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RBNZ sees rebound in bank profits since 2009 petering out in coming years as competition intensifies and tougher capital rules kick in

RBNZ sees rebound in bank profits since 2009 petering out in coming years as competition intensifies and tougher capital rules kick in

The Reserve Bank of New Zealand has noted significant profit growth from banks since 2009, but now expects that growth to slow as competition intensifies and banks have to retain more capital to meet tougher Basel III capital requirements.

The Reserve Bank said in its half yearly Financial Stability Report bank profits troughed in 2009 because of higher bad debt expenses and taxes after the major Australian-owned banks agreed to large one off tax payments.

“Profitability has subsequently recovered, reflecting the cyclical improvement in the economy over recent years and the associated decline in bad debt expenses, together with higher net interest margins,” it said.

Bank retail net interest margins had risen from around 190 basis points in late 2009 to around 230 basis points now as customers shifted to more profitable floating rate loans.

“Bank profitability is slightly lower than pre-crisis levels, measured by the return on assets or the return on equity,” it said.

“While there is further scope for bad debt expenses to decline and boost profitability, it is unlikely that profit rates will increase much further,” the bank said.

The central bank said the outlook for profits would be shaped in part by how banks responded to lower credit demand. That could include further cost reductions and more intense competition for market share.

“Greater competition would limit the potential for further increases in bank net interest margins, which have been rebuilt somewhat over the past few years.”

The bank said the increase in net interest margins had been driven by a re-pricing of risk on loans to both households and businesses, and “by progressively passing higher funding costs through to borrowers as relatively low margin fixed rate loans roll off.”

“Typical future rates of return on equity are likely to be somewhat lower as a consequence of the implementation of the new Basel III rules for capital adequacy,” it said.

The Reserve Bank, which regulates New Zealand’s banking sector and runs monetary policy, said the banks were well placed to meet the tougher Basel III capital rules and were also well above the Reserve Bank’s minimums for stable funding, known as the Core Funding Ratio.

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72 Comments

Updated with video of Spencer and Bollard answering some questions from Bernard at the bottom.

Cheers

Alex

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Oh how the memory fades - Happy to agree - not: "after the major Australian-owned banks agreed to large one off tax payments".

 

THE New Zealand Government has stung four Australian-owned banks with a $NZ2.2 billion ($1.76 billion) tax bill in the little country's largest-ever commercial tax settlement case.

The banks had vowed to fight the claims, with experts predicting the saga would drag on well into the new decade without any sign of victory for the Government.

But in a surprise announcement late yesterday the banks admitted defeat, with Westpac agreeing to pay NZ$885 million relating to nine structured finance transactions between 1998 and 2002 and BNZ to pay NZ$658 million for six deals entered into between 1998 and 2005.

 
Read more: http://www.news.com.au/business/anz-cba-nab-and-westpac-in-17bn-nz-tax-settlement/story-e6frfm1i-1225813353004#ixzz1uKSOtbCf

at the very time the economy is/was weak, interest margin goes from 190 to 230 points. all the while on a mountain balance outstanding.... So much for women and children first..

 

http://www.rbnz.govt.nz/statistics/az/2989605.html

Take a look at Farm debt:

Jan 2001 12,245 Jan 2011 46,591

- thats dollars million. Dairy is 3 x's up at Jan 2011 29,726

Agricultural credit series – Annual as at June – historical, copy of survey form

 

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He has more faith in the generosity of Australia's banks than I do. Will they really reduce margin in a chase for market share; or will they happily share the very high margins around among themselves? If they would choose lower margings for market share, why have they not done it until now?

I know which option I think they will choose.

Properly capitalise KiwiBank, and there might be some genuine competition.

Bollard seems significantly out of his depth.

 

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Maybe its a case of having to......

 

Re Dairy Farm debt. The other day the bank mentioned that they were fine for lending money provided we meet and use this calculation:

Milk price $6, Farm Exp $4, interest coverage 1.5 (ebitda needs be 1.5 time interest pmt), interest only pmt (plug rate) 9%, and this would be at LVR of 50%. - middle of the South Island. These numbers assume farm equity accepts a return of around 6% or > (otherwise their LVR would go up/or loan amt go down).

 

Well we used that assuming NZ was all one farm, ie NZ Inc Farms (numbers and/or assumptions may not be 100% etc, etc and accepting the non-fonterra production) but you get the drift:

$6 kg/MS pus 30 cents a dividend times 1,452 million kg/MS (up 10% from 2011 MS volume - ex fonterra accounts) would equal $9,148 m pmt from fonterra to farmers.

Less the $4 per kg as exp (assume stock sales net out between farms)

and this gives ebitda of $3,339 million, divided by 1.5 equals $2,226 m for interest pmts at 9%.

 

To get the value of NZ Inc.'s farm, we divided the $2,226 m by 9% to get the loan NZ Inc. would get at LVR 50%. It equals $24,738 million, that is $4,988 million less than has already been lent (as per the RBNZ Dairy Farm lending - being $29,726 m) - see the post above.

(We know that there is $1,113 m as earnings not used for interest, however, steady state on farm capex is easily 30 cents a kg so the "slack" is more like $600m).

 

Running the numbers at $5.75 milk price (say next year the new loan would be $7,677 million less that current balance). volume of MS has only a small influence, its all about price. (At milk price round $5 we struggle to pay interest at 6%).

We know if tight that there should be movement in the $4 exp number, and stock sales (probably less volume as well), etc...

However, It seems that NZ Inc. would not be able to re apply and successfully refinance all its debt on current "normal" lending terms (its not like the whole place can have a "special" deal).

However general thoughts:

1. banks do not want interest rates to go up anytime soon. and we have not talked about reducing the loan.

2. these are broad averages, we know most debt is concentrated with 20% of the farm population.

3. it is a great shame that fonterra hasn't given industry a lead as to farm gate milk price path.

