David Hargreaves thinks the struggling Fonterra dairy co-operative will need a close eye keeping on it as it endeavours to get its wobbly milk cart back on the trail

By David Hargreaves

It may seem strange to suggest that people need to look past Fonterra's 'headline' annual result in assessing how badly our giant dairy co-operative has gone astray.

On one level the net loss of $196 million would seem the perfect place to start in terms of saying, wow, bad year, what are you going to do about it, people?

But, remember the result included a combined, spectacular, $600 million hit from the Danone case ruling following the 2013 botulism scare and the Beingmate writedown. 

So, you might say that without those two things, the year would not have been so bad.

But yes, it was bad - and the double whammy Danone/Beingmate impacts should not overshadow that. Focusing on the two 'big ticket' items contributing to the loss would only help blind us to the fact that Fonterra is an organisation in very bad need of grass-roots recreation and rebuilding.

The poor performance runs deeper

For me it was highly significant that Fonterra, in stating that its debt position - as given by its measure of 'gearing' - had risen to 48.4% from 44.3%, also indicated that about, roughly three-quarters of that increase was down to the twin Danone/Beingmate blows. 

So, in other words, and far more damningly in my view, about a quarter of that rise was down to the sheer poor performance - pushing to one side for a moment the rights and wrongs of the Danone and Beingmate misadventures.

Fonterra's indicating that it wants to reduce it's debt by about $800 million this year. That's a big ask even for a big business.

What's happened?

It's worth tracking what Fonterra's 'normalised' operating earnings (EBIT) have looked like since 2014 and the bumper $8.40 milk price year. 

In 2014 normalised EBIT was $269 million. The following year as the price of milk dropped, and therefore the co-op's costs dropped, the normalised EBIT rose to $974 million. Then in 2016 it jumped again to $1.358 billion.

However, last year it slipped back to $1.155 billion, and this year it's down to $902 million. So, in the past two years Fonterra's operating earnings have slumped by just over a third, which is a lot. That is a trend that needs turning around quite quickly.

Over the same period, the return on capital has fallen from 12.4% in 2016, to 11% in 2017 and now just 6.3% in 2018.

We are all stakeholders

Obviously the success or otherwise of Fonterra is vital for farmers - but it goes much further than that. We are all stakeholders. The decision to create Fonterra made the whole country dependent on Fonterra doing a good job and getting good bang for our dairy buck globally. 

If Fonterra mucks it up, there goes a big part of our economy.

So, I would say Fonterra's efforts to right itself this year will need to be watched very closely. I honestly feel that if Fonterra can't demonstrate an ability to sort itself out then some sort of Government-level intervention might be required.

Now, I don't like that sort of thing at all. But remember, it was a Government decision to create Fonterra in the first place.

Of course, the co-operative is 'under new management'. Chairman John Monaghan has barely had time to sit down.

One of the first things I think he should do is clarify the situation around the Chief Executive. 

This has been most unsatisfactory since the previous incumbent Theo Spierings announced he would be going early this year, but then didn't and then we didn't hear about a replacement and then we heard that Miles Hurrell had been appointed as an 'interim' Chief Executive and Spierings went.

However, there was no reference to Hurrell being 'interim' in any of the results material released on Thursday. And he certainly didn't act like somebody who was keeping the seat warm for someone else.

Clarify the CEO role

Okay, so Monaghan needs to come out and say pretty quickly 'Hurrell is our guy' and we carry on. It's not a tenable position for an organisation the size of Fonterra to not have a permanent boss. Look, it's not tenable for the bookshop down the road to not have a permanent boss.

Assuming that Fonterra does indeed have a new full-time CEO then he and the new Chairman do certainly need 'cutting some slack' when it comes to putting in place a plan.

Trouble is, they are going to have to get it right quite quickly - and I will state my doubts from the outset about whether a chairman who has already been on the board for 10 years and an executive who's been with Fonterra since the start will necessarily be able to apply the fresh perspective it now badly needs.

This, verbatim, is the three-point action plan outlined by the new management in Thursday's announcement:

1. Taking stock of the business – Fonterra will re-evaluate all investments, major assets and partnerships to ensure they still meet the Co-operative’s needs today. This will involve a thorough analysis of whether they directly support the strategy, are hitting their target return on capital and whether it can scale them up and grow more value over the next two-three years. This will start with a strategic review of the Co-operative’s investment in Beingmate.

2. Getting the basics right – Fonterra has already begun taking action and fixing the businesses that are not performing. The level of financial discipline will be lifted throughout the Co-operative so debt can be reduced and return on capital improved.

3. Ensuring more accurate forecasting – the business will be run on more realistic forecasts with a clear line of sight on potential opportunities as well as the risks. It will also be clear on its assumptions, so farmers and unit holders know exactly where they stand and can make the decisions that are right for them and their businesses.

I have to tell you, I'm not inspired.

