Hong Kong, Sep 30, 2016 AEST (ABN Newswire) - The Directors of China Dairy Corp Ltd (ASX:CDC) (the "Company") are pleased to present their report, together with the financial report of the Company and its controlled entities (the "Group") for the financial year ended 30 June 2016, and the auditor's report.

FINANCIAL AND OPERATIONAL REVIEW

Financial summary

The table following (refer to link below) presents key financial data for the 2016 financial year ("FY2016") and the 2015 financial year ("FY2015").

Milk sales

Milk sales revenue is generated from the sale of milk from CDC's company-owned cows. Over FY2016, milks sales revenue increased by US$33.2 million (68.5%) to US$81.6 million. This large increase was due to a number of key developments as outlined below:
- Increase in contracted milk prices

The Company's raw milk is sold to 4 customers (previously 5 as at 30 June 2015) under contracts which set the price of milk over the term of the contract, enabling CDC to avoid the volatility of market milk prices. In November 2015, the Company replaced 4 of its old customers with 3 new customers that entered into 2 year agreements to purchase raw milk from CDC at RMB 3.80 per kilogram. This was higher than the 4 outgoing customers who purchased raw milk from the Company at RMB 3.50 per kilogram.

- Increase in number of company-owned cows

The number of company-owned cows saw a large increase over the 2016 financial year. As presented in the tables below, the total number of company-owned cows increased from 22,206 heads as at 30 June 2015 to 35,058 heads as at 30 June 2016, an increase of 57.9%. Of these, the number of milkable cows increased from 9,996 heads as at 30 June 2015, to 20,130 heads as at 30 June 2016, an increase of 102.0%.

Milk sales commissions

Milk sales commission revenue is generated through the sale of milk from cows the company has sold to external farmers. The farmers pay for the cows over a repayment period that is between 1 and 8 years. While the farmer is paying off their cow, CDC has a right to 30% of the milks sales revenue generated from these cows. This is provided by the farmers in exchange for the Company arranging the sale of milk from these cows to its customers. Revenue generated through milks sales commission from the company's sales commission cows increased by US$1.59 million (8.9%) over the year to US$19.5 million. This increase was due to a number of reasons as outlined in the following table (refer to link below).

- Increase in contracted milk prices

The milk produced by sales commission cows is currently sold to 4 customers under contracts which set the price of milk over the term of the contract (2 years). In February 2016, the price of milk that 3 of these customers purchased milk at increased from RMB 3.35 per kilogram to RMB 3.60 per kilogram.

- Increase in average number of sales commission cows

The number of sales commission cows decreased from 17,250 heads as at 30 June 2015 to 14,034 heads as at 30 June 2016. The reason for this decrease is due to the external farmers paying-off the principal of the cows and no longer needing to pay the Company a sales commission on the milk sold. Despite the decrease in the number of heads as at 30 June 2016, the average number of sales commission cows increased by 1,062 heads (6.9%) to 16,517 heads over the 2016 financial year when compared to the previous financial year.

Gross profit

Gross profit decreased by US$2.6 million (-5.7%) over the 2016 financial year to US$43.5 million. The decrease in gross profit can be attributed to a number of cost factors that have changed for the company over the year. These include ongoing production costs as well as costs brought on due to investment in the Company's operations. The key items behind the increase in the cost of goods sold are described below.

- Cow feed and entrusted farmer fees

CDC has strict requirements on feeding its cows. As a large part of its company-owned cows are entrusted to 179 local farmers to feed, milk and rear, the Company utilises a consistent feeding methodology to ensure that the milk produced from these cows is consistent in yield and quality across its entrusted local farmers.

This means that these farmers must feed the cows using a feed that has the composition as dictated by the Company. As CDC is responsible for providing the fees for the farmers to purchase the feed, the Company has incurred large cost increases due to many of the feed components increasing in price over the 2016 financial year. This includes the cost of grains, grass, corn stalk, hay and ensiling. The farmers are paid a fee to rear and feed the cows entrusted to them based on the age of the cow as presented in the following table (refer to link below).

Costs related to feeding the cows reared by the Company and its entrusted farmers accounted for 79.6% of cost of goods sold in FY2016 and 86.2% of cost of goods sold in FY2015.

- One-off grant to farmers

During FY2016, the Company made a one-off grant of RMB 600 to its entrusted farmers for each young and adult cow they were outsourced to rear. The grant was made so that the entrusted farmers could make improvements to their equipment and farmland. At the time the grant was made, there were 174 farmers who reared a total of 2,058 and 9,267 young and adult cows respectively. 82% of the total cost of this RMB 6.8 million (US$1.1 million) grant was included in the cost of goods sold.

