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Keith Woodford explains how Fonterra’s Australian operations must now be centre stage to Fonterra’s financial unravelling

Keith Woodford explains how Fonterra’s Australian operations must now be centre stage to Fonterra’s financial unravelling

Fonterra’s announcement that it expects a loss of around $600 million or more for the year ended 31 July 2019 has big ramifications for Oz Fonterra.  With overseas-milk pools now lying outside the central focus of Fonterra’s new strategy, and with Fonterra seriously short of capital, the Australian-milk pool and associated processing assets look increasingly burdensome.

If Fonterra were to divest its Australian operations, then it would demonstrate that Fonterra really is retreating to be a New Zealand producer of New Zealand dairy ingredients. It would also reinforce the notion that consumer-branded products are now largely beyond its reach.

This strategic position is close to where Fonterra was in around 2006, when it decided that it was 50 years too late to take on the likes of Nestlé.  It did have both Australian and Chilean operations at that time but they were smaller than now. It also took on an initial shareholding in Chinese San Lu at that time, but essentially Fonterra saw itself as a New Zealand-based co-operative.

Thereafter, Fonterra began increasingly to see itself as an international dairy powerhouse. That perspective drove the strategy for more than ten years, but the implementation was woeful. 

Stepping back to something more modest will be disappointing to those who saw Fonterra as a ‘national champion’.  However, it now looks like the only option, given the hole that Fonterra has been digging for many years.

In recent years, Fonterra has been processing about two billion litres of Australian milk each year. For a short period, it became the largest Australian dairy process with a market share of around 23 percent. The Australian operations have underpinned much of Fonterra’s consumer-branding strategy.

Fonterra used to describe Australia as a ‘home market’. This was built on the notion that the local New Zealand market was too small to be the necessary beach-head for global consumer markets.

Consequently, although the Australian production has only been around 10 percent of Fonterra’s total production, it has been much more important in terms of consumer-ready products.

Fonterra is now caught in two Australian pincer movements. The first is that Australian dairy production is in both short and long-term decline. In part that is due to drought, but it goes deeper than that, with structural change that includes both broader economic pressures and loss of irrigation rights.

The second pincer is that Fonterra is now losing market share to its rivals. In a market where companies are competing for milk supply, Fonterra is operating from a weak position.

Overall, it looks increasingly as if Fonterra is well down the track to losing at least 500 million litres per annum of its previous supply, representing a decline of around 25 percent. That decline has potential to accelerate.

Fonterra advised the Australia Competition and Consumer Commission (ACCC) in December 2016 that its Australian equity was $AUD one billion. Since then, Fonterra has invested further in Australia. As a comparison, Fonterra now has total global equity of less than $NZ 6 billion.

Fonterra plans to now write down its Australian assets by $NZ70 million. That does not look enough.

With speculation in Australian dairy circles that there will be a least one Australian processor casualty, then Fonterra is widely identified as a potential candidate.

Part of Fonterra’s problem is that it has dug such a deep hole. There has been a series of mis-steps, based on poor understanding of on-the-ground realities. The mis-steps go right back to the initial buy-in to Bonlac around the turn of the century, started by the Dairy Board. However, that was just the first mis-step of many.

The harsh reality now facing Fonterra is that no-one will want to buy a non-profitable business with stranded assets.

This current situation is very different to the situation some two years ago when Murry Goulburn Co-operative finished digging its own hole. At that stage there were no stranded assets and so there was good competition for Murray Goulburn, with Canadian company Saputo coming out the winner.

The consequent complication for Fonterra is that in the absence of buyers, Fonterra becomes vulnerable to much bigger write-downs in the value of its Australian assets. This in turn puts a lot more pressure on Fonterra’s New Zealand balance sheet with implications for its overall financial ratings.

In that environment, the pressure comes on to sell more and more assets. In that environment, the financial structure unravels.

It’s never good to be selling assets in a fire-sale. This is part of a broader problem for Fonterra that apart from Tip Top, which sold remarkably well, its other dispensable global assets are all struggling to find buyers.