4. fonterra has maybe $5,802 million dollars of debt too.

5. there does not seem to be any borrrowing capacity left...

6. if fonterra farm gate milk price stays around $5 to $6, then any quick increase in income comes from the dividend, or selling the share (TAF - wise), or ?

 

Q: what happens next?

 

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Henry, Fascinating, thanks; and I understand your question is  probably both rhetorical, and not just to me.

I am not a farmer, so confess that my confidence in an answer, or even being sure of the question, is not great. 

However, from what you say, the banks seem to have two obvious choices in the event that a large number of farmers cannot pay their debts. One is to generously lower their interest rates to say 6%, so that the loans are affordable.  The other is to foreclose on the farms, which would then be sold offshore to the only people with real money, given that our successive governments have ensured there are few useful assets in NZ's hands, a policy the Nats have followed with steroids.

I'm picking the banks will choose the latter- the foreclosure route. The 50% LVR gives them plenty of scope. 

If we had a half decent Reserve Bank; and or Government, they would see this coming before the train wreck, but their record to date is not good. They have tools; lower interest rates, printing money, some capital controls, lower exchange rate management to lower some farm costs, and expand the returns in NZ dollars. Maybe even modest inflation (see the UK) to ease some debt.

No sign of using them so far. Bill English won't work it out by himself, but he has enough farmers living near him to tell him. Shame it has to wait until a train wreck.

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Henry Tull....don't know if your still there but ...uh run an eye over this would you......

 http://www.comcom.govt.nz/assets/Dairy/Dry-run-review-2012/DIFL-Dry-Run…

you'll have to activate it as it's a PDF acrobat 9 doc.....but a cracking read nonetheless....lets know eh...? 

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Christov, thanks, yes and yes.

The currency is a big deal:

Fonterra's CFO Jonathan Mason said Fonterra's hedging policy saw it realise an average exchange rate for the year of 72 USc when the actual average was 77 USc, which meant Fonterra booked hedging gains for the year of NZ$863 million or around 70 cents of payout/kg of milk solids.

http://www.interest.co.nz/node/55560/rural%20news

 

and the independents are well reved up:

Fonterra Cooperative Group executives have rubbished a Deloitte report for local dairy industry competitors that claims it charges up to 50 cents a kilogram too much to supply them milk, accusing them of trying to bog down the cooperative in investigations.

http://nz.finance.yahoo.com/news/fonterra-execs-come-swinging-competito…

 

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Thanks Henry T.......

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Q: what happens next?

 

Do you really want to know? If you do:

 

1. Check out Fontera's net tangible assets per share. This will have gone backwards since the 2011 accounts (due as you have mentioned to paying dividends from reserves).

 

2. Work out from globalDiaryTrade prices what a Kg of milk solids going into processing is currently yielding as exports of WMP, SMP, AMF and buttermilk (two thirds of our milk production goes into those export products) as compared to 6 or 12 months ago. Convert both to NZD at the prevailing rates.

 

3. Deduct the costs per Kg of milk solids of your processor (operating, overheads, debt servicing and any dividend) and you will have some idea of next seasons likely payout if current prices and NZD:USD exchange rates hold, and a reference against a previous seasons payout.

 

Let me know if you conclude any of our banks have a clue.

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CR: Yes and happily looking the other way, the local agri-lenders (as reported here) are saying they want to increase market share happy in the knowledge they will be bailed out ....

But there is no "headroom", say this CAL yr there is 1,450 million kgMS, verus $29,726 million of dairy debt, thats an average of $20.5 loan for each and every kgMS collected... 

 

The way of the banks is to "rotate" their management every couple of years, so thay all toe the party line (party line from Sydney/Melbourne), and when pressed say: "It was like that when I got there"......

For example:

The Reserve Bank's latest financial stability report paints an ugly possibility for New Zealand's rural powerhouse: "the possibility that the exchange rate stays high while commodity prices fall further."

The pattern over time is for the global forces that drive commodity prices tend to take the New Zealand dollar along for the ride.

What's unusual about the current situation is that the world's biggest central banks have the floodgates open in terms of monetary stimulus.

http://nz.finance.yahoo.com/news/farm-steam-comes-kiwi-213154106.html

 

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the possibility that the exchange rate stays high while commodity prices fall further.

 

The RBNZ is only noting what has been apparent for 2-3 months. I also note that their FSR is now showing dairy debt relative to export prices (or something like that - it is couple of days since I looked at it). That way they don't need to show that ag debt is up $1 billion on a year ago. Works well in showing improvements while prices are up, but not when that reverses.

 

I think both the dairy debt and MS production are higher this year than the numbers you suggest, but the debt per Kg MS likely hasn't changed much. But knock a couple of dollars per Kg off the payout for a couple of seasons and it gets very ugly for milk producers and processors.

 

If I had Fonterra shares I would be redeming as many as possible while I could still get $4+ for them.  

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Agreed, the numbers do lagg.

I suspect you are right, the commodity business is subject to price cycles, and when/if the brands business makes a margin, someone else in the "value chain" looks to eat our lunch (Oz superamarkets) ...

 

So commodity mkts aside do the co-ops lads have the wit/willingness to out smart/stand up to commercial markets and consumer market corporates.

 

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The main failing of DIRA (there are many) was, and still is, that it saddled Fonterra with a business model that tried to combine a co-operative with a consumer brands business. The two businesses are mutually incompatable because they require different capital structures and risk profiles.

 

It is fairy simple, but no one over the last 15 years in any leadership position within the dairy industry, government, academic or research institutions has had the wit to work it out.

 

No surprises there, but it brings us to the current situation where farmers want a co-operative for the reliability, control and low cost structure that co-ops provide producers, but Fonterra management/governance want to be an international corporate consumer brands business with high overheads, higher risks and fat salaries.   

