PROGRESS INTERIM REPORT

Transcription

1 FONTERRA CO-OPERATIVE GROUP LIMITED PROGRESS INTERIM REPORT 2015

2 STRAIGHT AHEAD TO A PROGRESSIVE, GLOBAL CO-OPERATIVE We have a clear strategy. We ve strengthened the core and built the right foundations. Now we re focused on driving performance to achieve a higher Farmgate Milk Price and earnings. Looking ahead, we aim to set a platform for wider growth, with new milk partnerships and powerful brands that take our dairy nutrition to the world. Clear priorities that will drive performance and make the most of our combined potential.

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4 CHAIRMAN AND CHIEF EXECUTIVE S LETTER 2015 LETTER FROM THE CHAIRMAN AND CHIEF EXECUTIVE Our Co-operative s strategy is designed to increase volume and value so that we can maximise our Farmgate Milk Price and earnings on a sustainable basis. With the lower forecast Cash Payout this season, compared to last year s record returns, farmer shareholders and investors want to know two things at the half year: where we stand on our forecast Farmgate Milk Price and what we are doing to pay the best dividend. Our forecast Farmgate Milk Price is $4.70 per kgms. Given the results achieved in the first half of the year, and the continued volatility in international prices, we are lowering our forecast dividend to cents per share. The Board has declared a 10 cent interim dividend. This reflects the results achieved to date. Fonterra is offering a dividend reinvestment plan for the first time. Shareholders who want to participate for the interim dividend need to submit a notice of participation by 13 April In total, we have a forecast Cash Payout of $4.90 $5.00 for the current season. The half-year results to 31 January 2015 are below expectations in a period when the Farmgate Milk Price was low and we are reducing the forecast dividend range. They are a snapshot of variable conditions for production, demand and pricing and the volume of carryover inventory. Our half year was a period of two distinct quarters, both influenced by market dynamics, production conditions for milk and the cost of raw milk last season and this season. VOLUME In New Zealand, milk production got off to an excellent start in the first quarter with warm, wet conditions and good pasture growth. By November, season-to-date production was four per cent ahead of the comparable period last season. A very dry summer in most regions curtailed production in the last three weeks of January, leading to a reduction in our milk volume forecast to slightly below last season s production. A recovery in New Zealand milk production is unlikely in the second half, with farmer 2 PRIORITIES

5 FONTERRA INTERIM REPORT 2015 WHOLE MILK POWDER PRICE AND CURRENCY WMP USD/MT 4,500 CURRENCY NZD/USD , , , , , MAY 2014 JUN 2014 JUL 2014 AUG 2014 SEP 2014 OCT 2014 NOV 2014 DEC 2014 JAN 2015 GDT WMP AVERAGE WINNING PRICE NZD/USD SPOT RATE shareholders opting to dry off herds early in some regions because current farm budgets do not support the use of supplementary feed. Oversupply from dairy producing regions around the world in the early months of the financial year saw the trade-weighted GlobalDairyTrade (GDT) price index hit a five-year low in December. When supply outweighs demand, buyers undervalue milk, and that is reflected in prices that declined to unsustainable levels. As global milk production growth eased back in the second quarter, sales volumes began to build as a result of improved demand. Pricing sentiment also improved and this has been reflected in the GDT prices for Whole Milk Powder (WMP) and Skim Milk Powder (SMP). From December 2014 to 17 March 2015, WMP prices have risen by 31 per cent and SMP by 13 per cent. The lower commodity prices placed downward pressure on our Farmgate Milk Price in the first half. This was partially offset by currency, with a benefit of approximately 30 cents per kgms to the forecast Farmgate Milk Price as at 31 January Our NZD/USD average conversion rate for the period was approximately 80 cents. VALUE Across the first half, total sales volumes of 2.2 million MT were 10 per cent ahead of the same period last financial year. Revenue, at $9.7 billion, was 14 per cent lower for the comparable period, reflecting lower global prices for dairy ingredients. Normalised earnings before interest and tax (EBIT) for the six-month period to 31 January 2015 was $376 million compared to $403 million in the prior period, a reduction of seven per cent. The Co-operative recorded a net profit after tax of $183 million for the period, a reduction of 16 per cent. In reviewing our previous year s performance, it is important to note that last year, in order to protect the Co-operative, the Board decided to pay a lower Farmgate Milk Price than the price calculated under the Farmgate Milk Price Manual. In the first quarter, opportunities to improve ingredients, consumer and foodservice gross margins were restricted until inventory from the prior year was cleared. PRIORITIES 3 PRIORITIES

6 CHAIRMAN AND CHIEF EXECUTIVE S LETTER 2015 WE ARE THE WORLD S LARGEST DAIRY EXPORTER FARM SOURCE WELL CONNECTED EFFICIENCY Fonterra Farm Source launched, as a comprehensive package of regional advice, digital tools, competitive discounts on farm necessities and financial options for managing farmers businesses. More than 8,000 farmers have accumulated $2.3 million in Fonterra Farm Source Rewards. The Fonterra Farm Source app delivers milk data and business information to farmers smartphones. It has 3,500 users. The Estimated Tanker Arrival (ETA) app was launched. It helps farmers plan their day with more accuracy, enabling more efficiency on farm. There is often a lag between when product is produced and when it is sold. During the first quarter, the value of our ingredients inventory was relatively high as it was mostly produced when WMP prices were higher, ranging between USD2,700 and USD4,700 per MT. However, these higher inventory costs were not recovered due to rapidly falling WMP prices in the first quarter of this financial year which dropped to a low of around USD2,400 per MT. This gap between the value of inventory and selling prices in the first quarter created a margin squeeze. This contrasts with the first quarter last year when the value of inventory was based on a lower milk cost and was sold at a higher price. In the second quarter this year, earnings for ingredients improved benefiting from the lower cost of milk. The majority of the half-year normalised EBIT was earned in the second quarter and this is expected to carry over into the second half of the financial year. Our consumer and foodservice businesses in Asia and China source all of their milk from New Zealand and benefited in the second quarter from the lower cost of milk. Our Australian and Chilean consumer and foodservice businesses source their milk in-market. Earnings were significantly impacted by higher milk prices within each of these milk pools, which squeezed margins. In Australia, Chile and Brazil, the prices paid for milk are influenced by in-market dynamics rather than global prices, so our businesses in these markets have faced higher input costs. Meanwhile, our Sri Lanka business has turned around, with improved earnings in the first half, after rebuilding the market share lost following the temporary suspension of our operations last financial year. Despite some market challenges, our consumer and foodservice business overall achieved volume growth and improved pricing, together delivering a $91 million increase in our gross margin. Normalised EBIT in consumer and foodservice for the first half was $116 million, an increase of 23 per cent on the prior period. OUTLOOK Our first half results combined with the current market conditions mean that our expectations for the full year have resulted in an updated forecast dividend range of 20 to 30 cents per share (based on our policy of paying 65 to 75 per cent of net profit after tax). We are maintaining our current forecast Farmgate Milk Price. 4 PRIORITIES

