An independent report prepared for Fonterra's farmer shareholders shows that the co-operative had an "opportunity cost" of $2 billion in foregone earnings in its first 17 years of existence.
In addition, analysis of the returns on the 'value-added' part of the Fonterra business shows that this achieved on average just 0.2% a year more return on capital than the ingredients business, which was "significantly below" the 1.3% premium needed to justify the increased risk of the value-added business.
The findings in the report by corporate advisory business Northington Partners confirm the general, widely-held, belief that Fonterra as a business has substantially under-performed in terms of return on capital since its formation.
The report was commissioned by the Fonterra Shareholders' Council earlier this year.
Council chairman Duncan Coull says it was in response to "a heightened level of commentary within the supplier base, media and the broader financial community" in relation to the perceived performance of our Co-op since it was formed in 2001.
"The assessment clearly shows that Fonterra’s financial performance since inception has been unsatisfactory. When considered as a stand-alone investment, the average returns generated by Fonterra since inception are lower than relevant benchmarks," Coull says.
The report shows that Fonterra's return on capital averaged 6% a year, post-tax, which is below the accessed benchmark of 6.9% to 7.7% - and the returns for Fonterra have been lower in recent years.
"This differential is material when considered over the full 17-year period, amounting to an opportunity cost of over $2 billion in foregone earnings. In simple terms, this is the gap between the returns actually achieved by Fonterra and the benchmark cost of capital over time," the report says.
The council says: "The opportunity cost of around $2 billion is reflective of the Co-op’s inability to generate Shareholder value over and above the cost of capital for its owners."
The 'value-added' part of Fonterra's business has attracted a lot of recent attention, not least because of the disastrous investment in China's Beingmate Baby & Child Food Co, which is now up for review and likely to be exited by Fonterra.
The analysis in the report shows that the value-add segment of Fonterra’s business has generated a return that is only 0.2% p.a. higher than the Ingredients segment. This premium is far lower than the estimated 1.3% margin that is required to compensate investors for the higher risk profile associated with the Value-Add business
The shareholders' council says the analysis broadly illustrates that Fonterra has not generated sufficient additional return on its Value-Add business.
"This is important because the value-add business units are now using an increasing share of Fonterra’s capital.
"For the first five years since inception (FY02 – FY06), the Value-Add business accounted for 36% of Fonterra’s capital.
"This has increased to 50% of Fonterra’s capital over the last 5 years (FY14 - FY18).
"However, we should also note that recent investment in consumer brands and other value-add opportunities represents a long-term proposition that may take some time to generate the expected outcomes. For example, the initial investment in China was expected to be loss-making in its early years, before generating target returns after the business matures and reaches the required scale.
"Higher returns from these investments may yet be realised."
In terms of shareholder returns, the report has compared an investment in Fonterra with the return from the NZX 50 Index. Again this is not flattering, with Fonterra's shareholders achieving an average pre-tax return of 6.3% per annum, while the NZX 50 has averaged 9.6%.
Duncan Coull says the council’s view is that the information provided in the report "should inform a wider discussion between Board, Management and Shareholders around the continued evolution of our Co-op and in particular what can be done to ensure ongoing returns meet, as a minimum, the opportunity cost of Farmers’ capital invested in the Co-operative".
He says notwithstanding the findings of the report, the council remains firmly of the view that the co-operative structure "is the only structure that will provide for the enduring needs of our intergenerational farming families".