Emerging markets and innovation central to Fonterras growth plans

Emerging markets and innovation central to Fonterra's growth plans

"Volatility is here to stay, don't have any illusion it will change."

After reporting a slump in Fonterra's annual profits this week, CEO Theo Spierings was at pains to tell the market the global dairy market will remain erratic. However, the head of the world's largest dairy exporter also outlined how the group plans to ride out changes in supply of and demand for milk.

The year on which the New Zealand dairy giant was reporting ran until the end of July. The period had therefore started with the botulism affair, when there were fears (which turned out to be false) a batch of Fonterra's whey protein concentrate was contaminated.

Fonterra booked a NZ$30m charge from the scare, which amounted to contractual penalties paid to customers. It remains in arbitration with one customer, Danone, which had to recall products. A ban from China on whey protein concentrate from New Zealand remains in place.

Asked what the financial impact of the affair on Fonterra, Spierings pointed to the charges but said it had been able to focus resources on exporting whole milk powder to China.

The drop in Fonterra's profits came from rising dairy commodity prices. It saw its earnings fall by more than three-quarters. "Milk costs were very high," Spierings told reporters on Wednesday (24 September).

Of course, the spike helped Fonterra in one way. With it being a major B2B supplier of dairy ingredients, higher commodity costs helped drive an increase in sales. Group revenue hit a record, growing 19% to NZ$22.3bn.

However, Spierings said Fonterra could only partially pass on its input costs and it saw its profitability suffer. Net profit after tax was NZ$179m (US$144.3m), down 76% on the previous 12 months. Normalised EBIT dropped 50% to NZ$503m.

"We priced what the market could bear. If we had priced ourselves out of the market that would have been the wrong thing to do for the co-operative and our farmers and board backed us there," he said.

Spierings' mention of Fonterra's co-operative status was telling. In its last financial year, the higher revenues meant the farmgate milk price Fonterra paid its farmer shareholders was NZ$8.40 per kilogram of milk solids. Combined with a NZ$0.10 dividend, it meant the cash payout to Fonterra's farmer shareholders was NZ$8.50, a record since the co-operative was set up in 2001, it said.

However, looking to the new financial year, Fonterra has forecast a drop in the farmgate milk price and in the cash payout - thanks to the volatility it and its peers in the dairy industry are seeing in the sector. The company said strong milk production worldwide and the impact of Russia's import restrictions on global supplies meant it was lowering its forecast for the 2014/15 farmgate milk price from NZ$6 to NZ$5.30 per kilogram of milk solids. The dividend is forecast at NZ$0.25-0.35, up on 2013/14 as Fonterra does expect margins, notably in its consumer and foodservice unit, to improve this year. That said, Spierings said there would be continued volatility in the market.

"There are even more issues in the world geopolitically, if you look at west Africa, Russia, Ukraine, the Middle East - in key areas of demand," he said. The Fonterra boss said "one weather event" could change pricing dynamics but the message was clear - the co-operative has to strengthen its business to help it weather the volatility in global dairy prices.

Meeting rising demand for dairy in emerging markets is central to Fonterra's strategy. During the year, the company struck deals with UK groups Dairy Crest and Fayrefield Foods to market the infant formula ingredients they make.

Within China, Fonterra signed a deal with US-based infant formula group Abbott on the New Zealand firm's latest "dairy farm hub" in the country. Abbott and Fonterra plan to form a joint venture that will invest a combined US$300m into a third farm hub for Fonterra, the location for which has yet to be disclosed.

And last month Fonterra announced a "global partnership" with Chinese infant formula producer Beingmate. The companies plan to establish a venture to buy Fonterra's Darnum plant in Australia. The venture will also establish a distribution agreement to sell Fonterra's Anmum brand in China.

In Asia, Fonterra saw volumes from its consumer and foodservice division rise 12% - or by 18% when one strips out the disruption the company saw in Sri Lanka. Profits dropped by more than half but Spierings and his colleagues were upbeat about the company's performance and prospects. Spierings, for one, said Fonterra was "very proud" of the volume figures.

CFO Lukas Paravcini explained Fonterra was prepared to take a hit on profitability in Asia for, the company hopes, longer-term reasons.

"We could compensate for [higher input costs] through pricing only partially. It is a conscious decision of this co-operative to promote volume because we know that this is a temporary situation and we want to be better off – once the situation normalises – to capture the benefit of extending our volume," he said. Paravcini said Fonterra saw "the same impact" in Latin America, where the company managed to increase volumes 3%.

Looking at the Fonterra business more broadly, the company is also working to give more focus to its portfolio. Spierings reiterated the co-operative's plans to centre more resources on fewer brands and markets. "We are operating in 93 markets, with 60-plus brands. We are not going to win like that. We are going to focus on eight markets, with five brands. Ninety per cent of our resources go behind these brands [and] markets."

Fonterra listed four of the brands: B2B brand NZMP, plus three consumer brands, Anchor, adult health-oriented brand Anlene and Anmum. Next week, the co-operative plans to provide more details on a fifth "global brand". Spierings refused to be drawn the details of the brand, although just-food understands it is not a consumer-facing product.

Spierings conceded Fonterra needs to improve the performance of one of its consumer-facing brands. "Anchor is a work in progress. It is a true global brand but we have to do some maintenance there around the world, which is ongoing."

The company has devised four "benefit platforms" it wants its brands to target: natural energy (which Spierings said is a focus towards more protein-based milks); growth and development; mobility; and cognition.

And laying behind these platforms are three product attributes Fonterra believes will set it apart from its rivals - taste, texture and sustainability. "That's really where we can create a lot of value and that's where we are ahead of the competition," Spierings insisted.

There is, of course, a lot of subjectivity behind that statement. All companies - let alone all dairy companies - would argue they are working on these attributes. Sustainability, for instance, is an area Fonterra's global rivals are looking at closely, Ireland and its Origin Green programme being one example.

However, Spierings was adamant and said he had seen evidence Fonterra could stand apart, particularly on taste and texture, and pointed to its foodservice business, a channel the co-operative is focusing on more due, it says, to the profitability it brings.

"We do have a taste preference and texture advantage. We know that from our foodservice business," he said. Based on our farming model and our IP, we can produce products that nobody can compete with. We need to use that to create value."

Perhaps of most note on product development was Spierings' comments on protein. He said Fonterra would look at milks with more protein and less sugar. "The biggest problem in the world right now for obesity is sugar. To have a shift in balance more towards protein. We believe we have significant IP based on our farming model. We have a different composition of proteins in our milk."

Fonterra is, then, looking forward with optimism. It had a challenging year, which started with the botulism affair and continued with volatility in commodity prices. However, with a range of strategies, the co-operative believes it can continue to prosper.