No Easy Answers for Clean-up of Milk Powder Industry; The government wants domestic companies to consolidate and increase their market share, but this is easier said than done

06.27.2013 19:10

No Easy Answers for Clean-up of Milk Powder Industry

The government wants domestic companies to consolidate and increase their market share, but this is easier said than done

By staff reporters Qu Yunxu and He Chunmei

(Beijing) – Premier Li Keqiang said in late May at a State Council meeting that the government would supervise the quality of infant milk powder using the same standards as those used for drugs.

Then, on June 4, the Ministry of Industry and Information Technology (MIIT) said that from June 1 to August 31 it would launch a safety inspection of milk powder production in an aim to improve quality and boost consumer confidence.The quality of baby formula has been among the country’s top food-safety concerns. The domestic industry has seen its reputation tarnished after several quality scandals, especially in 2008 when the industrial chemical melamine was found in several milk products. The chemical was blamed for the deaths of six infants and for making up to 300,000 other children ill.

In an attempt to clean up the industry, the MIIT also said it would encourage domestic infant formula companies to consolidate. The government wants to see domestic producers conduct mergers and acquisitions themselves, Wang Liming, head of the ministry’s Consumption Industry Department, said at a forum on June 18.

Foreign producers of milk powder account for 60 percent of the domestic market, the MIIT said, but it wants domestic companies to own this portion of the market in two years.

At the same forum, Wang mentioned the possible acquisition of Yashili International Holdings Ltd., a formula producer in Guangdong, by China Mengniu Dairy Co. Ltd., one of the largest dairy firms in the country. Later that day, the two companies announced the deal.

On June 20, nine ministries issued guidelines to regulate milk powder producers’ quality control efforts. The ministries, led by the Food and Drug Administration, require producers of milk powder and formula to operate and control milk sources themselves while strengthening quality inspection throughout their business chains.

The guidelines suggest consolidating the milk powder industry and eliminating unqualified capacity.

Several analysts said that if the guidelines are strictly implemented by milk powder producers, small companies would be eliminated.

However, industry insiders say that consolidating the industry will not be easy. They point out that only a few large dairy firms, such as Mengniu and Inner Mongolia Yili Industrial Group Co Ltd., have the financial strength to buy and too many small milk powder producers are not worth acquiring. Also, many regional dairy firms are closely linked to local governments as big taxpayers.

A Good Start

Mengniu’s annual production of infant formula is 4,758 tons, while the figure for Yili is 64,200 tons. Mengniu’s milk powder and cheese products accounted only for 1.6 percent of its total operating revenue in 2012, its financial report shows.

Because Mengniu is the leading domestic milk producer, it was urgent the company take a greater share of the milk powder market, an executive from a large domestic dairy company said.

Mengniu has already taken steps in that direction. It and Yashili announced their deal in a statement on the Hong Kong Stock Exchange on June 18. The announcement said the transaction would be worth more than HK$ 10 billion.

In 2012, Yashili’s share of the milk powder market was 4.5 percent, and Mengniu’s was less than 1 percent.

Mengniu predicts that after the deal its milk powder segment will contribute 10 percent of its total revenue. It also says it will not intervene in Yashili’s daily operations, and it will keep its employees and executives.

All of Yashili’s milk comes from overseas, a source at Mengniu said, and Mengniu will not change this, either.

Industry Consolidation

After Mengniu and Yashili announced their deal, reports that other domestic makers of formula were seeking investors started to circulate.

One of the companies named was Synutra International Inc., which is similar to Yashili in terms of market share and annual production. In 2012, Synutra’s market share was 3.9 percent and its annual production was 24,500 tons.

Investors such as French dairy firms and pharmaceutical companies from the United States have contacted Synutra before, a source close to the company’s executives said. But Synutra turned them away because it felt they were not offering enough money.

The generally messy domestic situation will make it difficult to implement the guidelines issued by the nine ministries. Industry expert Wang Dingmian used Shaanxi Province as an example. There are 25 milk powder companies with licenses in the northwestern province and they produce a whopping 300 brands of milk powder.

The value of many small companies’ annual output was between 300 million yuan and 500 million yuan, the leader of an industry association in Shaanxi said, and most of these companies were so small they were not worth buying. However, these firms are important to the local economy, especially to dairy farmers who earn the lion’s share of their income from them.

In addition, some large regional milk powder companies are big taxpayers for local governments, an industry expert who declined to be named said. If the companies run into food-safety problems, they tend to rely on local governments for cover-ups.

“The problem with the domestic milk powder industry is that the government doesn’t monitor producers’ technology and research and development,” the leader of the industry association in Shaanxi said. “Without this, the food-safety problem cannot be solved.”