China Endures Another Contamination Scare

NEW YORK (TheStreet) -- Over the weekend news broke of a potentially serious contamination of dairy products produced by New Zealand dairy co-op Fonterra.

Dairy co-ops go back to the early 1800s in New Zealand as means for farmers to work and market their product more effectively. Fonterra goes back just to 2001 but represents 95% of the country's milk producers and does business in 140 countries.

New Zealand is often lumped in as being a commodity-based economy but really is more of an agricultural-based economy. Dairy products account for as much as 15% of GDP. For years it was a question of when Fonterra would go public which it finally did last December. For now there is no ADR or ordinary listed shares to trade in the U.S. but U.S.-based investors should be able to access the stock through one of the global trading platforms that many online brokerages started offering in the last couple of years.

It was announced that 38 tons of whey protein from May 2012 were contaminated with a bacteria that could cause botulism. The contamination was blamed on a seldom-used pipe that had not been sufficiently cleaned. The immediate reaction was to send Fonterra shares down almost 9% and the New Zealand dollar down 2% in the face of restrictions imposed by China on future dairy trade with New Zealand.

During the trading session, however, the shares recovered to close with a 3.6% decline and the kiwi, as the currency is known, cut its losses in half. The intraday turnaround could attributable Fonterra CEO Theo Spierings' immediate apology, his having flown to China already to explain what happened and the expectation he set that restrictions should be lifted in just a couple of days. New Zealand's, trade minister, Tim Groser is also likely headed to China. In 2008 New Zealand became the first country to sign a free trade agreement with China.

Whey protein is used primarily in powered infant formula, which means that fresh milk and yogurt are not affected by this incident. In addition to China, the potentially contaminated powder was also exported to Australia, China, Malaysia, Russia, Thailand and Vietnam. Luckily for everyone involved there have been no reported illnesses from the contamination.

The company says that at this point most of the still-existing contaminated powder has been isolated and recalled but the company faces a potential image problem in facing questions about the delay in disclosure. Prime Minister John Key noted that the contaminated batches were produced 15 months ago but it is only making news now.

There is also a potential image problem with its customers in China, where most of the powder went. Over the years there have been several news stories from China of locally produced food and dairy products that was contaminated with deadly outcomes. Many of the articles on the current Fonterra news have quotes from scared mothers which will be difficult to overcome even if CEO Spierings is correct about trade curbs being lifted.

While this might open a window of opportunity for Chinese dairies, that appears to not be evident yet as China Mengniu Dairy was down 1.3% in the Hong Kong Session overnight.

The reaction in the New Zealand benchmark NZ 50 Index was dismissive of the news, dropping slightly at the open but it closed with a modest gain. The iShares MSCI New Zealand Capped ETF ( ENZL), which does not hold Fonterra, is down about 1% early in the U.S. session but that appears to be attributable to the drop in the currency.

Going forward it is likely that Fonterra does work things out with the Chinese government because China needs the milk and milk products and, despite this news, imports from New Zealand are still a more reliable alternative for the Chinese people.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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