Given this conundrum, the decision path inevitably leads back to what else Fonterra might be able to do to raise more cash.

Some commentators are suggesting that Fonterra might separate off its consumer brands in another company. That starts to sound somewhat like a good bank and a bad bank solution as occurred internationally at the time of the GFC. The bad company might include Soprole, DPA Brazil. China Farms, Beingmate and Oz Fonterra. 

 It would be remarkable if anyone wanted to take on a company in that form. More likely is that each will have to be hocked off separately.

Ten and more years ago I was an advocate of Fonterra splitting into a two-company model, with a processing co-operative and a second value-add company that was investor-focused. Alas, the days when that could have been the answer have passed.

The other alternative is that, one way or another, farmers will have to stump up with more capital. That prospect would be highly unpopular with farmers, many of whom have their own debt and balance sheet issues to deal with.

Until now, I have been resistant to the notion that Fonterra’s problems might be solved by reducing the milk price.  My reasoning has been that this would simply paper over the cracks and inefficiencies in the food service and consumer businesses.

However, with the cracks now turning into crevasses, there may be no other option. In fact, Fonterra has already done this twice since implementing the current capital structure in 2012. But this was in a very different socio-economic climate. And this time the amount would have to be considerably greater.

All of this arises from more than ten years of group-think combined with massaging of messages. It seems that Fonterra believed its own propaganda. At farmer level, it was effective.

Most of Fonterra’s farmer directors have travelled widely on formal visits to the markets but have never done enough of their own footslogging away from the company propagandists. Fonterra’s external directors were also the wrong type of people.

Within the last year, there has been increasing acknowledgement from within Fonterra as to the difficulties that it faces. However, there is still too much defensive messaging. It is very hard for corporates to resist a public-relations culture of story-massaging that comes from deep within the corporate DNA.  

The time has come when Fonterra needs to lay out absolutely everything in front of its farmer members.

*Keith Woodford was Professor of Farm Management and Agribusiness at Lincoln University for 15 years through to 2015. He is now Principal Consultant at AgriFood Systems Ltd. Previous article on Fonterra’s challenges can be found at You can contact him directly here.

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You are so right it makes me cry that weve all sat around with our eyes closed for so long.............

Some good commentary on Fonterra today. More thoughtful and connecting the dots in the farmer cooperative model. Thanks

How much is needed? Has there been any industry comment about how much is needed to return debt to a comfortable level? I imagine the question is not that straight forward particularly with the uncertainty of asset valuations. If its 'only' a couple of dollars a kg that's one thing, however....

None of us know the answers, and it is because we need more information on asset values. But as a first guess, I would say that Fonterra now needs another $2 billion of additional equity from new capital to regain financial credibility. If it comes from retained earnings, then it would have to pay tax on those retained earnings, so the figure might be closer to 3 billion. But as I say, we know Fonterra is in lots of trouble, but anything beyond that is a guess in need of information.

Thanks Keith. The Fonterra Annual Report has NZ Milk Collection for the 2017/18 season at 1,505 million kgMS. Sounds like that implies a couple dollars a kgMS needed from somewhere. A few dairy farmers I have asked have said if needed trim the payout but only above what hey need to comfortably cover costs. What rules and regulations would need to change for that to be a legitimate approach?

As I understand it, no rules or regulations have to be changed. All that Fonterra has to do is publicly announce that they are paying out less than the milk price as calculated by the milk price formula. Directors would then have to sign off on that. The problem is those farmers who need every cent because of their existing high debt and the pressure from banks.

Fonterra functions more as a court than a company. At its centre, however, is an emperor without clothes - an idea of itself, a fantasy. The decisions of directors and excecutives have been those of courtiers to this idea, the fantasy of global capability. Business history shows that it has little or no such capability. It has been shamed in almost its every foreign endeavour. Once we recognise that the emperor has no clothes, there is nothing left at the heart of this outfit but a sense of entitlement.

jeeez. I get grumpy when the council takes on more debt on my behalf as a rate payer. But crickey, having your own 'business partner' letting you down like this on top of everything else is terrible. How depressing on a cold wet morning in the shed. At the personal level you have to sympathize with these farmers.