 

Farmers have been misled to believe that they can have the best of both worlds despite Fonterra in reality delivering to shareholders the worst of both. That proof requres considerable analysis, but it is there. TAF may soon make Fonterra being the worst of both worlds obvious without the need for any in depth analysis.

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CR: Well put. Your clear thinking and crisp writing style is a credit to you.

 

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Thanks Henry - your encouragement is much appreciated.

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I would second that, to both you and Henry_Tull Colin, but don't get much comfort from your analysis. I think you know I'm a supplying shareholder, and am pretty anxious to see Fonterra return to its cooperative principles. The value of milk at the farm gate is what someone is prepared to pay for it. We still have the ability to produce high quality milk relatively efficiently. I suspect the economic principles which have promoted the rational leading to the banking industry and farmers gearing themselves to the brink of extinction, is the same as that driving the rational behind TAF, and I bet a quid the business models of the so called independents and MAF for that matter.

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I would second that, to both you and Henry_Tull Colin, but don't get much comfort from your analysis. I think you know I'm a supplying shareholder, and am pretty anxious to see Fonterra return to its cooperative principles. The value of milk at the farm gate is what someone is prepared to pay for it. We still have the ability to produce high quality milk relatively efficiently. I suspect the economic principles which have promoted the rational leading to the banking industry and farmers gearing themselves to the brink of extinction, is the same as that driving the rational behind TAF, and I bet a quid the business models of the so called independents and MAF for that matter.

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"Deadly Handshake" and "Dance of the Tarantulas" come to mind.

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About the banks, if they had to "mark-to-market" based on the valuation calculation they currently use, the market down/write down would be a huge problem for them.

And why they push back against RBNZ tighter lending ratio/capital requirements.

 

This mornings news re JP Morgan demonstrate the "mark-to-market" mishap.

The CIO has seen significant mark-to-market losses in its synthetic credit portfolio, the firm said, a portfolio that has “proven to be riskier, more volatile and less effective as an economic hedge than the Firm previously believed.”

http://www.forbes.com/sites/steveschaefer/2012/05/10/jpmorgan-dives-aft…

 

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How do commodity price swings affect commodity exporters, and how should their policies respond? These questions ave become relevant again with the confluence of a weak global economy and the sustained buoyancy of commodity markets following the slump of the 1980s and 1990s.

Refer Chapter 4: Commodity prIce swings and commodity exporters

http://www.imf.org/external/pubs/ft/weo/2012/01/pdf/text.pdf

This chapter reexamines the macroeconomic performance of commodity exporters during commodity price cycles. It highlights how performance moves with the price cycle.

Against the backdrop of near-record commodity prices, coupled with unusual uncertainty in the global outlook, the priority for commodity exporters is to upgrade their policy frameworks and institutions in addition to building fiscal buffers.

 

Fonterra revenue 2011 was $19,871 million.

Dairy farm debt is approx. $29,726 = (Refer RBNZ), Fonterra owes $5,802 milllion and a portion of $7,343 million (Sheep and Beef Farm debt) is related to dairy grazing. Policy frameworks and institutions have no headroom..

 

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Here is a live example: Down on the farm: Given the issues touched on here and other posts we see lest see what that means down on the farm. Here is a 335 ha farm for sale in Canterbury:

 

http://www.trademe.co.nz/property/rural/auction-473919129.htm

http://www.bayleys.co.nz/513118

 

Production: Currently milking 1,000 cows (average for year 1,040) and on target for 2011/12 budgeted production in excess of 500,000kgMS.

Farm Buildings: 50-bail rotary dairy - retro fitted three seasons ago with Nu Pulse milking plant and an Allpro electronic monitoring system

Irrigation: There are two consents and three irrigation wells. Water is pumped by Goulds pumps - one x 150kw, the other two are 75kw. Irrigated by two centre pivots - one covering 181 hectares and one covering 91 hectares, plus a Briggs 200 Rotorainer on a nine day return and long lateral sprinklers.

Soils: Chertsey silt loams, Lismore and Eyre soils.

Rainfall: Approximately 600mm per annum.

Two milk silos - 21,000 litres and 11,000 litres (Synlait owned)

 

So it supplies synlait (can see the factory from the farm), therefore no fonterra shares, and no dividend income.

synlait (remember) are advocating the fonterra milk price is 50 cents too high at any level, and while they have been paying approx. fonterra price based on their calcs, they contract (2 yr + exit notice?) saying farm payment maybe 25 cents less than fonterra mp if they fell needs be.

 

The LUDF trial farm gives and set on numbers for historical purposes...

http://www.siddc.org.nz/lincolnuniversitydairyfarm/ludf.html

The normailised earnings per kg (editda) we used (no div), (no stock sales - can be 20 cents to 50 cents/kg) (ongoing capex/ or depn/amort can be 30ish cents/kg) (the bank loan calc is posted above) were:

2005 - 1.43

2066 - 1.05

2007 - 1.37

2008 - 4.51

2009 - 1.11

2010 - 2.60

2011 - 4.13

2012 - 2.45

2013 - 1.60 (est).

 

What is the farm worth as a going concern including stock on a $/kgMS?

 

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The Real Estate Institute is warning of a slowdown in farm sales as seasonal conditions look set to sour, ending the best quarterly sales period since August 2008

http://www.interest.co.nz/rural-news/59304/businessdesk-farm-sales-set-…

 

Here is an earlier farm valuation thread from March 2012.

Mid Canterbury Federated Farmers dairy section chairman Hamish Davidson said.......

........It would be heartening for banks which had lent a lot of farmers money over the years, as well as the farmers themselves, that there was some value in the land they owned....

http://www.interest.co.nz/rural-news/58378/record-sale-conversion-farm

 

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Christoff: I'm starting to get the picture. Pored over Fonterra's 2011 year end Annual Accounts. What a swamp. In that year they made a profit of NZD $1384 million in "cash flow hedges" (which could mean anything) but only transferred $863 million to profit, the rest being deferred. Annual profit was $771 million after accounting for and including the $863 million which means trading activities (actually) produced a loss for the year.