7 FONTERRA INTERIM REPORT 2015 GLOBAL BRANDS CAPACITY $555 million investment under way to build a further dryer at Lichfield in South Waikato and to install three plants at Edendale in Southland. We know that our farmer shareholders are looking to us to deliver sustainable earnings in a volatile market. We have a single-minded focus on delivering results: increasing sales volumes, reducing complexity, and taking out costs to maximise returns. To accelerate delivery on strategy, the management team is leading a comprehensive business transformation programme. It will firmly embed the best features of entrepreneurial thinking, such as effectiveness, efficiency and agility. This will require some tough decisions, but we are committed to improving performance. We have made good progress so far but we need to increase the pace of change. We remain strongly committed to the V3 Strategy we formulated three years ago, which has been a huge change for the Co-op. The strategy is creating sustainable returns through the integration of our ingredients multi-hubs and targeted consumer and foodservice positions in our key markets. We remain uniquely placed in the world with our global reach, asset footprint, and integrated grass-to-glass supply chain. But the change so far has not been easy. Capital structure change was a necessity. However, the precautionary recall last year, and recent contamination threat have been unwelcome distractions. These events remind us that the world is constantly changing and we have to be agile and responsive so we can remain ahead. We have the building blocks in place to deliver on our vision and strategy for the long term and the determination and aggressive plan to accelerate performance improvements. John Wilson Chairman Theo Spierings Chief Executive PRIORITIES 5 PRIORITIES

8 UNITY GIVES US SCALE, STRENGTH AND INTEGRATION It enables us to execute our strategy and secure the best Farmgate Milk Price and earnings SET STRATEGY STRENGTHEN CORE COMPLETE DRIVE PERFORMANCE IN PROGRESS To achieve global relevance we need to put the stepping stones in place today. From 2012 to 2014, we developed our V3 strategy, strengthened the core of the business and put in place a secure capital structure. Our strategy is designed to grow Cash Payout by converting more of the milk we source into higher-returning products, especially through our consumer and foodservice operations. The more progress we make, the more we turn the value wheel. We have made good headway globally, setting the stage for consumer and foodservice growth in Latin America, China and Asia, and growing both volume and value in our key markets. We continue to build on our strengths with the ultimate goal of being a truly global co-operative by The success of the V3 strategy can only be measured by how much value has been captured through a higher Cash Payout and other tangible benefits such as increased value of the Co-operative and our farmers dairy assets. Now we are continuing to push forward with the aim of maximising performance so we can increase our Cash Payout. Work mapped out over the next two to three years includes investments to increase our capacity in New Zealand so we can make better choices around what we make with our farmer shareholders milk. Better choices mean better returns, so the capital outlay now is important to set ourselves up for sustainable returns to farmer shareholders over the long term. We also have a clear path ahead to grow value via our consumer and foodservice businesses, especially in Latin America, Malaysia, Indonesia, China and Sri Lanka. Success here will flow through to our dividends. Our business transformation programme will ensure we continue to deliver on our strategy, with velocity. 6 POTENTIAL

9 FONTERRA INTERIM REPORT SCALE UP TO GLOBAL CO-OPERATIVE Establishing partnerships with A-ware, Beingmate, Dairy Crest and Abbott, and redefining our relationship with Nestlé is setting us up for volume and value performance to fund growth. Importantly, these relationships are giving us access to the high-quality milk pools that are also crucial to global relevance and growing returns for our farmer shareholders. Ultimately, we want to grow milk volumes to 30 billion litres from New Zealand and from five other secure milk pools in key geographies around the world by These milk pools are our defence against becoming a regional player with our opportunities defined by milk produced in New Zealand. Our multi-hub strategy supports our goal of leadership in dairy ingredients. It also helps protect our current leadership position in export markets. This leadership often opens up opportunities to work within borders, as we do in China, where revenue will come from exports and milk we produce in market. 7 POTENTIAL POTENTIAL

10 WE HAVE A MULTI-HUB STRATEGY FOR MILK GROWTH A-WARE, HEERENVEEN, NETHERLANDS WE ARE COMPLEMENTING OUR NEW ZEALAND MILK SUPPLY WITH MILK POOLS OFFSHORE TO CAPTURE VALUE AND SUPPORT OUR STRATEGY TO BECOMING A GLOBAL CO-OPERATIVE In our milk pool strategy, our farmer shareholders milk is targeted to the highest-returning products in New Zealand, where we have significant powders experience and global market share. Other milk pools, such as those in Australia, Chile, China and Europe, enable us to capture the best share of market demand, especially in value-returning segments such as specialised infant formula ingredients and whey. Building our New Zealand milk pool is as important as establishing global milk pools, especially as more international processors look to take advantage of New Zealand s reputation and our farmer shareholders efficiency. Our New Zealand ingredients business underpins the Farmgate Milk Price. Therefore, a clear priority is to increase our production flexibility in New Zealand so that we can always make the most profitable decisions about what we make, especially around the peak. In August, the Board approved a $555 million investment to build a further dryer at Lichfield in South Waikato and to install three new plants at Edendale in Southland. This investment will increase our capacity for Whole Milk Powder, Milk Protein Concentrate and Anhydrous Milk Fat. Investments are not simply about increasing our ability to process more milk, or having more options around what we make. Each new high-volume build lifts our total asset efficiency in terms of yield, quality and cost of production, and in the long run this supports the Farmgate Milk Price. To support growth in milk production, we rolled out Fonterra Farm Source. This initiative is a comprehensive package of regional services and support, digital tools, competitive discounts on farm necessities and financial 8 POTENTIAL