Unfortunately John Kirwin is going to be busy.

thanks keith good insights into fonterrable
i like you though they should have split the company years ago

The group think has been epic.
Often based on a suit's intuition, or opinion of what just happened. The "view" becomes the working truth for the underlings...

it's a tough world out there, what if they start to smell blood in the water...

So Fonterra dumps assets but what if banks do a collateral call on the wounded animal? Then some of those main buyers start pushing commodity prices down, while it's already wounded to making it fatal?

Then we have loads of indebted dairy farmers needing to sell and lets face it sheep and beef farmers are not going to ever pay enough, you will crash land price from 40+k a hectare to 15k.

So do we let foreign buyers in to scoop up the bargains, like we did to our Forests etc?

Does NZ inc need to step up to the plate and add some capital because the alternative is just so ugly? Of course most of that will go to foreign banks.

Two years ago I had a conversation with a long time rural real estate agent. He was at the sticky end then, dealing with farmers at the end of their tether. Too indebted to get out. Too indebted or fed up to stay. What a shemozzle. Of course there goes my retirement. Some dairy farmer was gona pay me a fortune for my block. I would retire and live on the interest.
Well thats hilarious. Rural land has to take a hiding in the foreseeable future. And anyone thinking they will live off interest in the long long term needs psychiatric care.

except history has taught us cash is king, if banks stop lending it will be again.

Cash might be king but where would you be game enough to keep it?
Keeping in mind real cash they are doing their best to make illegal. So the cash you speak of is stored on computer and becomes the banks property once deposited.

King plus size Sleepyhead. Come ter think about it, that's an apt description for Fonterra....

Belle, im probably younger than you, i remember my father talking about the 'ring and sting bank' I think Wrightson/Dalgety.

The ring to post more collateral, sell the house at the beach/Taupo, children out of private schools. You need something liquid.

"Negative and record low yields make sense for reasons that have nothing to do with investments in negative and record low yields. You have to see these assets as balance sheet tools, repo reserves whose entire purpose is to allow a firm to weather a market storm which disrupts the normal characteristics of how the world truly operates. The cost of holding those reserves is immaterial to the survival characteristics which are contained within them.

For as much as every central banker dismisses liquidity risks because of QE and bank reserves, none of them, not a single one, says anything about repo and collateral reserves. We don’t need them to say anything – the bond market is speaking for them."

If Fonterra had been split into two, with the processing and the value add separate what makes anyone think the ending would have been any different?
Would there have been different management? More oversight? Could it have been worse, and more shareholder funds lost?
I am not sure if anyone else felt this way but it seemed to me there was a culture of extreme arrogance at the head of Fonterra for most of its existence, but very much so in the last few years. Given more money to play with, (and I use that term play because play and lost they did) what crazy other schemes would they have cooked up?

One of the core lessons from my MBA was that corporate culture is the hardest thing to shift. One way was for the new CEO to immediately fire 10-25% of the staff. Didn't seem to matter which staff. The key thing was to shock the show to its core, 'unfreezing' was the term used, show 'em all that Fings are About to Change Bigly, and then proceed with the rearrangement. And with so many over-salaried group-thinkers at F, that old advice may not be a bad place to start.....

In Fonterra's case 50%. They have something like 1staff per 80,000kgs Ms. Other processers have around 1per 180,000.

Fonterra produces around 2% of the worlds dairy. Only 5% of global dairy is exported, and of that Fonterra has around 38% of the market. Fonterra has a significant offshore staff, which is something that other dairy processors who don't export as much don't require. NZMP makes over 3000 products. To compare Fonterra with other processors that make only 1,2 or 3 products is comparing apples with chalk. However, I'm not saying that we don't need to consider staffing numbers, only that processor staffing comparatives are irrelevant.

But isn't that the point. Why do they need this massive extra staff to add nothing?

