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Got Milk? China’s Thirst Could Prove a Cash Cow for Investors

Milk may not be a traditional staple in the diet of most Chinese people, and beef has long played a minor role in the mainland diet, too. It’s far behind pork and chicken in the pecking order. But both products are seeing a surge in demand as tastes evolve, exposure to Western cuisine increases, and the middle class wields its wallet. Financiers have begun to take note.

A couple of recent deals illustrate the increased emphasis on securing China’s food supply and security when it comes to cattle. Investors will want to note that both domestic farming companies and overseas agricultural assets are in play.

Overfarming and relentless monoculture having depleted much of China’s agricultural land. Although Beijing is now paying more attention to the environment, national and local governments alike have had a long-term emphasis on economic development above all else. The objective was to haul China out of the peasant agricultural era, not to encourage more farming.

Now Chinese companies are scurrying to make up for the nation’s farming deficit. Like many industries in China, the domestic business is highly fragmented and perfectly poised for mergers. International farms and farm assets are in huge demand since they carry cachet and answer fears (that my wife and I quite rightly share) among everyday shoppers that Chinese-grown food is tainted with all sorts of nasty chemicals. 

Most significantly, Chinese real-estate developer Shanghai CRED finally completed its painful courtship of the cattle empire S. Kidman & Co. That is not only one of Australia’s largest cattle ranches, with 185,000 heads, but also the nation’s largest private landowner.

The Chinese company had been blocked twice in its attempts to take over Kidman. It finally got permission from Aussie Treasurer Scott Morrison in December to buy a one-third stake in the company, but only after it teamed up with mining magnate Gina Rinehart, whose Hancock Prospecting owns the other two-thirds in a joint venture called Australian Outback Beef.

Rinehart had the name-brand clout to force through the deal — she is Australia’s richest citizen, according to Forbes, with a net worth of $12.2 billion. Still, the largest single farm in Kidman’s empire, Anna Creek, is excluded and will be sold to the Williams farming family in South Australia because it is considered sensitive to defense, being near military operations.

Australian Outback has pledged to increase the herd by 20,000 cattle over the next 18 months and invest as much as A$19 million in capital improvements. It beat by A$500,000 a $386 million ($282 million) bid from an Australian consortium that had successfully played on fears over increased Chinese investment in Australia to ward off previous bids, including a separate attempt by Shanghai Pengxin Group. CRED and Pengxin are both privately held.

China’s largest dairy-farming company is also changing hands. China Mengniu Dairy(CIADY) , which was caught up in the scandal over infant milk powder that was tainted with poisonous plastic, has moved to shore up its reputation by making a general offer for all shares of China Modern Dairy, China’s biggest dairy with 220,000 head, and also its biggest raw-milk producer.

In the process, the private-equity company KKR (KKR) is cashing out of its holding in China Modern Dairy Holdings HK:1117. KKR and partner CDH are selling a 16.7% stake to China Mengniu for around $242 million. That triggered a requirement on the Hong Kong stock exchange to make an offer to all shareholders, one that values China Modern Dairy at $1.6 billion.

Shares in China Modern Dairy leaped 10% when news of the deal came out. But KKR appears to be essentially breaking even on its holding. KKR and CDH ended up owning the stake when China Modern Dairy bought Success Dairy in mid-2015, swapping the private equity companies’ stake for a 9% holding in China Modern at a value of $245 million.

That reignited KKR’s on-again-off-again relationship with the China Modern. It originally invested in the company in 2008, but sold that stake to China Mengniu in 2013. Investors are now pushing KKR to take money off the table in China as it prepares a $7 billion Asia-wide fund, its third.

While CRED’s deal makes immediate sense, there’s considerable doubt about whether China Mengniu will swallow China Dairy successfully. It has struggled for more than two years to absorb Yashili International Holdings HK:1230, another infant-formula company, after buying it in 2013. Poor performance at Yashili drove China Mengniu to a large loss last year. 

However, Yashili has also broadened China Mengniu’s reach. The French food company Danone (DANOY) in 2014 paid $550 million for a 25% stake in Yashili, as it goes global to compete with international market leader Nestle (NSRGY) . Yashili’s New Zealand subsidiary now supplies Danone with base milk powder.

Standard & Poor’s put Mengniu’s long-term credit rating on credit watch, “with negative implications,” the ratings agency said, after the China Modern Dairy deal. It was put off by the higher potential financial burden of acquiring the increased stake.

But China Mengniu has a new CEO in the form of Lu Minfang, who is keen to put his stamp on the company. Yashili’s milk-powder competitors Yili Group SH:600887, Biostime International Holdings HK:1112 and Beingmate Baby & Child Food SZ:002570 are also struggling, and are prime takeover targets, too.

China and its 1.4 billion mouths to feed are the ultimate goal of all this action. Kidman supplies Japan, the United States and Southeast Asia with grass-fed beef, and the head of the new joint venture that owns it explicitly said it wants to break into the Chinese market.

Danone had 7% of sales in China, its fourth-biggest market, before snapping up its stake in Yashili. While domestic, China Mengniu hopes it is putting its involvement in the 2008 scandal over milk powder that was tainted with melamine behind it by ensuring a stable, safe supply of milk.


Source: Real Money

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