11 FONTERRA INTERIM REPORT 2015 GLOBAL MULTI-HUB LOCATIONS Milk Powder / Foodservice Whey Cheese / Whey / Infant Formula UHT / Foodservice options for our farmer shareholders to help them manage their farming businesses. Fonterra Farm Source enables our strategy by growing the milk pool in New Zealand, which is core to the business, while protecting and enhancing our share of total New Zealand milk production. Fonterra Farm Source is also a vehicle for providing financial solutions when farmers need them. Good examples are enabling farmer shareholders to defer compliance with the share standard until April, taking financial pressure off them in a tight year. We also eased that pressure by extending Fonterra Farm Source credit to 180 days to help farm budgets. Other financial tools include the Dividend Reinvestment Plan and Invest As You Earn, which both help farmer shareholders share up to match production as needed. To grow our New Zealand milk pool we launched a separate milk sourcing subsidiary to attract valuable milk and provide a new pathway to membership in the Co-operative. Called mymilk, it is seeking to attract milk from farms in the Canterbury, Otago and Southland regions that are not currently supplying Fonterra, with no initial obligation to buy our shares. Instead, we are offering one-year contracts, renewable for a maximum of five years. After that time a mymilk supplier will be encouraged to join the Co-operative and buy shares. Meanwhile, the Co-operative as a whole gains from higher milk volumes through efficient plants, which lowers our overhead costs, delivered through a profitable mymilk business. Accessing milk pools does not always need to mean creating farms as we have in China, or collecting milk from contract suppliers as we do in Australia, Sri Lanka or Chile. Increasingly access also comes via partnerships, which works well for both parties. 9 POTENTIAL POTENTIAL

12 ACCESSING MILK POOLS DOES NOT ALWAYS HAVE TO MEAN CREATING FARMS. INCREASINGLY ACCESS ALSO COMES VIA PARTNERSHIPS, WHICH WORKS WELL FOR BOTH PARTIES For example, Fonterra is the dedicated and exclusive sales channel for galacto-olgosaccharide and demineralised whey powder, both used in infant formula and made by our partner Dairy Crest in the UK. Our partnership with Dutch cheese producer A-ware gives us access to million litres of milk in the European market. During the half year, we worked toward the commissioning of our dairy ingredients plant in Heerenveen in January The Fonterra ingredients factory takes all liquid whey from A-ware s cheese production and will process this into 5,000 MT of whey protein and 25,000 MT of lactose specialty ingredients; these are used in high-value paediatric, maternal and sports nutrition products to supply Fonterra customers in Europe and Asia. This is our first wholly owned and operated ingredients plant in Europe. Ingredients from A-ware and our Dairy Crest alliance come into play in our partnership with Beingmate Baby and Child Food Co Limited. Post balance date, Fonterra submitted a partial tender offer to acquire up to 20 per cent of Beingmate and this was completed in March. After regulatory approvals, we will set up a joint venture with Beingmate to purchase Fonterra s Darnum plant in Australia through wholly owned subsidiaries. Beingmate will own 51 per cent of the joint venture. We will also establish a distribution and licensing agreement to sell our Anmum brand in China. This partnership demonstrates our multi-hub strategy and global milk pools at their best, with ingredients from our European pools going into the high-value infant formula products to be made at Darnum in Australia for China. The partnership will also see milk from New Zealand exported to China through our high-quality Anmum infant formula brand. 10 POTENTIAL

13 FONTERRA INTERIM REPORT 2015 BEINGMATE GLOBAL PARTNERSHIP After regulatory approvals, we will set up a joint venture with Beingmate to purchase Fonterra s Darnum plant in Australia and establish a distribution and licensing agreement to sell our Anmum brand in China. 25,000 MT LACTOSE SPECIALTY INGREDIENTS The Fonterra ingredients factory takes all liquid whey from A-ware s cheese production and will process this into 5,000 MT of whey protein and 25,000 MT of lactose specialty ingredients. 11 POTENTIAL POTENTIAL

14 ACCELERATE CONSUMER AND FOODSERVICE GROWTH OUR EIGHT KEY STRATEGIC MARKETS China Malaysia Brazil Chile Sri Lanka Indonesia Australia Strategic Markets Leadership Markets New Zealand Relevance means being number one or two in our eight key strategic markets. We already have leadership positions in key dairy categories in New Zealand, Malaysia, Sri Lanka and Chile, and in China, Brazil, Australia and Indonesia we are focused on building scale operations. We will be growing our consumer positions, continuing to maximise our foodservice potential and really backing a lean and focused portfolio of brands the Anlene, Anmum and Anchor brands supported by some strong regional brands such as Soprole, Fernleaf, Mainland and Western Star. As we form new partnerships we are evaluating existing ones, ensuring they continue to generate value for all parties. We have completed the transformation of our Dairy Partners Americas (DPA) joint venture with Nestlé, with our new arrangement better aligned to the strategies of both companies. We now have a majority stake in DPA Brazil, giving us the opportunity to drive strategy and accelerate growth. Together with a local partner, we have acquired Nestlé s share of DPA Venezuela and we have sold our share in DPA s milk powder manufacturing business to Nestlé. Finally, Nestlé acquired our share in DPA Ecuador. These changes mean we can focus on building our position in everyday nutrition in the rapidly growing Brazilian and Venezuelan markets and develop foodservice opportunities that will generate higher volumes and value. We are particularly targeting volume and value growth in the yoghurt and dairy dessert categories. 12 POTENTIAL

