One freezing evening in June, the new boss ofÂ Fonterra Cooperative GroupÂ Ltd.’sÂ FCG.NZÂ -2.54%Â Australian unit began an unusual fact-finding mission. She stayed overnight on a farm in Gippsland, in Australia’s Victoria state, to help discover what had gone wrong in one of the New Zealand dairy giant’s biggest markets.
As if in an episode of «Undercover Boss,» a reality-TV show in which the heads of some of America’s biggest companies slip anonymously into front-line jobs, Fonterra’s Australian managing director Judith Swales rose at dawn to milk some 200 cows in temperatures hovering near zero degrees Celsius (32 degrees Fahrenheit). Ms. Swalesâ€”who as a child had often joined her milkman father on his morning rounds in Yorkshire, in the north of Englandâ€”had plenty to think about as she ended the morning mucking out the dairy shed.
Fonterra is the world’s biggest dairy exporter, collecting about 22 billion liters of milk a year and accounting for about a third of global supply of products ranging from cheese to baby formula. (New Zealand is called the Saudi Arabia of milk, for its outsize contribution to global exports.) Dairy products are in growing demand in Asian economies such as China as the region’s rising middle class looks to consume more protein. Still, the dairy giant has struggled to replicate its success at home elsewhere.
Fonterra on Thursday said its earnings before interest and tax would be lower than previously forecast, hurt by a drought in New Zealand earlier in the year and difficulties turning around its Australian business. It now expects earnings of around one billion New Zealand dollars (US$796 million) in the year through July, below previous guidance of NZ$1.1 billion.
«Our Australian business remains under pressure,» Chief Executive Theo Spierings said in a statement. «Although a recovery plan is being implemented, it is in its early stages and will not counteract the impact on earnings of intense competition and the accelerated reshaping of our business.»
Australia has been a tough market for several years. The company’s sales there fell about 14% in the financial year ended July 31, 2012, and were down by a similar amount in the first half of fiscal 2013. Revenue last year was less than half that of rival Murray Goulburn Co-operative, Australia’s biggest dairy producer.
Ratcheting up the pressure on its rival, in April Murray Goulburn struck a 10-year deal to supply private-label milk to grocery chain Coles at reduced prices, in return for the supermarket chain’s agreeing to stock its Devondale-brand cheeses for the first time in almost a decade. Fierce competition between the nation’s two major grocery chains, Coles and Woolworths, has driven the price of milk to as little as A$1 a liter.
Adding to Fonterra’s woes, a decade-long drought has left many Australian farmers heavily indebted, while dairy companies have far more processing capacity than they need to handle reduced supplies. A U.S. drought also pushed up global prices last year for grain used to supplement the diet of grass-fed dairy cattle.
«It was great to sit down over dinner and hear firsthand about life on a dairy farm and then get to experience it,» said Ms. Swales in a recent interview. Unlike on the U.S. television show, where bosses turn up incognito in lowly roles to troubleshoot, Ms. Swales visited at the invitation of farmer Wayne Weller and his wife Joan, who raise about 1,150 dairy cattle across 400 hectares (988 acres). Their lush region, in an otherwise arid country, is home to many of the nation’s dairy herds.
Australia isn’t the only foreign market where Fonterra has faced challenges. In 2008, the company became ensnared in a scandal involving a dairy supplier in China. At least six children died and 300,000 became sick from milk containing dangerous levels of melamine, an industrial chemical. More recently, it has been drawn into a fierce price competition on a range of milk products in China that may dent earnings.
In a bid to turn around its fortunes in Australia, Fonterra plans to close a less-efficient processing plant and has culled products, including flavored milk and some cheeses, to focus on big-name brands such as Mainland and Western Starâ€”the biggest-selling butter in Australia.
Ms. Swales, who joined Fonterra from Heinz’s Australian unit in April, is seeking to trim costs and improve efficiency at the company’s remaining processing plants in the country, as well as working with suppliers like Mr. Weller to try to lower farm costs.
«There are a lot of fixed costs on a farm. You can tinker a bit, but you can’t reduce them by 30%,» Mr. Weller said by telephone from his Gippsland farm.
Fonterra food scientists are also focused on developing innovative new products like a shredded cheese that browns more evenly when it melts on pizza, and cooking cream that doesn’t split when heated quickly.
«We’re moving out of the pure commodity space and into premium, branded products,» Ms. Swales said. «The key thing we have to do is deliver to Australian and international consumers the dairy foods they want to eat every day.»
Michael Harvey, a senior analyst at Rabobank in Melbourne, said Fonterra was in a «good position» to turn around its Australian business, despite the recent challenges. «It has a big processing operation, strong brands,» he said.