- Depreciation on increased capital investments

The Company incurred markedly increased depreciation costs in FY2016 due to a number of investments in the business as described below:

- Depreciation on improvements and additions made to its farms near the end of the 2015 financial year and over the 2016 financial year. The Company acquired the land use rights to two new farms (Xianfang farm and Schuangcheng farm) in May 2015. To prepare and equip these farmlands, a number of investments were made covering vehicles, farming equipment and machinery, farm infrastructure and buildings.

- In January 2016, the Company entered into an agreement with an external party to build a forage production plant on its Xinha grasslands, a piece of land the Company utilises to grow grass for use in feeding its cows. The total cost of the forage production plant will be approximately US$6.9 million when completed with the Company having spent US$4.3 million as of 30 June 2016. Depreciation on the finished sections of the forage production plant are included in cost of goods sold.

- Depreciation on the increase in the company's biological assets coming from an increase in the herd size as well as the depreciation due to the increase in feeding costs.

Depreciation accounted for in cost of goods sold increased from US$2.2 million in FY2015 to US$4.6 million in FY2016.

- Labour

The Company saw an increase in direct and outsourced labour costs related to the production and sale of milk due to the increase in the Company's herd size as well as the migration of the Company's dairy farming operations from the Qiqihaer and Shangzhi regions to the Xiangfang and Schuangcheng farms in Harbin, Heilongjiang. Direct and outsourced labour costs in cost of goods sold increased from US$0.5 million in FY2015 to US$2.4 million in FY2016.

Operating expenses

Operating expenses increased by US$4.1 million (235%) over the 2016 financial year. This was predominantly due to selling and marketing expenses and general and administrative expenses as explained below.

- Selling and marketing

The increase of sales and marketing expense is due primarily to the increase in the Company's herd and the utilisation of the new farmlands in Harbin. This required the Company to increase spending on publicity costs as well as on outsourced sales staff to promote the Company's increased production numbers and the migration of its dairy farming operations from the Qiqihaer and Shangzhi regions to Harbin in Heilongjiang.

- General and administrative

The increase of general and administrative expenses is due to a number of factors including increased maintenance costs and an increase in depreciation on improvements on the Company's office buildings, labour costs and expenses related to the Company's IPO.

Production metrics

The Company's average milk yields per milkable cow remained relatively flat for its company-owned cows, falling 100 kilograms per cow, due predominantly to the disruption of migrating its herd from the Qiqihaer and Shangzhi regions to Harbin in Heilongjiang.

Average milk yields per sales commission cow increased by 500 kilograms to 8.1 tonnes in FY2016.

Farmland and migration of cows

Land in China is owned either by the state or by collectives and cannot be sold to individuals or companies. In order to gain access to land, private entities must acquire a land use right ("LUR") over the particular piece of land. These LURs function like long-term leases over the land, allowing the party to develop on the land based on its designated purpose. The Company has land use rights over a number of tracts of land as detailed in the following table (refer to link below).

The Xinhua grasslands and Fularji farms are currently used to grow grass for use in the Company's feed requirements. The Fuljari farm will later also be used as an R&D site for producing specialised fodder to be used in the feed of cows producing milk for the Company's liquid milk business when it reaches an appropriate stage.

The other farmlands are used for CDC's dairy farming operations. The Xiangfang and Schuangcheng farms are the two new tracts of land acquired by the Company in May 2015 into which CDC has heavily invested over the 2016 financial year to prepare and equip for its dairy farming operations. In November 2015, the Company moved the majority of its cows from the Qiqihaer and Shangzhi regions to Harbin in Heilongjiang. In the process, to reduce transportation costs, it also changed a number of its customers to those closer to Harbin at more favourable terms and replaced its older entrusted farmers with new ones in the Harbin region.

Dividends

The Company was pleased to declare an unfranked interim dividend on 24 May 2016 of A$0.0057 per CDI for the profits it generated over the 2016 financial year to 31 March 2016 (9 months).

Outlook

Moving forward, the Company intends to focus on a number of initiatives as outlined below:

- Optimisation of the herd

Over the 2016 financial year, the Company has begun to optimise the age structure of its company-owned cows to:

- Reduce the proportion of older milkable cows, meaning the cows which have been producing milk for over 5 years, as this will help to further increase milk production and quality; and

- increase the proportion of milkable cows to increase the level of production.

As presented in the table below, this is evidenced by the increase in the proportion of milkable cows which increased from 44.9% in FY2015 to 57.4% in FY2016.

CDC anticipates to grow and optimise its herd through acquisitions of new cows to help increase long-term performance and maintain the Company's competitiveness. Over the 2016 financial year, the Company acquired 8,300 cows while selling 2,282 cows to external parties in line with its strategy to optimise the age structure of its herd.

