “We are seeing the Middle East and Africa performing very well. Southeast Asia continues to perform well and the rest of North Asia, in particular Japan and Korea, are also performing well.”

Hurrell sees some clouds on the horizon. The global economic outlook is poor. Many of the destinations for Fonterra’s product have had fiscal stimulus programmes as the economies come out of Covid. It’s not clear what will happen to demand as these programmes wind down.

Fonterra is on a programme to remove costs from the business, it could save as much as a billion dollars by 2030.

Hurrell is looking at trimming costs across the board, the annual total costs in the business are in the region of $9 billion to $10b. Part of that will include closing inefficient plants.