 

For the 6 months ended January 2012 they have lost $472 million on "cash flow hedges", but that's OK because they have a deferred balance in the slush fund carried forward from 2011.

 

So, Fonterra is a derivatives trading operation not a "dairy manufacturing" business.

 

Am I right in assuming your proposition is if Fonterra's "masters of the universe" can make better than $1 billion in 1 year trading NZD then RBNZ with its resources and capacity and capability should be able to do the same?

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If you want to see the flip side (Fonterra's large treasury losses) check out their 2009 Interim Accounts. 2009 was I believe the year Fonterra stopped having their interim accounts audited.

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You are right about them keeping back residual to offset losses...that is the complaint from DIFL in submission ...because, being 12 months in arrears as it were, it has to be ..or is being factored in to the net cost. That may (?) be O.K. during periods of low volatility but turns to custard in periods impending......and could leave them bleeding at the nose at both ends....

 On to the RBNZ it's position would have to be overt as opposed to covert ,....don't know if their level of exposure would then become too great...( transmitted.)

My proposition  , as it were , was (A) to find the complicity , (B) take advantage if it were to continue or be at least reasonabley predictable. 

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The 'smoothing' of dairy payout - from good seasons to bad is what was practised for decades by the industry.   Sir Henry abolished it despite be warned against it and so it was interesting to see retentions come back.  Something about history repeats...............The Corporates on the other hand would never engage in the practice, because they are only interested in paying the least amount they have to, to suppliers - very different philosophy. 

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So true CO, as verified by suppliers of cooperatives world wide induced to accept external investment and loss of control as a result. When the NZX administers a fund, different legislation to the co-op constitution calls the tune.

As pointed out by Henry_Tull in separate posts, last week in front of PP select committee on DIRA, John Penno was arguing Fonterra suppliers were getting paid too much for there milk, as the return on capital was too low. The capital he refers too is the legacy of generations of cooperative growth. In other words the best most efficient and innovative method to grow value, and return on capital is to pay suppliers less. Eureka, The Alchemy of Growth, our leaders are geniuses.

I

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HEDGING

Fonterra opened its GlobalDairyTrading platform in 2008. In 2009 Fonterra lost $803 million on "cash flow" hedging losses. Global Dairy Market is a futures market which is cash settled. There is no delivery. Fonterra is the main market-maker (yes? no?)

Some years ago, 2 colleagues were managing a $20 million book of "treasury" futures which they kept hedged at all times. They were operating 24 hours a day, 12 hour shifts. They would re-assess the exposure of the book every hour. In volatile times their hedge positions would be revised more frequently. They would be buying or selling (opening or closing) at any given time.

 

Watch the Dow Jones or S&P500 Futures market come Non-Farm-Payrolls night. With one minute before the announcement the orders in the order-book evaporate. If you have an open position coupled with a stop and if you are on the wrong side of the move and get stopped out you will despair at just how far away from your stop-loss you get filled, a loss that can be enormous.

 

Colleagues. At the time of the Twin Towers catastrophe the market was closed for a week. They were locked in. When it re-opened it was volatile. They were adjusting their hedge every 5 minutes and struggling to keep it balanced. Suddenly, in an instant the market-makers disappeared, pulled all their orders out, and colleagues couldn't get out. They lost a lot of money.

 

Fonterra. The fortnightly auction works against them. In a fortnight, prices can move a long way away from the previous auction. Because they are both sides of the book they are potentially exposed on one side, unless they are completely square.

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iconolast.....nice piece.!!

Here's a tidbit from Weldon....for any Dairy person to be concerned about as his thoughts will be on the same page as those becoming involved  in......well,....changes.

 Chicago had grain farms, then grain markets, and then grain futures - ending with the Chicago Board of Trade - the best futures exchange in the world. New Zealand has the same opportunity to build a hub of agricultural and capital markets activity around dairy. Fonterra is the foundation. The second plank is Fonterra's Global Dairy Trade auction platform - which from my travels in the world of offshore dairy would see better outcomes for Fonterra if it were not owned by Fonterra but by a neutral operator. 

That was today  or yesterday by the way.

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Christov - just curious - was Weldon's comment before or after the launch of the NZ Dairy Futures market?  I would have thought the third plank was the NZX Dairy Derivatives Market. Was Weldon brassed off the GDT trading manager is in the USA?

 

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mmmmmmmm...CassO..the comment was current......and I thought it showed a wee bit of frustration at Fonterra clearly still having one foot in the Co-operative  camp....

It won't just be his opinion he's spouting( I think)_........not that I thought it was that important , just wanted to demonstrate those well connected in the "maket forces" territory were not altogether happy with the way thing are .

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Thanks Christov.  Your, Henry Tull, iconoclast and Colin Riden's comments are much appreciated.  You have insight and understanding of the financial world that I don't, so can be a 'breath of fresh air' in putting your views forward. I wonder what the reaction will be if farmers throw out TAF on June 25th?

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I find their input insightful and illuminating along with yours CO. Obviously I'm nervous about the prospects of TAF fearing short term corporate folly for the loss of long term co-op stability. If TAF is scuttled, farmers and the public need too stand up too misguided government interference. Maybe Richie will be able to mobilise the masses if we're so lucky, although as Dad said, most NZs probably don't know who Richie is.

I'm all for NZ consumers have affordable dairy products, but suspect that's a supermarket story as opposed to co-op monopoly on supply. But imposition of FVS is destabilising, and independents should bid for what milk they need on an open fair and transparent auction, paying what it's worth. That way NZ maximizes export receipts.

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Why wasn't "raw milk" included in the Global Dairy Trading system and simply allow for the independents to bid for their supplies?

