Contaminated Chinese milk costs Fonterra $139 million


Fonterra says the Chinese milk contamination scandal will cost it at least $139 million.

Announcing the company’s annual results today, Fonterrra revealed the full impact on its Chinese partner San Lu of the controversy, which has left at least four infants dead after
consuming baby formula containing melamine.

Fonterra chairman Henry van der Heyden said: “We are certainly not putting the financial consequences ahead of our primary priority of consumer safety. We are focusing all our efforts
on what Fonterra can best do to work with the Chinese authorities and help get safe dairy products to Chinese consumers.”

The $139 million estimate is made up of the cost of recalling products plus Fonterra’s “anticipated loss of San Lu brand value”.

Fonterra has poured nearly $200 million into the joint venture since buying a 43 per cent stake in December 2005, but the investment has been gutted by last month’s announcement that
Sanlu has been selling poisonous infant formula for babies.

“Throughout this crisis, Fonterra’s paramount concern has been for the health and safety of Chinese consumers and recalling contaminated product as quickly and effectively as possible
in the Chinese environment. The scale of this tragedy has been truly shocking and our heartfelt sympathies go out to all the affected children and their families,” said van der Heyden

He described the latest revelations that San Lu management were investigating complaints of sick infants as early as eight months before the San Lu Board and Fonterra were first
informed on August 2 as “deeply concerning”.

“That Fonterra was not informed earlier is frankly appalling,” he said.

Van der Heyden said the Board had reaffirmed its long term, strategic commitment to the China market, believing that Fonterra was well placed to supply safe and healthy dairy products
to Chinese customers and consumers and contribute towards helping improve the Chinese dairy supply chain.

Chief executive Andrew Ferrier said there would now be more testing of products coming into the company’s supply chains, including melamine.

Responding to criticism of his lack of profile around the scandal,van der Heyden said the board’s role was clear – to ensure management took appropriate action.

A decision had been made early on to have Ferrier “front the issue”.

Ferrier said “When something goes astray, management must front. There is no question in my mind about this.”

The job of governance by the board was to make sure management did its job appropriately.

Milk price

On the financial front Fonterra announced a final payout of $7.90 per kilogram of milksolids (kgMS) for the 2007/08 season, comprising a milk price of $7.59 per kgMS and a value return
of 31 cents per kgMS.

The actual final cash distribution to Fonterra shareholders will be $7.66 per kgMS after the Board decided to retain 24 cents from the “value return” component of payout.

Retentions were signalled by the board earlier this year as part of a plan to “strengthen further Fonterra’s balance sheet in the light of instability in financial markets.”

In total Fonterra will distribute $9.1 billion from the amount available for payout of $9.3 billion. This is a 65 per cent lift on the prior season’s distribution of $5.5 billion.

The Fonterra board has also lowered the payout forecast for the current 2008/09 season to $6.60 per kgMS from the $7.00 per kgMS forecast in May.

The $6.60 forecast comprises a milk price of $6.25 and a value return component of 35 cents.

Van der Heyden said prices has fallen away from last year’s record highs. High prices have dampened global consumer demand and, at the same time, have encouraged production increases in
exporting regions around the world.

He said the 2007/08 result followed one of the most volatile and challenging years in global markets in recent memory, compounded by the drought which affected production in New

Fonterra achieved revenues of $19.5 billion from the sale of goods in the 14 months to July 31 2008.

A 63 per cent increase in weighted US$ average sales prices offset an average exchange rate seven cents higher for the season at 74 cents resulting in the record result.

Commodities and Ingredients sales revenues, excluding intersegment sales, were $13.5 billion, while Australia/New Zealand’s were $3.3 billion. Asia/Middle East’s sales revenues were
$1.9 billion and Latam’s $789 million.

Fonterra collected 1,192 million kilograms of milksolids, including contract milk, a 4.3 per cent decrease on the prior season due to drought conditions across much of New Zealand.

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