Fonterra’s annual report contains no big surprises. The strategy is one of stepping back from consumer brands and global milk pools. This has been driven by necessity. As such, it is a move towards a little Fonterra and away from the vision of a big global Fonterra.
There is an old saying about cutting the cloth to suit the purse. That is where Fonterra sits right now.
There is no indication that Fonterra plans to retain money from milk-price payments in this coming year. However, it is clear that Fonterra does plan to hold back more funds from future profits than it has in the past. That is all very well, as long as profits can first be generated.
In Fonterra’s presentation, there is a specific contrast drawn between historical ‘debt-funded growth’ to a future of a ‘conservative balance sheet’. Also, ‘aggressive growth’ is to be replaced by ‘competitive advantage’.
It seems that future capital expenditure at no more than $500 million per annum will be similar to current levels of depreciation. That emphasises that it is essentially a ‘no growth’ Fonterra.
The five-year target for the earnings is 50 cents per share. The proposed dividend is 40%-60% of this, implying a dividend of 20 – 30 cents within five years.
Next year’s earnings are estimated at 15-25 cents per share, suggesting a dividend under the new policy of about 10 cents and a similar amount for retentions. That would be about $160 million of retentions, most of which will go to debt reduction.
Fonterra’s dividends do not usually carry franking credits and so these will carry tax liabilities in the hands of investors and farmers. Next year’s net dividend is therefore already looking very small, even if things do go to plan.
It’s notable that Fonterra’s assets include over $500 million of tax credits, suggesting Fonterra itself will not need to pay much tax for a long time.
In all of this, the first big question is whether Fonterra has identified all of the dead rats that need to be swallowed. Specifically, are there more assets that will need to be written down?
I note that CFO Marc Rivers acknowledges that asset valuation ‘is not an exact science’.
I have previously identified Australia and Chile as places where asset values look shaky. I had hoped to get more clarity around those assets but the annual report is not very forthcoming.
In the fine print of the detailed financial statements, but not in the Annual Report version thereof, there is some information as to the valuation process for Australian assets. They are based on comparative dairy asset sales in recent times. They are not based on value in use.
The problem here is that the overarching Australian dairy situation has declined rapidly in the last two years. It looks to me as if some of the Fonterra assets in Australia, particularly in Victoria, are now becoming stranded. Just like Beingmate and China Farms, they will be hard to sell.
I do note that Fonterra acknowledges that Australian valuations reflect an assumed improvement in business outcomes. Time will tell on that one.
The Chilean situation remains opaque. By going to the Chilean accounts (largely in Spanish) as at 31 December 2018 and converting the figures to New Zealand dollars, I estimate that total Soprole assets, including Prolesur have a book-value of around $930 million dollars. The Chilean book-value of equity is around $660. My Chilean sources tell me they do not think the assets could be sold for anywhere near that.
I note that one of Fonterra’s directors has been telling farmers that Fonterra only has $200 million of Chilean assets in its books. I don’t think that can be correct. The $200 million would have to be just one part of the fixed assets. I am seeking and currently awaiting clarification from Fonterra.
It is clear that China Farms is still struggling. This last year it lost $30 million without any allowance for interest or a contribution to overheads. The previous year the loss was $38 million. Production has also declined over the last two years.
Over half of the China farms value relates to livestock. The animals will find a ready market at good prices. The big question is whether anyone will want to buy the infrastructure of a loss-making enterprise.
The current value for Fonterra’s share of Beingmate of $234 million is reflective of the 5.54 RMB market value of Beingmate shares as at 31 July. Since then the shares have dropped around 6%, but these shares are volatile. I note from information elsewhere that Beingmate is now converting itself to be a property developer.
Perhaps the great disappointment from the Annual Report and associated strategy release is that there seems to be little indication to how Fonterra plans to increase its operational efficiency.
I don’t question the operational efficiency of milk collection and processing at many of its plants. Rather, I question the efficiency and costs of all of the other aspects of the business. For example, how does Fonterra plan to reduce its overheads?
The new regional structure will create opportunities for strategic redundancies but will also bring its challenges. There is no word on shifting the Head Office from Auckland to a regional centre such as Hamilton, which many farmers would like to see. Many would see that as an action consistent with cutting the cloth to suit the purse.
At this stage, most of Fonterra’s farmer members support the current leadership despite enormous disappointment, frustration and anger at how events have unfolded. However, if this year does not go well, then next year there will be nowhere for the leaders to hide.
Outside of Fonterra itself, there will be many people who will criticise Fonterra’s new strategy of drawing back to something much more basic. It is indeed a sad day. The problem is that Fonterra has made such a mess with its international endeavours that it really has no other option in relation to branded products and the international milk pools.
I find it remarkable that Fonterra is still only playing at the edges of the A2 issue of which there was no mention by Fonterra in its strategy announcement. I also note that Synlait has now confirmed its milk payments for the 2018/19 year, and with premiums included, its average payment is 23 cents per kg milksolids above Fonterra. Yili is also paying above Fonterra. Tatua will confirm its payout on Monday and it will be much higher again.
*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 https://keithwoodford.wordpress.com/category/fonterra. You can contact him directly here. There is more by Keith Woodford on Fonterra here.