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Good point, whatever mechanism so long as it's simple, fair and cheap to run.

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Exactly! But I guess it's because DIRA (Dairy Industry Restructuring Act) regulates the supply of 'raw milk'.  GDT is solely a Fonterra process-not governed by DIRA.  Corporates don't want to compete for the milk, with each other, - it might cost them more ;-)  I have heard that Fonterra has contracts for raw milk, on willing seller/buyer basis, outside of the DIRA provisions but with whom and for what end use, I don't know. 

 

I don't have a problem supplying the likes of Goodman Fielder and niche domestic marketeers with milk.  It is supplying companies with milk whose products are solely for export that I have an issue with - especially those who have no requirement to compete at the farm gate for milk.

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Some years ago, 2 colleagues were managing a $20 million book of "treasury" futures which they kept hedged at all times

 

What for?

 

Normal to use the futures and associated options which represent the CTD to duration match hedge a cash position.

 

Outright futures are a position in themselves for momentun trading purposes which are capital light to maintain position. They are not to be hedged unless running a cash position against them as I mentioned then there is basis risk to contend with between cash and usually the off the run CTD. It's the basis that requires the constant adjustment.

 

And in my time it was not unusal for big prop traders to lay a 2000 contract out right position in TY?? futs prior to what used to be called the non -farm payroll announcement to see what might happen.

 

Or were they spread trading say TU??  vs TY??  which also requires constant monitoring as the undelying CTD changes for each contract?  

 

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Global Dairy Trade is for physical delivery of a specified amount of product, it is not a cash settled futures market.  As far as I understand, Fonterra's financial hedging policies only involve the NZ Dollar and not future commodity prices.   The NZX runs a cash settled futures market based around the Global Dairy Trade auction prices. 

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Thanks. See that now. I put up a post a couple of weeks ago asking where the markets were and how I could see them. Didn't get an answer. Can see now the GlobalDairyTrader Auction site is the Physical and the NZX GlobalDairyTrade is the Future using the Phyiscal as the "underlying". The similarity in the wording and the difference in locations wasn't clear.

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Wag the dog. A continuing story:

 

New NZX chief executive Tim Bennett wants to use his experience in Asia to encourage investment into New Zealand's listed companies and its dairy futures market.

Bennett says New Zealand should tap into the growing pool of money in Asia and provide agricultural investment opportunities for them on the stock exchange.

http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=108…

 

According to an NZX statement, one of Bennett's most notable achievements was supporting the development of the global iron ore derivatives market, which cleared $10 billion in contracts last year.

He has also advised on strategy and acquisitions on a number of exchanges in Asia and the Middle East.

http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=107…

 

NZX has tapped a relative unknown to replace Mark Weldon as the stock exchange operator gears up to expand its presence in agricultural commodity markets.

http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=107…

 

NZX chief executive Mark Weldon said the dairy futures market was key to the exchange's strategy.

http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=107…

 

NZX's success with its Dairy Futures market, which was launched in 2010 and was last week celebrating the milestone of having traded 10,000 lots, illustrated the potential for derivatives trading, Weldon said.

Gaynor said Dairy Futures had been successful because of the participation of major companies such as Fonterra, Nestle and other overseas manufacturers.

http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=107…

 

Note to self: In the futures market the participants never need disclose who they are or aren't.

 

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Greetings Henry_Tull, hope all is well.

Admittedly I don't understand futures and derivitive markets etc. But when in WA mining industry as a geologist in 1997, it was often commented that foward selling was responsible for the collapse in price of gold, because of incongruent market signals relating to offset between demand and supply. I think it fell to around $230/once, senior geologists with tennage kids and mortgage, made redundent overnight and sent back to Perth to drive taxis. Do you have any knowledge of this, and can it be compared to what NZX Mark and Tim promote?

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Omno, yes 1997, the gold price slump to less than $300 was to a degree driven by the Asian crisis (and for example the Australian treasury selling reserves).

On November 26, 1997, the spot future Gold price closed below $US 300 (at $US 296) for the first time since March 15, 1985. Gold ended 1997 at $US 289.90. The $US 300 "floor" which had supported Gold ever since it first rose above that level in July 1979 had now become a "ceiling".

 

Here is a Sykes link discussing several miners of the day having production cash costs of around $400. This meant some gold operations were stopped immediately.

http://www.pierpont.com.au/article.php?Pierpont-goes-into-gold-vulture-…

 

An issue with the NZX dairy futures is if as "asset class" it attracts the attention of hedge fund type hot money, that wants to take a view/position on milk powder. This can produce large swings in forward month prices, which when derived into a milk powder forward price curve, has influence on the spot price or auction price (upon which futures are settled), which in turn drive a % of Fonterra export contract prices.

 

In short we are opening up to non-supplier centric power influencing the price we suppliers obtain. Hedge fund or prop trade dollars are happy to make money when prices rise or fall depending on their view. As sellers, with a handle on our volume, we don't need hot money coming in being able to bet against us.

Markets may be free (as if) but they are not fair. And to my mind its a degree of pricing control and influence we are giving up for no quantified benefit (as suppliers/sellers).

 

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Its the co-op structure that makes Fonterra a stronger credit than otherwise...

And a reason financial types would love to come and play...

 

May 14 - Fitch Ratings has affirmed New Zealand's (NZ) Fonterra Co-operative Group Limited's (Fonterra) Long and Short-Term Issuer Default Rating (IDR) at 'AA-' and 'F1+'. The Outlook is Stable.

http://www.reuters.com/article/2012/05/14/markets-ratings-fonterra-idUS…

 

Fonterra's ratings are underpinned by the strong defensive characteristics of its ingredients business, the financial flexibility afforded by the effective subordination of its farmer creditors and the margin protection offered to it by its fully integrated business model.