15 FONTERRA INTERIM REPORT 2015 As we form new partnerships we are evaluating existing ones, ensuring they continue to generate value for all parties. In foodservice, we are exploring the implementation of our chef-led foodservice strategy in Brazil. This involves our chefs working with foodservice professionals like chefs and bakers, developing recipes using our ingredients. By enabling businesses to grow through culinary innovation, we grow demand for our products and unique support offering. In all of our markets, relevance is also measured by our customers, consumers, peers and stakeholders ranking us in the top tier for reputation. Underpinning this goal is our four-year programme to establish a global benchmark for food quality and safety, now in its second year. In foodservice, we are exploring the implementation of our chef-led foodservice strategy in Brazil. By enabling businesses to grow through culinary innovation, we grow demand for our products and unique support offering. 13 POTENTIAL POTENTIAL

16 BRINGING IT ALL TOGETHER OUR CO-OPERATIVE IS OUR FARMER SHAREHOLDERS AND OUR PEOPLE WORKING TOGETHER FOR ONE PURPOSE: TO BRING TRUSTED DAIRY NUTRITION TO THE WORLD. OUR STRENGTH COMES FROM THIS UNITY AND OUR FUTURE DEPENDS ON IT Global relevance is an ambitious goal but we can achieve it because we are building on a very strong foundation that has been years in the making. We have a secure base in our capital structure that gives us the balance sheet certainty to drive hard on performance and invest for growth. We are focused on governance that combines the right mix of skills and experience required for a global company that has the interests of our New Zealand farmer shareholders in mind. We have a very clear strategy with clear priorities and it is delivering results. These results are being achieved because as a co-operative we are confident in who we are and what we stand for. Our values and our identity are strong and our people are aligned to our purpose to be the world s most trusted source of dairy nutrition. These values are demonstrated in our sustainability and social responsibility programmes where we work within our communities around the world. In New Zealand, our Fonterra Milk for Schools programme is now operating nationally with 1,498 participating schools and 170,000 children receiving a free serving of Anchor UHT milk every school day. The programme ensures good nutrition is now part of the school day, thanks to the support of our farmer shareholders. It is in addition to our KickStart Breakfast partnership with Sanitarium, which provides more than 100,000 breakfasts each week to around 800 schools in New Zealand. Fonterra Milk for Schools has served as a model for a pilot to provide free milk for schools in Sri Lanka. Announced in November 2014, it is part of a wider programme to encourage the development of Sri Lanka s dairy industry where we source milk from around 4,000 farmers. 14 POTENTIAL

17 FONTERRA INTERIM REPORT ,000 GOOD NUTRITION FOR OUR CHILDREN The amount of children receiving a free serving of Anchor UHT milk every school day. The programme ensures good nutrition is now part of the school day, thanks to the support of our farmer shareholders. 1,498 PARTICIPATING SCHOOLS The Fonterra Milk for Schools programme is now operating nationally with 1,498 participating schools. We continue to make progress with our 10-year programme with the Department of Conservation (DOC), focused on improving water quality in key dairy regions in New Zealand. Under the Living Water partnership, DOC and Fonterra, along with local communities, iwi and farmers, is working together to improve the health of five catchments. These are Hikurangi in Northland, three Waikato peat lakes Areare, Ruatuna and Rotoma nuka, Miranda/Pu korokoro on the Firth of Thames/Tikapa Moana, Te Waihora/Lake Ellesmere in Canterbury and Waituna in Southland. Work includes planting native trees alongside streams and rivers to improve water quality, managing animal pests and weeds, and making sure the right habitats are in place to enhance biodiversity and provide homes for native fish and birds. This complements the significant investments of time and money our farmer shareholders have put into fencing waterways on farms, riparian planting and upgrading effluent systems so they are fully compliant, and help improve on our already highly productive farm systems. Fonterra has also linked up with Westland Milk Products, Tatua, Open Country and Synlait to commit $5 million to accelerate research and development in improved ways to remove rats, stoats and possums from large areas of land in New Zealand. This funding will add to the investment by NEXT Foundation and DOC into the Zero Invasive Predators (ZIP) programme last year and is targeting new tools in addition to existing control methods such as Our Co-operative is our farmer shareholders and our people working together for one purpose: to bring trusted dairy nutrition to the world. Our strength comes from this unity and our future depends on it. 15 POTENTIAL POTENTIAL

18 PROGRESS UPDATE Our progress in achieving our potential can be grouped under two headings: cash generators and growth generators. Cash generators finance our growth today, while growth generators are our source of future cash. Cash generator priorities are to optimise New Zealand milk and to lock in the competitive positions of our consumer businesses in mature markets, especially in Australia and New Zealand. This graphic shows progress this year. CASH GENERATORS OPTIONALITY INVESTING IN INGREDIENTS ASSETS TO IMPROVE FLEXIBILITY, MAXIMISING MILK PRICE AND EARNINGS NEW ZEALAND Pahiatua dryer and distribution centre: $235 million invested, increases capacity by 2.4 million litres per day. Completion date: September FIX UNDERPERFORMING BUSINESSES SRI LANKA Sri Lanka market share rebuilt following the temporary suspension of our operations last financial year. GROWTH GENERATORS MULTI-HUBS CONNECT GLOBAL MILK POOLS TO CAPTURE VALUE AND SUPPORT OUR GOAL OF BECOMING A GLOBAL CO-OPERATIVE NETHERLANDS: A-WARE PARTNERSHIP Plant commissioned and ready to process 5,000 MT of whey protein and 25,000 MT of lactose specialty ingredients. A-ware provides us access to million litres of milk. ACCELERATE CONSUMER AND FOODSERVICE CHINA: BEINGMATE PARTNERSHIP Investment in one of the largest infant formula brands in China. Growth of Anmum brand in China via licensing arrangement. TRUST IN SOURCE THIS IS FONTERRA Year two of our programme to establish a new global benchmark for food safety and quality. This is Fonterra brings together people, who we are and what we stand for and our strategy. 16 POTENTIAL COMPLETED WORK IN PROGRESS