- Sales commissions structure

The Company will look at new commission and repayment structures of its sales commission business model. To date, the Company has sold cows to external farmers by estimating the remaining useful life of the cow based on their age when sold and then having a repayment plan over this period (anywhere between 1 to 8 years). Over the repayment period, the external farmers who purchase the Company cows must provide 30% of the milk sales generated by selling the milk to the Company's customers as a fee for arranging the sale of milk. This enables the Company to earn a sales commission from a cow for the milk sold over its useful life even after the cow is sold to an external party.

The Company will investigate different structures to sell cows which will align better with its continuing optimisation of the age structure of its herd. It's CDC's intention to look at longer repayment periods of 6 to 8 years while adjusting the sales commission down from 30% to 20%. While this would yield a lower commission, it would provide the revenue stream per cow over a longer period while also gaining more interest from external farmers due to the decreased sales commission. The Company anticipates that a structure similar to this would result in a larger number of cows sold and a greater production quantity from a business model where the Company has lower direct costs.

- Processed liquid milk

One of the Company's growth and diversification initiatives is to develop a new business stream which provides processed liquid milk products for children. The Company sees this as a large growth area in China, especially given the recent announcement by the PRC Government of the removal of the one child policy by allowing families to have two children. This is expected to increase demand for dairy products.

One of the aims of the Company is to produce raw milk that will be used in its processed milk products that has all the nutritional requirements without the need for additives to be put in during the processing stage. This will require a focus on specialised feed for the cows to ensure that the milk produced in high in nutritional content and suitable for children.

The Company begun work on this research & development into feed by working with the Northeast Agricultural University ("NAU") to investigate different diets for cows that can achieve the Company's goals. Currently, testing is being conducted on some of the Company's cows on the Yulong farm which will be used as the initial base for this business stream.

In addition, the Company is in the initial stages of cooperating with Harbin Institute of Technology to carry on research and development of new types of children's dairy products.

The research and development into adequate feed and children's dairy products, which is the initial phase of the new business venture, is expected to be done over the next few years and will include finalising the feed and types of processed dairy products to produce in a small-scale production facility.

Once the initial phase of the project has been completed, the Company will scale up the production of the processed dairy products by increasing its production facilities and cows used to produce milk for its processed liquid milk products.

The Company also intends to expand into Mongolia with respect to this business stream for a number of reasons including its proximity to Heilongjiang, the country's established dairy industry which has good support from the government and low labour and land costs. In Mongolia, the Company will develop a second base for testing and production of processed liquid milk for children.

The Company's management have repeatedly travelled to Mongolia to inspect various sites with the intention of establishing a test base on which they will first set up a mid-sized dairy farm and subsequently acquire between 800 and 1,200 cows to conduct breeding research and development. It is expected that the Company will achieve its aims with its short-term Mongolian expansion sometime in 2017.

- Australian investments and/or acquisitions

In Australia, the Group's inorganic growth initiatives will be focused on two fronts; exploring the acquisition of dairy processors of high quality products while also searching for dairy farming operations which will allow the Group to improve its farming processes and technologies.

Australia has a strong reputation in global markets as having an advanced dairy industry that produces high quality and safe dairy products. The Chinese milk scandal of 2008, where milk products were adulterated with melamine, put significant pressure on the Chinese dairy industry and caused consumers in the country to put more trust in products from advanced dairy producing nations like Australia than they do on local products. This provides a good opportunity for the Group to explore acquisitions of, or investments in, dairy product producers in Australia to sell their products into the Chinese market.

As an advanced dairy producing nation, Australia's technological processes in cow breeding and milk production are of a higher standard than those typically found in China. As such, the Group will also explore acquisitions of Australian dairy businesses that possess the processes and technologies that can be applied to the Group's operations in China to improve the efficiency and quality of milk production.

The Company has been exploring the Australian market since its listing on the ASX to find suitable candidates in line with its inorganic growth plan in Australia.

To view the report including tables and figures, please visit:
http://abnnewswire.net/lnk/X601SDAR


About China Dairy Corp Ltd

China Dairy Corporation Ltd ASX CDCChina Dairy Corporation Limited (ASX:CDC) is a company primarily engaged in the production and wholesale of raw milk and the rearing, breeding and sale of dairy cows in Heilongjiang province, China.

CDC generates revenue through two primary business models: 
- the sale of raw milk from cows that are owned by the company; and
- milk sale commissions on the sale of raw milk from cows the company has sold to farmers.

As at 31 December 2016, CDC owned 31,877 cows and partnered with farmers with an additional 21,617 cows from which CDC makes a sales commission on the milk sold.

    


Contact

David Paul Batten
Independent Director and Local Agent
T: +61-2-8051-3008
E: david.batten@chinadiaryco.com

China Dairy Corp
T: +61-2-8051-3008
E: inquire@chinadairyco.com
www.chinadairyco.com



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