 

The effective subordination of milk payments to farmers is provided in Fonterra's constitution, and results in the effective subordination of milk payments to principal and interest obligations (and other costs). Based on Fitch's understanding of the legal framework underpinning the subordination of milk payments and management's estimates of advance rates, the agency assumes a minimum 10% of milk supply costs at the end of each fiscal year (31 July) to service principal and interest payments. Notwithstanding Fonterra's ability to withhold the entire milk supply payment until all other costs have been met, it has traditionally, at its own discretion, advanced payments to farmers for milk supplied over the course of the season. Fonterra expects advance payments (before 31 May each year) to amount to around 80% of the total cost of milk for the season.

 

A positive rating action may be considered if debt to EBITDA reduced to below 1.5x (currently 2.15x) on a sustained basis. A negative rating action could follow if debt to EBITDA increases to 2.5x on a sustained basis or if overseas milk supply accounts for more than 30% of NZD cost (currently 11% of NZD dollar cost).

 

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Thanks for insightful and illuminating contributions once again Henry_Tull. Lucky to have your input. 

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Thanks for insightful and illuminating contributions once again Henry_Tull. Lucky to have your input. 

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Many thanks; you may have seen this...

Wally Newman is deputy chairman of Cooperative Bulk Handling (CBH), owned by Western Australian grain farmers, and was in Wellington last month to speak at an education seminar run by the New Zealand Cooperatives Association. He told Rural News toying around with structures has been disastrous for many Australian farmer co-ops. Most are now fully owned by investors.

Investors see co-ops as "ripe plums on a tree ready for easy picking". Incentives that drive corporatisation include success fees for lead consultants, executive bonus shares, prospect of increased director fees and equity distribution to current co-op members.

Capital raising is also a tactic. However, once investors have their foot in the door, things begin to change.

"Investors seek better returns than what they would get from the banks... this means growers are no longer in the equation. Directors work for investors."

 

http://www.ruralnewsgroup.co.nz/rural-news/rural-general-news/farmer-co…

 

The examples of corportised co-ops is just across in Oz. There appear to be no examples where the farmer members are better off (consistently higher returns, or sustained increase in property value) corportising compared to not.

As posted before, why don't supporters of TAF quote $ numbers as to the benefit of such, ie. ongoing increase in farm income.

 

 

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Had a look at "Cooperative Bulk Handling" annual report. It's 148 pages long. Of those 148 page. 70 pages of executive reports, then 4 pages comprising a Profit and Loss Statement, a Balance Sheet, and Cash Flow Statements. Followed by a further 75 pages of explanatory notes.

 

Fonterra's 2011 annual report is 121 pages long. Lot of explanations. No Balance Sheet. Any idea why not?

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Boils down to 2 things:

Intent of management & board and slack NZ reporting rules/legislation.

They choose to report to the minimum legal requirements.

 

See an earlier post about NZX, with the example below of Dean Foods the USA Dairy Corporate Annual Report.

http://www.deanfoods.com/media/55677/df_2011_annualreport.pdf#page=2

 

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An uphill job as off shore investors see the NZX listing rules as too generous to listed firms and their boards and executive. The comparison is to US requirements of a firm:

 

http://www.deanfoods.com/our-company/about-us.asp

http://www.deanfoods.com/media/55677/df_2011_annualreport.pdf#page=2

The evolution of Dean Foods into a leading dairy processor began in the early nineties with an acquisition focused strategy centered on creating scale to align with a consolidating customer base. Between 1993 and 2009, we completed more than 40 acquisitions of high quality dairies, dairy products and plant-based brands, increasing net sales from $150 million to more than $13 billion in 2011.

 

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The divided Fonterra shareholders views on DIRA is making it difficult for the Select Committee.  Will be interesting to see what recommendations they come up with.

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As shareholders who pool resources to maximise return received for our product, I think I can say we want to see our co-op make a return on capital sufficient to support a strong balance sheet to ensure ongoing sustainability and growth if appropriate. This has worked for 100 years and is successful internationally. It defines developed economies from developing, and the co-operative dairy industries in Denmark, Germany and the Netherlands, supported and promoted by their governments are a good example. Fonterra is a result of cooperative growth and strength, but steady infusion of corporate ideals, (share standard, votes tied to shares, and PR laced with spin) has the co-op on the ropes, driven by misguided political interference (DIRA; milk any cheaper since formation NZ consumers?) at the behest of investment community, and weak industry leadership.

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Omno
"wants to see our co-op make a return on capital to support a strong balance sheet"

 

Where can I find Fonterra's "Balance Sheet".

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I agree about shareholder decisions been made difficult.  More and more suppliers I speak to are questioning it on the grounds mainly of not trusting Fonterra governance, as feel they are only being given half the truth/story, re 100% ownership. If shareholders got preferential rights for the units, I think it would go quite a way to quell some of the unease with some of the folks I speak to.  Under a bookbuild shareholders could find they won't get the shares they want and then have to go and pay a premium to buy the units on the open market from hedge funds etc, once trading commences.  "We built the bl..dy company up and then we have to go and pay some New York institutional investor to buy units in our own bl..dy company! It's just not right" is a comment I hear often. 

There's a meeting here (Eastern BoP) for shareholders next wednesday night.  Jim van der Poel will be the director rep.  I'm gutted I have other commitments but the MOTH will go.

 

Select Committee -  with all this division, and the TAF vote after they have had to report to parliament, the SC would be better to delay any decisions/recommendations until after the TAF vote - they will be damned if they do, and damned if they don't whatever decision they make, if they decide anything before the vote.

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What a nightmare. Have been reading up and researching DIRA and TAF and these creatures sired by government decree. Makes you think of something with many slippery tentacles. How does one get a leg-rope on it? Could become a vampire-like-squid if they don't. Cos they become too big to fail.

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The Shareholders Council may hold one end of the rope iconclast.  If 50% or more of Councillors aren't happy with it, then TAF could be a dead duck in the water.