19 FONTERRA INTERIM REPORT 2015 Our consumer and foodservice businesses in priority markets, including China, ASEAN and Latin America, are the growth generator priorities. Progress across all priorities is supported by our programme to establish a new benchmark in food safety and quality, building trust in Fonterra as a source of dairy nutrition. Lichfield dryer project - $398 million investment, adds some 4.4 million litres per day to capacity. Completion date Edendale expansion, three plants, AMF, MPC and reverse osmosis. Increases capacity by 1.4 million litres per day. Commissioning Initial consultation for two dryers at Studholme, capable of delivering nine million litres more capacity. AUSTRALIA Australian costs down 21 per cent over two years. Strategies in hand to combat intense competition and achieve greater use of Australian assets. Grow infant formula exports Grow specialty cheese. Improve returns from yoghurt. UK: DAIRY CREST Fonterra is the dedicated sales channel for Dairy Crest s ingredients used in infant formula. CHINA: ABBOTT Agreement in place to jointly develop a dairy farm hub in China. Antitrust approval received from Chinese Government. AUSTRALIA/NZ: BEINGMATE Partnership designed to grow ingredients exported from New Zealand and Australia to China, including infant formula. LATIN AMERICA: DAIRY PARTNERS AMERICAS Revised joint venture to better reflect strategy for Nestlé and Fonterra. Retains Nestlé as partner in Brazil, with Fonterra owning a 51 per cent controlling stake. Enables volume and value growth in foodservice and everyday nutrition in all dairy categories in Latin America. All come together for our purpose: TO BE THE WORLD S MOST TRUSTED SOURCE OF DAIRY NUTRITION. 17 POTENTIAL POTENTIAL

20 FINANCIAL HIGHLIGHTS NORMALISED EBIT (NZD) $ 376M LOWER PRICES FOR GLOBAL DAIRY COMMODITIES IN THE FIRST HALF RESULTED IN LOWER INPUT COSTS. HOWEVER, THESE COST BENEFITS ONLY CAME THROUGH IN THE SECOND QUARTER AS MARGINS IN THE FIRST QUARTER WERE CONSTRAINED BY THE HIGHER-PRICED OPENING INVENTORY PRODUCED USING PRIOR-SEASON MILK 18 PERFORMANCE

21 FONTERRA INTERIM REPORT 2015 $4.90 FORECAST CASH PAYOUT PER KGMS TO MILK COLLECTION 1,150M KGMS $5.00 VOLUME ( 000 MT) REVENUE (NZD) 2,189MT $9,746M NET PROFIT AFTER TAX (NZD) INTERIM DIVIDEND PER SHARE $183M 10CPS Fonterra refers to normalised EBIT when discussing financial performance. Refer to page 53 for further details on non-gaap financial measures. PERFORMANCE 19 PERFORMANCE

22 GROUP OVERVIEW 2 % INCREASE IN VOLUME The impact of consolidating DPA Brazil and our Venezuela consumer business for the first time was an additional 160,000 MT of sales in the first half relative to the prior period. Excluding this, volumes increased by two per cent. AS PART OF OUR COMMITMENT TO ONGOING IMPROVEMENTS IN OUR DISCLOSURE, WE HAVE ENHANCED THE COMMENTARY IN THE BUSINESS REVIEW SECTION TO ALIGN WITH OUR GLOBAL STRATEGY The purpose of this improvement is to provide more clarity on the ingredients, consumer and foodservice, and international farming businesses, and the key drivers of earnings in each. To ensure continued transparency and consistency, we have retained the standard segment note disclosure of the regional business units in the financial statements and added an additional table disclosing the performance of the regions within the consumer and foodservice segment. Volumes increased by 10 per cent to 2.2 million MT. During the period, we reorganised our DPA alliance with Nestlé in Latin America. We gained management control of DPA Brazil and a consumer business in Venezuela, and sold our share in DPA Manufacturing and DPA Ecuador. The impact of consolidating DPA Brazil and our Venezuela consumer business for the first time was an additional 160,000 MT of sales in the first half relative to the prior period. Excluding this, volumes increased by two per cent. Other drivers of volume growth were China farms, which increased due to farm expansions, and our consumer and foodservice business in China. Group normalised EBIT of $376 million in the first half was $27 million lower than the prior year. Lower prices for global dairy commodities in the first half resulted in lower input costs, however, these cost benefits only came through in the second quarter as margins in the first quarter were constrained by the higher-priced opening inventory produced using prior-season milk. Our ingredients business was up $7 million compared to the same period last year. Although the ingredients business benefited from positive product mix returns and higher price premiums, earnings were impacted by a lower return from powder products (which inform the Farmgate Milk Price) and an unfavourable product mix in Australia, which impacted margins. Our consumer and foodservice business was $22 million higher than the prior period as a result of a recovery in Sri Lanka and a good performance across Asia, in New Zealand and to a lesser extent in Greater China. This was partially offset by lower earnings from Soprole, where higher milk costs were not fully recovered. Earnings from our international farming business were down $29 million due to lower milk prices in China and the livestock revaluation adjustment from the prior period that was not repeated in the current period. Operating expenses were 15 per cent higher, with the largest driver being the newly acquired Latin American businesses. 20 PERFORMANCE