Fonterra has around 20000 staff and I understand that most are in NZ. But do they add nothing? FarmSource stores employ many people, so as other processors don't have retail outlets do you believe they should all be closed? Sustainability advisors are another Fonterra initiative for suppliers, so if we want to pare down shareholder services to what some other processors have, would you recommend that the sustainability advisor service be shut down? As a sharemilker you may not use their services like a shareholder would so may not see the benefit of them. We could also shut down the Sustainable Catchment scheme as that would cull a few people and save some dollars, Kickstart Breakfast, and so on. Reducing our research and development teams would also reduce the number of PHDs we employ.
How do all the above 'add nothing'?

Casual Observer -You make a valid observation about staffing levels at Farmsource stores. Historically RD1 had a reputation for being over managed, over staffed and over priced. A while back there was a real shakeup of staffing levels to try and match retailer competitor's cost structures, there was also a drive to negotiate better deals and terms. RD1/Farmsource started doing what it was designed to do, reduce supplier input costs.
I remember Craig Norgate saying when he took control of Wrightson they were like an elephant that could step on him at any time. Now the stores that I visit are again bloated with staff (for their turnover) and no longer competitive on price. A sign of Fonterra in general?

Good observation Wilco. May I make a more frightening one. The new Fonterra boss was in charge of the retail was he not? Just as things crashed around 2014 they were in the midst of starting their rebranding excercise to Farmsource from RD1. What was wrong with RD1? Anyways they carried on with it. Its very pretty. I like the colours. Free coffee and a sit down if you like. All I really need is a clean loo. (Woolworths bladder). So although I like what they have done with Farmsource, all that spending has made not one iota of difference to me. I dont know why it wasnt canned back in 2014.
This big brand freshening was most likely a Hurrell thing. At a time when the payout went from $8 to $4.
New paint jobs, new warehouse type shops. Fonterra has to grow and change, but I well remember at the time they stopped opening on a saturday morning because there were no shoppers.
So as much as I want this new management to succeed, was anything learnt by the past? Or is this just another guy that has no appreciation of the money and lives in his hands. Because there was no pull back when farmers were in crisis not so long ago.

Exactly the point I made to Fonterra boffins when Miles was appointed! No respect for the money when its not yours!!!

Look up Prices law....
You only need a few good folk to go and the whole joint implodes.......

There was a lovely worked example if this in Hokitika...

The value-add company would have had separate management and a separate board. It would not have had the luxury of ongoing farmer share purchases to fund it. Hopefully it would have developed an appropriate culture for an entrepreneurial brand-focused company. There would have been no guarantees of success. Thereagain it could not have continued as a failure for so long, propped up by new farmer shares and the returns from commodities. But it is now too late for all of that

Keith, what do you make of the Kerry Gold example?

Kerry has been long term outstanding. But not necessarily easy to replicate. And the major beneficiaries long term have not necessarily been the farmers, but the investors.
I prefer Tillamook in Oregon as a model of how to succeed with value-add within a co-operative. Or indeed Tatua here in NZ. But Fonterra, because of its scale,could not have simply replicated Tatua.It would have had to do different things. But the same culture and business philosophy would have been applicable, and using A2 as the key differentiator.

Thanks Keith. A lot clearer.

I don't agree that we should exit Australia.
I do admit Fonterra's presence there has been less than perfect. Ten/fifteen years ago Australia was the natural refuge for disenfranchised Fonterra suppliers escaping NZ. That was why Murray Goulburn and others were able to hold Fonterra down, Fonterra upset a lot of potential suppliers with their treatment of farmers, they aggressively paid premiums for larger suppliers alienating the Ma and Pa farmers. So to defend their market share Fonterra used chequebook diplomacy while never developing loyalty from their suppliers.
Management misjudged future milk flows chasing a faltering irrigation belt (Northern Victoria) for supply while competitors focused further south in areas with higher natural rainfall.
Despite all this there is still potential for Fonterra to succeed. Milk (apart from fresh) is value added. There is commonality of supermarket ownership and control that suppliers with better relationships than Fonterra utilise successfully. And lastly our countrys are similar in language, behaviour and culture and easily managed from NZ.