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one characteristic that has become most evident so far in my research is this: It's symptomatic of the "divide and conquer" rule .. the divided will be conquered .. it's a classic situation of: the power of the powerful few versus the weakness of the fragmented and divided many.. a few ideas .. are starting to form .. will ponder them until I have finished my trawling .. I understand the business problem and TAF is not the answer ..

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Is votes tied to shareholding a case in point.

From what I know successful co-ops stick to one shareholder, one vote to maintain democratic integrity and vitality of the co-ophttps://www.cbh.com.au/our-members/the-principles-of-co-operatives.aspx. Last week Theo hosted the Fonterra executive from around the world at Mystery Creek. They were roughing it in a fleet of campervans. One night they had a dinner, fine organic fare and wine. 100 shareholders were invited to join them. It was reported as connecting with the grass roots. I wonder how much voting punch the 'selected farmers pack We have a most important vote coming up. http://www.stuff.co.nz/waikato-times/news/6892210/Company-execs-rough-it-in-Waikato

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E.BOP, thought you were Southland CO!

Yesterday I was at a FF AGM in Waikato, and tension was apparent, the co-op is divided. I’d say we voted on Faith (TIF, Trading In Faith) in 2010, and the difference is the ‘vocal minority’ are looking into the detail behind the proposition, and rightly not liking what they see, and the ‘silent majority’ choose to retain the Faith.

Tatua suppliers at the meeting, can’t understand what we’re doing.

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Live in EBoP, farm in Southland, spend time 50/50 in each. I was at Fed AGM in Southland on Wednesday - there is concern down there. David Carter spoke at AGM was questioned by member over share price - got the usual political spin. Don't think Carter did National any favours.  Fonterra hasn't organised shareholder meetings down there yet - last time they did 240 farmers turned up and it was a very 'robust' meeting.  I don't think they want another like it so are considering shed meetings - a big mistake if they go that way.  The co-op is divided and I think regardless of the vote outcome, Fonterra has some serious problems as that division is not going to disappear after the vote.  I believe some select committee members are realising just what a pandora's box DIRA and it's associated garbage is.

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Some good points, the solution:

Fonterra needs to return to cooperative principles. 

Redemption risk is mute point if can set share value consistent with co-op principles.

Fonterra needs investment return to maintain healthy balance sheet for capex, growth if beneficial. Achieved through retentions,this equates to returns to all members by maintaining or enhancing performance of co-op.

Raise capital, as above; perform so as to enable retentions, prudent financial instruments

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Casual Observer, Omnologo, Colid Riden, Christov

Fonterra and contestability at the Farm Gate.

My memory had faded and forgotten all about this until CO mentioned the desire for competition at the farm gate. This may not be news to you.

For some years until about 2005, as a result of trading in BONLAC financial instruments kept a very close eye on the shenanigans of the milk industry in Victoria until Fonterra came along and took Bonlac over. Bonlac was a co-op so their shares weren't available to be traded. They had the common need of raising capital. They did it in the debt market.

At the time there were two major co-ops, Murray Goulburn and Bonlac who controlled about 50% of the Victioran market which is about 90% of the Australian milk market. Bonlac had about 25% so it wasn't the biggest fish in the pond. I can vividly remember over the 5 years I was interested, Bonlac complaining (in press releases and in shareholders briefings) about the dificulties they had in obtaining milk supply and retaining members. The competition was ruthless. They were having to compete constantly, having to "buy" market share of the "milk supply" by bribing and seducing suppliers away from other processors. The competition to obtain supply was great enough to encourage the establishment of "milk brokers" who tout their suppliers to the highest processor bidders. See Milk Brokers http://www.dairysafe.vic.gov.au/industry/milk-brokers/45-milk-brokers. Milk Brokers encouraged promiscuity. There was no loyalty to any one co-op. Processors paid through the nose.

 

So, Fonterra knows all about competition at the farm gate, being right up to their armpits in it. Loyalties are transient. Nothing to be overawed about. Wonder if they're are telling you about it and how they manage it. It's a reasonable bet they're not.

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Thanks iconoclast, I appreciate your efforts in researching out a good example of the pitfalls of straying from co-op principles.

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Murray G seems to be coming to life:

“I am pleased to announce that this step-up takes MG’s price to $5.35 per kilogram milk solids which exceeds our recent end-of-year forecast of $5.30,” Mr Helou said.

“The price increase has been achieved through cost reductions and operational efficiencies, which have improved our margins despite a softening in world market prices and unfavourable foreign exchange conditions.”

http://www.mgc.com.au/index.php/news/third-increase-in-farmgate-milk-pr…

Aust $5.35 times 1.28 equals NZ$ 6.85

Re earlier posts - parliament submissions, independent procesors say Fonterra farmgate price 50 NZ cents too high....

 

And this week:

As a result of these changes MG’s total workforce is set to reduce by about 12% or 301 positions.

“These are difficult but necessary decisions to ensure that Murray Goulburn can remain competitive. It is in the interests of our suppliers, shareholders, employees, communities and customers that MG remains a strong business into the future. We will continue to invest in programs and initiatives to significantly lower our operating costs, improve manufacturing efficiencies and strengthen our dairy foods portfolio,” Mr Helou said.

Mr Helou added the changes would make a significant contribution to Murray Goulburn’s goal of reducing operating costs by $100 million this year.

http://www.mgc.com.au/index.php/news/press-release

and

http://www.abc.net.au/rural/news/content/201205/s3500518.htm

 

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Thanks Henry_Tull and iconoclast. Appears Murray G is holding it's own in a difficult back biting environment. Is it safe to say it's the result of a healthy co-op? Sounds like a good solid strategy, but doesn't have characteristics of Alchemy of Growth. Anyone have an opinion on The Alchemy of Growth?

Henry_Tull, are Mr Helous operating costs, the same as the ones John Penno wants to reduce?

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Interesting thought.