23 FONTERRA INTERIM REPORT 2015 NZD million Six months ended 31 January 2015 Six months ended 31 January 2014 Change Total volume ( 000 MT) 2,189 1,988 10% Sales revenue 9,746 11,292 (14%) Gross margin 1,552 1,407 10% Gross margin percentage 15.9% 12.5% Operating expenses (1,337) (1,159) 15% EBIT % Normalised EBIT (7%) Net finance costs (303) (147) 106% Tax credit/(expense) 3 (52) Net profit after tax (16%) Earnings per share (cents) (23%) Economic debt to debt plus equity ratio 51% 45% Excluding that impact, operating expenses were up three per cent. This was due to the expansion of our China business and investment in brands, growth in China Farms, increased storage and distribution costs in the ingredients business, and higher group costs required to execute key aspects of our strategy. This includes set-up costs related to recent acquisitions. This was offset to some extent by savings in Australia and most markets across Asia. Net finance costs for the first half were $156 million higher than the prior period. This was mainly due to lower unrealised fair valuations of long-dated interest rate swaps used for hedging purposes. Actual cash and accrued interest was also higher, as borrowings increased due to higher working capital requirements to support our farmers during a low milk price season and higher capital spend to execute our strategy. Tax in the first half was lower than the prior period due to a higher tax credit as a result of the higher interim dividend. Our gearing ratio is up at 51 per cent as a result of lower equity retentions, higher capital expenditure and increased business funding requirements compared to the first half last year. This is in line with our expectations. INGREDIENTS Price premiums achieved above dairy commodity prices for ingredients and value-added services were $90 million higher than the first half last year. CONSUMER AND FOODSERVICE Greater China delivered strong volume growth of 36 per cent, driven primarily from our foodservice business and China brands. INTERNATIONAL FARMING Farming hubs are a key part of our strategy to be a more integrated business in China and milk production volumes increased significantly to over five million kgms for the half year. PERFORMANCE 21 PERFORMANCE

24 INGREDIENTS The Ingredients segment represents the ingredients businesses in New Zealand, Australia and Latin America. This segment also includes the Co-operative s corporate activities and Farm Source (formerly RD1), a rural supplies retailer in New Zealand. OUR INGREDIENTS BUSINESS BENEFITED FROM IMPROVED PRODUCT MIX RETURNS IN NEW ZEALAND AND INCREASED PRICE PREMIUMS Milk collection across New Zealand for the season to 31 January 2015 was 1,150 million kgms, up three per cent on the same period last season. Milk collection in Australia, which is our second largest milk pool, was 82 million kgms, up six per cent. Ingredients sales volume was flat, with lower New Zealandsourced sales to China offset by higher sales in other regions. Revenue was 23 per cent down, reflecting the 45 per cent lower dairy commodity prices during the first half compared to the same period last year. Normalised EBIT for the first half was $299 million, up two per cent relative to the comparable period. Our Ingredients business benefited from higher product mix returns in New Zealand and increased price premiums, with margins improving in the second quarter. Positive returns from product mix drove a $71 million improvement in gross margin compared to the first half last year. Product mix is made up of the return from both powder and non-powder products (refer to the chart on the right). The return from powder products was $182 million lower than the first half last year. There is often a lag between when product is produced and when it is sold, and this sales phasing varies by product type. In the first quarter the value of inventory sold was relatively high as it included a proportion of the previous season s product, which was produced when Whole Milk Powder (WMP) prices and hence milk prices were higher. However, selling prices achieved fell rapidly in the first quarter of this financial year with WMP falling to a low of around USD2,400 per MT. This gap between the value of inventory and selling prices created a margin squeeze in the first quarter. This is a reversal of the same period last year, when the value of inventory was based on a lower milk cost and sold at a higher price. In the second quarter this year, earnings from powder products 22 PERFORMANCE

25 FONTERRA INTERIM REPORT % NORMALISED EBIT Normalised EBIT for the first half was $299 million, up two per cent relative to the comparable period. NZD million Six months ended 31 January 2015 Six months ended 31 January 2014 Change Total volume ( 000 MT) 1,538 1,543 Sales revenue 7,617 9,900 (23%) Normalised EBIT % NORMALISED EBIT: KEY PERFORMANCE DRIVERS 90 (84) 253 (43) 292 (182) (27) 299 $ MILLION 31 JANUARY 2014 POWDER PRODUCTS 1 NON- POWDER PRODUCTS 1 PRICE PREMIUMS AUSTRALIA GROSS MARGIN OPERATING EXPENSES OTHER 31 JANUARY Powder products are Reference Commodity Products which inform the Farmgate Milk Price. These are currently Whole Milk Powder, Skim Milk Powder, Anhydrous Milk Fat, Butter and Butter Milk Powder. improved, benefiting from the lower cost of milk. Non-powder products also felt the first quarter margin pressure, but generated $253 million higher earnings than the first half last year. This includes a positive contribution from our long-term liquid milk contracts, which boosted returns. Strong milk production through the peak collection period, combined with capacity constraints, resulted in some additional transport costs and inefficient processing. However, these costs were lower than the comparative period, driven by investment in operational efficiencies, which delivered additional capacity of around 1.9 million litres per day compared to the peak last season. Price premiums achieved above dairy commodity prices for ingredients and value-added services were $90 million higher than the first half last year. In volatile times, we were able to offer our customers value under the relaunched NZMP brand, leveraging off an understanding of their needs. A change in global demand dynamics away from China enabled greater opportunities to sell to customers in Southeast Asia, Middle East and Africa, and increased sales of offshore government tenders. Gross margin on ingredients manufactured in Australia was impacted by an unfavourable product mix due to lower sales of nutritionals. Gross margin was $84 million lower due to an intensely competitive market for milk supply. The proposed joint venture with Beingmate to acquire the Darnum plant is likely to have a positive impact on our infant formula business in Australia. The Ingredients segment includes group overheads. Operating costs were $43 million higher, mainly due to higher costs to support our global brands strategy and ensure efficient allocation of resources across our global brands portfolio, and higher storage and distribution costs in the United States and New Zealand. The benefit of the increased spend to support our global brands is starting to be realised, with the performance of our brands across Asia. PERFORMANCE 23 PERFORMANCE