The review outlined in point one is obviously essential. But, of course, it is to be hoped that much more detail on that will be forthcoming over the next few weeks and months. 

Beingmate is singled out for attention. I think it's absolutely clear that this disastrous foray will be exited in whatever way can be done with some sort of grace as soon as possible. This will be an easy win for the new management.

The revelation (it has to be said, only extracted from the company by the persevering question line of long-time Fonterra follower and critic Rod Oram at the press conference) that Beingmate is no longer the exclusive distributor of Fonterra's Anmum baby formula in China, is a clear enough signal. The Anmum distribution deal was one of the main points - if not the prime one - of the original deal in the first place. Remove Beingmate as the sole distributor and you might as well not be involved with Beingmate at all.

Give them a chance, but...

So, that will be an easy win. But how closely will other investments and partnerships really be examined after that easy win has been declared? Well, we shall have to wait and see.

As for points two and three, 'getting the basics right' and 'ensuring more accurate forecasting' - well, woolly is what I would say at best.

Look, the new management has to be given a chance. But I don't think we can afford to give them too much time.

We really are past the stage now where this business needs to communicate with genuine openness. To provide information - not propaganda (and I'm afraid the 2018 annual review again strikes out on that one) and to show that Fonterra is at last heading in the right direction.

But as I say, people in high places - IE the Government - should not be shy about getting involved if things don't look as if they are significantly improving. Give Fonterra time. But not much.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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13 Comments

I wish them well in getting it sorted out , and its in the national interest to do so ........... after all its our bellwether company .

That said , this is a classic Business School case study .

Of course hindsight is an exact science , but we need to ask some hard questions

What went wrong in South America a few years back ?

What the hell were they thinking investing in Danone or Beingmate ( the latter name sounds like either a piss-take or a character in a Shakespearean comedy certainly not alls well that ends well .......... more A comedy of errors ) ?

How were these investment decisions made ?

What were the criteria used to make the investments ?

What was the Corporate Strategy for domestic growth ?

What was the Corporate Strategy for international Growth and expansion ?

How was the due diligence carried out and was it robust enough?

How was performance measured or monitored

Was the lax Corporate Governance in Beingmate considered as part of the investment decision ?

Were the cultural issues considered ? By that I mean the devil-may-care attitude of business ethics in China.

Given we know that Western businesses routinely get shafted in China , what controls were in place ?

Boatman: When and how much, did Fonterra invest in Danone. My understanding is that Danone was only ever a customer?

All the best people left Fonterra a few years ago and sadly it now has very average managers running it imho.
It needs a strong personality to shake it up...for the nations interest.

Organisations with monopolistic market positions often attract candidates after the easy ride generating lethargic performance.

It will only get worse, theres bound to be more bad results come to light. I predict an apocolypse similar to Air NZ going bust in the early naughties and requiring a govt bailout. Greedy farmers seduced by promises of untold wealth, now the short term thinking is coming home to roost and the banks will be circling...

Except the banks protect farm values... free markets would help everyone in the long run. The banks could be circling Fonterra though with leverage near 50%.

I've been wondering this since the replacement CEO thing. All the potential candidates staying clear because they don't want their CV branded with government bailout in some shape or form.Is there enough capital to tap into anywhere to reinvent themselves?

Very hard to see any change coming some old management, same people picking the board canidates. So many have been pointing out things like the lack of added value from Fonterra and been spat at for it over many years.
Im really struggling to see any chance of change.

I agree redcows, I find the governance and leadership culture frustrating and disappointing. Equally frustrating to read comments that the shareholders council represent farmers views as they certainly don't represent me.
The tree point plan doesn't fill me with confidence. It suggests previous management and governance was asleep at the wheel, despite massive performance bonuses, and for some reason current management and governance are going to transform the mess.

From my experience in a project we did with Fongterror a while back at work... its only surprising the losses aren't higher.

There seems to be a almost surreal going on farcical situation here. NZ’s largest and most vital economic producer, born out of a monopoly, and not yet hugely removed from that, has not at least in the last few seasons of late, been accountable for its management. Farcical? To pull from this article’s headline thus quoth Benny Hill “ his name was Earnie and he drove the fastest milk cart in the West.” RIP Earnie.

If NZ is not careful, Fonterra will go the same way as Silver Fern Farms. Fonterra as a co-operative is charged with achieving as much as it can for its owners, farmers, at the farm gate, but on another hand, it behaves as a corporation, whose main aim is to return as high as it can to its other owners, shareholders, and this is often achieved by way of screwing down the suppliers. What are they to truly be?
If I were Fonterra farmers I would look to be doing much the same as they are now with dairy cows but most definitely any expansion I would make would be into sheep and goats milk products.

"A large New Zealand dairy processor this week announced additional cheese and butter
availability to EU buyers beginning October 1. EU sources believe the cheese had originally
been destined for Iraq, Iran and Turkey, but the sales fell through."