My point is that Fonterra may no longer have the option to remain in Australia. It is competing with companies that have more muscle than it does. And with the new write-downs, it now has to sell a lot more assets than previsouly to get back into a blanace that staisfies its lenders.

I accept what you are saying - but it should only be last ditch desperation. They have plenty of other messes needing more immediate attention. I assume Fonterra assets in Australia are worth way less than was paid for them but I guess the only other option when no one wants your rubbish is to start selling your good stuff. Regarding the competitors with more muscle - Fonterra could compete if it learnt how to create loyalty with its farmer suppliers, it seems to have struggled to gain their trust to date.

Fonterra in both Chile and Australia has always acted as an investor-oreinted company. Loyalty has never been part of the equation.They have paid what they had to pay to get the supply of milk. Nothing more, nothing less. The problem now is that they cannot afford to pay what they need to pay and hence they are losing market share. Their Australian assets will be in the books at whatever Fonterra could convince the auditors they were worth. And it has always been in Fonterra's interests to have them valued as high as possible. Some assets such as Stanhope, which now has potential to be a stranded asset as it is in Northern Victoria where production is plumetting, are relatively new.

Kieth re calls for cutting the milk price.
A quick calculation would indicate that up to 25% of any injection from a milk price cut would be coming from non shareholders. Sharemilkers would obviously bare the brunt of this which would probably be the deathnell of sharemilking having been deliberately kicked by Fonterra when TaF was set up. But many others such as contract milkers with a percentage clause and what about those supplying MyMilk. Then there's the shareholders that presumably won't have to pay, the ones with gaurented milk price.
If Fonterra needs more funds then ok, but it must be the shareholders who have to stump up.
Writing out that list of anomolies , and I'm sure I've missed many, just goes to reinforce my long held belief that Fonterra is NOT a co-op, hasn't been for some time.

Forgot to add the effect on the 20% of farmers who don't even supply Fonterra but are pegged to Fonterra's milk price. When the milkprice last plunged Synlait and OCD banked enough profit to order big shiny new driers, or will they be forced to pay a proper milk price this time?

Yes, co-ops always struggle when the members are not aligned. Fonterra has at least four non-aligned groups which can be loosely classified as big farmers, little farmers, sharemilkers, and unit holder investors. And then there are other groups such as A2 farmers and winter millkers.

When Fonterra was a farmer owned co-op that exported stuff to the world, everybody seemed to do okay. Dairy farms sold for a certain price, many parts of NZ were deemed unsuitable for dairying, and everything worked perfectly okay no matter what kind of farming one did. Then everything changed. The carpetbagging upper managers seemed to be paid amounts of money totally unrelated to the money they made for the suppliers of milk to Fonterra. They invested vast sums of the farmers money in places and with people any farmer would have told them to keep well away from, if they had been told by their employees what was going on. These employees seemed to be paid large amounts of money totally unrelated to what they generated for the farmers, and then ran away with their immoral but legal loot. $43million in one case. All Fonterra can do now is retreat back into being an NZ dairy farmer owned co-op, take a cut in their co-op's value, and the farmers have to take a cut in their farms' perceived values, and sell dairy commodities to foreigners who do stuff with it. But give them a few years, everyone will forget, and another Theo will pop up, with the same ridiculous ideas, and another cast iron employment contract. Wait and see.

As a shareholder of long standing I hold the Boards at the time the decisions were made responsible, not the managers. NZ business has a culture of 'Not Me' when it comes to accountability and that includes directors. We also had what I believe were two autocratic managing, as opposed to governing, Chairmen, one of whom stayed way too long. The best thing, IMO, farmer shareholders have done is to break the 'Waikato cartel' that had an almost stranglehold control of the Board. Having the same auditors for so long is also not good business practice. Did they actually audit the accounts or simply glance over them and sign the paperwork?
Credit to the current Board for facing up to facts and doing what needs to be done. We can't make progress if we are locked in blaming the past. It happened, now we need to be forward focused.

Wait till you see how Fonterra spent their money on luxury offices in China and Asia of the farmers shareholders will to see this they will be extremely upset.