26 INGREDIENTS Global relevance must include the efficient, profitable processing of the milk we produce in New Zealand. Since 2009, some 70 per cent of capital spend has been in New Zealand to support the ingredients, and consumer and foodservice businesses. WHOLE MILK POWDER PRODUCTION CAPABILITY 27 METRIC TONNES PER HOUR 13 METRIC TONNES PER HOUR CLANDEBOYE DRYER TWO The Clandeboye site is one of Fonterra s largest manufacturing sites in the South Island, primarily producing butter, cheese and milk powders. Dryer two was commissioned in 2001 and can process around two million litres of milk per day and produce 300 MT of Whole Milk Powder per day. Further investment at Clandeboye means that today dryer two primarily produces Milk Protein Concentrate EDENDALE DRYER FOUR The Edendale site, north-east of Invercargill, is New Zealand s oldest manufacturing site still in operation. Commissioned in 2009, dryer four was the world s largest and most efficient dryer, now overtaken by Darfield s second dryer. Edendale s dryer four can process around 4.2 million litres of milk and produce 630 MT of Whole Milk Powder per day. BUILDING NEW CAPACITY More flexibility means optimised production choices, especially at the peak, so we make the product mix that delivers the greatest returns, while meeting the needs of consumers and customers worldwide. In addition to the Lichfield investment due for completion in September 2016, the $235 million site expansion at Pahiatua will increase North Island processing capacity by a further 2.4 million litres a day. This dryer will use the latest energy-efficient processing technology and will be the first in the country to reuse its own condensate. The first milk powder from this dryer is expected to roll out of the site by September Also due for commissioning in 2015 are the Anhydrous Milk Fat and Milk Protein Concentrate plants, as well as a reverse osmosis plant at Edendale in the South Island. This investment increases daily capacity by 1.4 million litres and supports our strategy to increase earnings by driving more milk volume into higher-value categories. Consultation has begun ahead of the potential lodging of consent applications for two new high-efficiency dryers at Studholme in Canterbury, delivering an additional nine million litres of capacity. If approved, the expansion will take place in two phases, with the first dryer on stream in five years and the second in 10 years. 24 PERFORMANCE

27 FONTERRA INTERIM REPORT METRIC TONNES PER HOUR LICHFIELD DRYER ONE The Lichfield site, built in 1995 in the South Waikato, is the location of our next high-efficiency milk powder dryer. The new dryer will provide an additional 4.4 million litres per day of processing capacity and will be capable of producing 700 MT of Whole Milk Powder per day. This is equivalent to Darfield two, which was commissioned in August In addition to the investment in New Zealand, we have also recently commissioned a new dairy ingredients plant in Heerenveen, in the northern Netherlands. The plant produces specialty whey and lactose ingredients which are used for high-value paediatric, maternal, and sports nutritional applications. The site has been developed in partnership with cheese manufacturer A-ware Food Group and supports our strategy in increasing the volume and value of our ingredients and branded products. The plant forms part of our fully integrated global supply chain from the farm gate direct to global consumers. PERFORMANCE 25 PERFORMANCE

28 CONSUMER AND FOODSERVICE The Consumer and Foodservice segment represents the consumer brands and foodservice businesses in Oceania, Asia, Greater China and Latin America. OUR CHEF-LED APPROACH CONTINUES TO DELIVER GOOD GROWTH IN OUR FOODSERVICE BUSINESS IN ASIA DUE TO STRONG GROWTH IN THE ITALIAN KITCHEN AND ASIAN BAKERY CHANNELS In the first half we reorganised our relationship with Nestlé in Latin America. This will enable us to build on the success of the partnership in markets that present considerable opportunities for growth Brazil and Venezuela. By taking management control in these markets, we can use our strengths gained in other consumer markets to deliver increased volume and value. Dairy Partners Americas (DPA) Brazil and our consumer business in Venezuela have been fully consolidated in our accounts for the first time and this inclusion is a key reason for the increase in volume and revenue in Latin America compared to the prior period. The consolidation has had no material impact on normalised EBIT since the equity-accounted earnings from DPA were included in EBIT in the prior period. Volume across our consumer and foodservice businesses was up 27 per cent to 840,000 MT in the first half compared to the same period last year. Volumes for the combined DPA Brazil and Venezuela businesses in the period were 160,000 MT. Therefore, on a like-for-like basis, volume was up three per cent. Revenue was up 22 per cent to $3.3 billion and five per cent on a like-for-like basis, reflecting our ability to increase price points in some key markets. 26 PERFORMANCE

29 FONTERRA INTERIM REPORT % NORMALISED EBIT Normalised EBIT for the first half was $116 million, up 23 per cent relative to the comparable period. NZD million Six months ended 31 January 2015 Six months ended 31 January 2014 Change Total volume ( 000 MT) % Sales revenue 3,256 2,671 22% Normalised EBIT % NORMALISED EBIT: KEY PERFORMANCE DRIVERS 43 (58) 48 $ MILLION 94 (4) (7) JANUARY 2014 VOLUME PRICE COST OF GOODS SOLD OPERATING EXPENSES OTHER 31 JANUARY 2015 Note: The impact on volume and revenue due to the consolidation of DPA Brazil and Venezuela is not reflected in the price, volume and cost of goods sold columns of the chart, but included in other to ensure those reflect underlying performance of the business. NORMALISED EBIT Normalised EBIT for the first half was $116 million, up 23 per cent relative to the comparable period. VOLUME Volume growth contributed to an increase in gross margin of $48 million, mainly due to Greater China, which delivered strong volume growth of 36 per cent. The recovery in Sri Lanka after the temporary suspension of our operations in the first half of last year was reflected in volume growth of four per cent in Asia. Volumes in Australia were higher in spreads and cheese categories and New Zealand delivered volume increases across most of the consumer brands domestically together with improved supply chain management. In Greater China growth in foodservice was supported by our successful chef-led approach and the launch of our new foodservice application centre in Shanghai in November. The foodservice rollout continued into three new cities, taking the total to 29. Our brands business in China continues to make good progress and is well positioned both in store and in the top e-retailers like T-mall. The rollout of Anchor in China continues with market share growth in the Yangtze River Delta region and in the North, which is a new region for the Anchor brand. Anmum TM infant formula is performing as per plan in selected markets. PERFORMANCE 27 PERFORMANCE