MG: could be more realignment of systems/procedures in a mature business.

http://www.abc.net.au/rural/news/content/201205/s3500518.htm

 

Synlait: probably more bedding down systems and procedures plus pressure from the Bright owners or to match their $.

 

Building the factory they taked about state of the art (read expensive) and change of specification once the build started (very expensive contract variations). And given the Dr nor the other two are industry (ie. engineering or factory) veterans, all the finance/farm/water issues, one would not expect "right-first-time". Bright have lots of engineers and factory managers to hand (we may see over time??)......

While Bright have investment cash the local 49% are still no better off than before re their share of working capital contributions and probably well back in the line when it comes to obtaining cash returns/dividends from the business (once 51%ers get their 18% and then approve etc).

Some thinking says they would have been better off to sell the whole thing. Esp when it comes to playing a long game....

 

http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=107…

But Richardson says real camaraderie is now building, pointing to the shopping expedition she enjoyed with Ke Li after a board meeting in Manila.

She credits Bright Dairy president Guo Benheng as being the "Godfather of the project".

Guo's own DNA includes a strong insistence on profits. Informed sources suggest he may want to expand Bright Dairy's commercial relationship with New Zealand.

 

Point of difference, MG don't think farmgate price is too much...

 

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Yes , thanks iconolast...eye opening for sure .......when the big F refers to the common objectives ,that may not mean a common share in the outcomes for all involved.

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Warrnambool Cheese & Butter is not a co-op. It competes for suppliers against Murray-Goulburn and Fonterra co-ops. It is not big. Doesn't enjoy economies of scale.

Warrnambool Cheese & Butter (WCB) is an Australian-owned company, listed on the Australian Stock Exchange since 2004.

Annual Report.
Strong commodity prices and improved production efficiencies offset a higher Australian dollar and enabled the Company to record strong revenue growth. Gross revenue increased 21.1% to $504.1m, and EBIT rose 81.1% to $30.6m. Milk intake was 879.2 million litres, a similar level to 2010

Payout this year was the second highest in the history of the Company at AUD $5.75/kg of milk solids (42.5c/litre), up 25.0% over the previous year, reflecting the underlying strength of the global dairy industry.

Warrnambool paid AUD $5.75 = NZD $7.36

Murray Goulburn Co-op which is much bigger paid AUD $5.35 = NZD $6.85

Annual Report
http://www.wcbf.com.au/media/17457/wcb_2011_report_final_low_res.pdf

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NZ independent processors claim Fonterra farm gate price is 50 cents too high. This would not seem the case when cross checking current farm gate milk price in Australia. 

 

http://www.dairyaustralia.com.au/Statistics-and-markets/Dairy-Situation…

 As at February 2012...

Opening prices from exporting manufacturers now appear to have been closer to the mark than in recent more volatile years, with less requirement to make additional payments through the season. Current modelling suggests a likely final average southern price range of $5.20 to $5.30 per kilogram of milk solids for the 2011/12 season. This estimate is indicative, as the proliferation of alternative payment systems means individual farmer payments will vary greatly around this average.

 

http://www.dairyaustralia.com.au/~/media/Documents/Statistics-and-marke…

 

Ex the Australian Finacial Review 11 May 2012. (it has a pay wall). MG Co-op cuts jobs to boost herds.

MG has a 11.4% share in WCB, Bega Cheese owns 16% of WCB.

NZ produced 17 billion litres 95% exported

Aust produced 9 billion litres 45% exported.

MG CEO Gary Helon said

"Australia should significantly boost milk production to benefit from Chinese demand".

"Dairy farmers needed to be encouraged to boost herds and production through improved milk prices"

and

"The way to entice farmers to expand is to offer farmers commercial prices".

 

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Once again thanks for the posts iconoclast and Henry_Tull.  WCB did well, profitable,strong balance sheet, happy suppliers. Good effort in a fickle market to gain supply. No guarentees though, what will happen when demand is not as strong? What's the take home message for a simple farmer, who is nervous with direction of Fonterra the co-op?

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Omnologo ...I'd say the take home message would be ...share relevant information by whatever means at your disposal...form a consensus about any misgivings...express those misgivings if necessary by vote while the power is still held at the farmgate....for that is what I believe they are trying to shift.

As iconolast pointed out the Divide and Conquer scenario appears to be in full swing.....The behemoth that is Fonterra is an entity all on it's own, market driven by Corporate forces clearly moving in conflicting direction from it's original charter.

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Many thanks Christov, appreciate the interest taken, and advice given.

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TAF and Fonterra .. my understanding so far .. taken a while ..

Fonterra has 3 "capital" problems

(a) Capital requirements for expansion/growth
(b) Redemption of Suppliers Shareholdings
(c) Redemption of Capital notes in 2016

TAF is designed to address item (b) only. It has taken (me) a year to pay attention and actually understand what TAF was about. If a supplier exits milk supply the company has an automatic obligtion to redeem the suppliers shares. If there is a drought and total milk supply drops (say) 20% the company has an obligation to redeem 20% of suppliers shareholdings. If climatic conditions improve and production improves 20%, suppliers have to acquire 20% extras shares, and Fonterra is the recipient of a lot of cash inflow. The fact Fonterra sees that as a problem means Fonterra is (a) using additional cash inflows of subscribed capital for working capital (and so it should), however by following sound business practice it has a serious problem if production suddenly dries up.

Fonterra has (about) $6 billion in equity capital.

Bright Dairy is sinking $8 billion into its NZ business. What happens to Fonterra's capital struture if Bright Dairy sets out to seek it's own suppliers and cannabalises Fonterra's supplier base ie as Warrnabool Cheese and Butter does.

That then raises the spectre of 2016. What happens if come 2016 when the Capital Notes fall due for redemption and holders dont wish to roll them over? ie the same spectre that crippled the Finance Companies.

They should address all the issues now.

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