UPDATE 2-Fonterra undeterred by earnings hit as it pushes further into China

Wed Mar 26, 2014 1:05am EDT

* EBIT falls 41 pct, on track for lower FY earnings

* Co-op hit as high dairy prices raise input costs

* Fonterra sticks to strategy to expand branded products (Recasts throughout, adds CEO comments, details)

By Naomi Tajitsu

WELLINGTON, March 26 (Reuters) - Fonterra, the world's largest dairy exporter, on Wednesday said a steep hit to its first-half earnings won't stop it from marketing more of its own-brand milk products in China and expand its food services business in the fast-growing market.

The New Zealand dairy co-operative on Wednesday reported a 41 percent fall in first-half earnings after higher input costs from soaring global dairy prices and a lack of capacity to process record-high milk volumes into higher-yielding products hit its margins.

But the farmer-owned co-operative is pushing on with plans to capitalise on increasing dairy demand from China and other countries, where growing middle classes are developing a voracious appetite for cheese, milk formula and other products.

Fonterra has the cash to fund its expansion plans in China after it raised 1.25 billion yuan ($201.53 million) in five-year "dim sum" bonds in January.

In an interview with Reuters, Fonterra CEO Theo Spierings said plans to build a UHT milk processing plant in China, which would be its first manufacturing plant in the company's largest export market, would likely be announced in 2014 or 2015.

"There's definitely plans to go into UHT in China because that's the way forward. Those plans you will see announced and coming to the table in the next financial year," he said.

Fonterra collected roughly 12 billion litres of milk from its farmers in the six months to Jan. 31, around 60 percent of which was processed into milk powder, mainly for wholesale export. Much of this goes to China to form the base of infant milk formula.

The company has been expanding its presence in the consumer brands and food services space, where it can earn fatter margins. Fonterra entered the Chinese market last year with Anchor-branded UHT milk and its Anmum infant formula products.

Spierings said the company is also expanding its food services operations in China, where more than half of all the pizza sold in the country are topped with Fonterra cheese.

The company supplies cream and butter to restaurants, hotels and fast-food restaurants in Beijing, Shanghai, and 18 other cities, doubling from two years ago.

Beyond China, it has begun construction of a $31 million plant in Indonesia that will package its Anmum, Anchor and Anlene products to sell in the southeast Asian country, a major importer of New Zealand milk powder.

MILK POWDER VS CHEESE

Controlling about a third of global dairy exports, Fonterra should be flying high on the back of the "white gold" rush as it earns its best returns from milk powder, but all-time high world dairy prices have ramped up its input costs while it has struggled to meet demand due a lack of factory capacity.

It maintained its forecast for the price it pays to its farmer shareholders of NZ$8.65 per kilo of milk solids for the year to July.

While this represents a record high farm-gate milk price, it is a discount of 70 NZ cents to its reference price calculated from global dairy prices, as the company cannot afford to pay such a high price given that a bumper dairy season has resulted in all-time high volumes.

Fonterra is obliged to buy milk collected by its farmer shareholders at historically high milk prices. What cannot be made into milk powder has been used for cheese products, which Fonterra said lost money over the period.

To ramp up production capabilities at home, the company is investing an additional NZ$400 million-NZ$500 million to its capital expenditure plans over three years, which it said it would raise through borrowings.

On Wednesday, the company announced that normalised earnings before interest and taxes (EBIT) fell to NZ$403 million ($345 million) for the first half, while net profit after tax fell 53 percent to NZ$217 million.

The company cut its interim dividend to 5 NZ cents per share, and reaffirmed that it expected to pay a full-year dividend of 10 NZ cents per share, down from 32 NZ cents last year.

In December, Fonterra warned that it expected full-year earnings to fall to around NZ$500 million-NZ$600 million from last year's NZ$1 billion.

Analysts said that the earnings fall reported on Wednesday showed that high dairy prices were hitting global operations.

"They reported the higher input costs, or the milk price, through margin compression across their different businesses," ANZ rural economist Con Williams said.

The company faces a lawsuit from France's Danone, which is seeking compensation following last year's product recall. Fonterra said it had set aside an NZ$11 million provision for the issue as a legal obligation in its contracts with Danone.

($1 = 1.1688 New Zealand dollars)

($1 = 6.2024 Chinese yuan) (Reporting by Naomi Tajitsu; Editing by Anthony Barker and Matt Driskill)

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