30 WE HAVE HAD SOLID REVENUE GROWTH ACROSS OUR TWO KEY MARKETS OF INDONESIA AND SRI LANKA PRICE MANAGEMENT Improved pricing management resulted in a gross margin increase of $43 million compared to the same period last year. In Asia, this had a positive impact, reflecting our ability to manage price points across a number of dairy categories including foodservice, despite the lower commodity prices. In Latin America we took price increases in Chile without losing volume and while maintaining market share. We have had solid revenue growth across our two key markets of Indonesia and Sri Lanka. The business maintained growth in everyday nutrition and foodservice with a strong performance from our Fernleaf TM brand in Malaysia. Our chef-led approach continues to deliver good growth in our foodservice business in Asia due to strong growth in the Italian kitchen and Asian bakery channels. DRIVING VALUE Driving value through winning brands such as Kahurangi blue cheese. 28 PERFORMANCE

31 FONTERRA INTERIM REPORT 2015 PRICE MANAGEMENT Improved pricing management resulted in a gross margin increase of $43 million compared to the same period last year. $ 43M FOODSERVICE BUSINESS Our chef-led approach continues to deliver good growth in our foodservice business in Asia due to strong growth in the Italian kitchen and Asian bakery channels. COST OF GOODS SOLD Input costs increased significantly across the consumer and foodservice business with higher cost of goods sold impacting gross margin by $58 million. This was mainly due to the higher cost of milk in Australia and in Chile in the first half compared to the same period last year. Movements in raw milk prices in Chile tend to lag global commodity prices. As a result milk was relatively more expensive in the first half as costs did not drop in line with key international benchmarks. This is in contrast to the prior year, where the rapid increase in global prices did not take hold until the second half, resulting in a strong first half earnings performance. In Asia, first-quarter margins in the consumer brands business remained under pressure as a result of last season s high cost inventory flowing through and this is reflected in the higher input costs. However, margins improved in the second quarter compared to the same period last year as the benefits of the lower dairy commodity costs started to come through. The higher input costs were offset to a small extent by the New Zealand consumer business where cost decreases came through relatively more quickly due to the higher proportion of fresh dairy products. OPERATING EXPENSES Operating expenses were $4 million higher mainly because of increased investment in our China consumer business. Operating expenses in China were $25 million higher mainly due to increased advertising and promotional spend to support business growth. In Latin America, expenses were higher due to increased storage and distribution costs in Chile. This was offset by Asia and Australia, where continued focus on costs led to further reductions in operating expenses. PERFORMANCE 29 PERFORMANCE

32 INTERNATIONAL FARMING International Farming represents the international farming operations in China. FUTURE INVESTMENTS IN CHINA FARMS MAY INCLUDE FUNDING FROM STRATEGIC PARTNERS AS WELL AS FROM FONTERRA. OUR GROWTH STRATEGY ADOPTS A HUB APPROACH, LEVERAGING ECONOMIES OF SCALE AND MITIGATING BIOSECURITY RISKS 30 PERFORMANCE

33 FONTERRA INTERIM REPORT % VOLUME Milk production volumes increased significantly to 67,000 MT for the first half as a result of the new farms that have come on stream since the first half last year (Yutian 3 in the Yutian hub) and the increased volume from Hangu, Yutian 1 and Yutian 2. NZD million 2 (4) ESTABLISHED Six months ended 31 January (7) START-UP Six months ended 31 January 2014 Change Total volume ( 000 MT) % Sales revenue % Normalised EBIT (27) 2 NORMALISED EBIT: KEY PERFORMANCE DRIVERS $ MILLION (9) (10) (17) (27) 31 JANAURY 2014 PRICE VOLUME COST START-UP FARMS 31 JANAURY 2015 FARM OPERATING EARNINGS LIVESTOCK VALUATION 31 JANAURY 2015 Farming hubs are a key part of our strategy to be a more integrated business in China, contributing to the growth and development of the local dairy industry and helping to meet Chinese consumers need for safe, nutritious dairy products. We now have two farming hubs with a total of nine productive farms. A single farm has capacity for around 3,200 3,500 milking cows and a double farm has around 6,500 milking cows. In total we have 24,000 milking cows plus 25,000 heifers and calves, across our farms to support our growth. Milk production volumes increased significantly to 67,000 MT for the first half as a result of the new farm that has come on stream since the first half last year (Yutian 3 in the Yutian hub) and the increased volume from Hangu, Yutian 1 and Yutian 2. This equates to over five million kgms of milk produced for the six months. Normalised EBIT in the first half was $29 million lower than the same period last year due to the higher livestock revaluation in the first half of last year not being repeated this year. In addition we had a lower milk price in China as a result of increased local supply surplus, accentuated by lower global dairy commodity pricing, and higher year-on-year start-up costs as we accelerated the pace of farm development. Livestock valuations include consideration of the age of the herd on farm and the medium-term view of milk prices in China. In the prior period the livestock revaluation saw a significant uplift reflecting milk price and the herd profile assumptions at the time. The revaluation gain in the prior period was not repeated in the first half this year. Future investments in China farms may include funding from strategic partners as well as Fonterra. Our growth strategy adopts a hub approach, leveraging economies of scale and mitigating biosecurity risks. A typical hub accommodates approximately 16,000 milking cows, consisting of three to five farms in one region. While growing a dairy business has its challenges, the opportunity is significant in China. As we develop the new hubs we will not compromise on milk quality, sustainability and high standards and this positions the business well for future growth. PERFORMANCE 31 PERFORMANCE