Chilean dairy has similarities and differences to New Zealand; Fonterra is not liked by Chilean dairy farmers who now prefer other processors

Chilean dairy has similarities and differences to New Zealand; Fonterra is not liked by Chilean dairy farmers who now prefer other processors
Chilean dairy cows in the Osorno (Los Lagos) region: Photo by Keith Woodford

I wrote this article in Santiago Airport, waiting for a rescheduled flight to New Zealand. It had been a long night with flights cancelled because of the tragic Santiago riots, and thousands of stranded passengers sleeping on chairs and on the floor. It took 56 hours to get home from Osorno in Chile’s dairy heartland back to Canterbury. Definitely too long for old bones!

I came to Chile at the request of Chilean dairy groups, including support from their government, to talk about A2 milk. As most of my readers will know, A2 milk is milk that is free of A1 beta-casein. However, it was also a great opportunity to look more broadly at the Chilean dairy industry, including how Fonterra fits into that picture.

I was accompanied by Canterbury dairy farmer Marvin Pangborn. Several years back we did a similar trip to the USA to try and understand something of modern dairying there.  We set ourselves a similar aim for Chile.

One of my aims was to talk exclusively to Chileans and not expatriate Kiwis. And that is how it happened. The Chileans talked about what they were doing, and their perceptions of what Kiwi farmers in Chile were doing.

The distinction is important. If we had spoken to Kiwis, we may have got a different perception, both of what the Chileans are doing and also what the Kiwis are doing in Chile. I already had fair knowledge of the Kiwi perspective, and so on this trip I wanted to get the Chilean perspective.

That meant, for example, that I heard different things than what Fonterra’s directors hear when they go to Chile.

Kiwis have been investing and taking their dairy technology to Chile for close on 20 years. The Chileans think the Kiwis got their timing right, and have consequently made excellent investment returns on the land they bought.

The Chileans also like some of the Kiwi technology. However, they are not so convinced about aspects of the overarching Kiwi farming systems.

Like us, the Chileans believe that grass lies at the heart of profitable dairy farming. In the Chilean heartland around Osorno, all farms are grazing farms. However, further north towards Santiago the rainfall drops markedly and grassland farming no longer works.

Here I want to focus on the Osorno model, or more correctly, the two Osorno models. One of those is the local Chilean system and the other is the Kiwi system as implemented by the Kiwis.

Even that depiction of two models is a simplification. Just as in New Zealand, the reality is a myriad of variations, and every farmer sees things somewhat differently.

Most of the Chileans we visited were big farmers. These farmers tend to be well qualified, often with university degrees in fields such as engineering, veterinary science and business. Their farms are typically between 400 and 2000 cows.  The Kiwi farms in Chile also tend to be large, and so the comparison has some basis.

There are also many small farms in Chile. For example, we met one group of around ten farmers whose production ranged down to about 20 milking cows. But I am not talking about those farmers here, simply because, despite their importance, their situation is of little direct relevance to NZ.

The big Chilean farmers look somewhat askance at the Kiwi system, and were not backward in voicing criticisms when probed, although there is also some admiration.

The Chileans think that Kiwis are too hard on their cows. The Chileans like to see cows fed better and producing more milk. That means using supplements where appropriate.  Typical production on the grazing farms we visited is well over 500kg milksolids per lactation and on some grazing farms much higher than this.

The Chileans also believe that in their country 12-month milking systems work better than seasonal milking. They told us that some of the Kiwis in Chile, although arguing strongly over the years for the seasonal system, are also now moving to 12-month production.

The challenge for 12-month production in the Osorno region is that winters can be exceptionally wet. Despite free draining soils, this creates big challenges both for animals and pasture management. These issues become greater if the cows are milking.

However, there are two other key parts to the story. One of these is that Osorno summers are drier than in New Zealand. Think of the Waikato, but with cooler and wetter winters, plus summers at least as hot and undoubtedly drier. That is how Osorno is.

The second key issue is that Chile now struggles to be self-sufficient in milk production. Nearly all of the product is used to feed the 18 million Chileans. Hence, the demand is for consumer-ready products rather than ingredients. That creates a demand for a steady supply of milk throughout the year.

This is where Fonterra comes into the picture.

Fonterra has two complementary companies in Chile, and it can be confusing. Soprole is 99 percent owned by Fonterra. However, Soprole also owns approximately 86 percent of Prolesur, and their profits are consolidated into Soprole and hence through to Fonterra.

Soprole itself has strong consumer brands. It used to be the lead dairy company in Chile but has now slipped to third position. I have previously written about that here. In contrast, Prolesur manufactures ingredients which it sells to Soprole.

In the Osorno region, Fonterra buys its milk through Prolesur rather than the parent Soprole. Given the focus on ingredients, Fonterra has also been in favour of seasonal production systems as these can reduce the cost of milk production.

The biggest problem for Fonterra in Chile is Prolesur rather than the overarching Soprole.  Prolesur, as an ingredient producer, has been either unable or unwilling to pay farmers enough to compete with the other big Chilean dairy companies such as co-operative Colun and investor-focused Nestlé. Accordingly, Fonterra’s Prolesur has been losing milk supply in a big way.

Fonterra knows that if Prolesur continues to lose farmer suppliers then there will be more stranded assets. This season, Prolesur is trying to entice farmers to stay by offering higher prices.

If Prolesur is to be sold, which is the logical business decision, then it must keep and enhance its supply of farmers.  The Chileans say that without milk supply, Prolesur is worth very little.

The problem for Fonterra is that whereas some Chileans still admire Kiwi dairy farmers, we never found one farmer who had a good word for Fonterra. Fonterra is strongly disliked as a consequence of the way it has treated its suppliers. Farmers say that never again can Fonterra be trusted.

Among the Chilean dairy companies, the co-operative Colun has an excellent reputation. It has been exceptionally successful and has seriously outperformed Fonterra. However, Colum has its factories full. It has been Nestlé which has been taking supply away from Fonterra in the last year.

Unlike Fonterra, whose plants are described by the Chileans as ‘old’, Nestlé has a modern infant-formula plant near Osorno. They can undoubtedly afford to pay farmers more than what Fonterra can. And farmers talk well of Nestlé. There lies the rub for Fonterra in Chile


*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.

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10 Comments

" Farmers say that never again can Fonterra be trusted " .. no mugs , those Chileans !

Very interesting , just remind me again ........... what the hell is Fonterra doing in Chile in the first place ?

I am sure we are going to see more assets written off and possibly sold to Nestle at firesale prices

Have they not heard of the term , stick to your knitting .

So the money question, Keith. Assuming F has on it's balance sheet 99% of 86% of Prolesur (say, crudely, 85% equity), and P is losing suppliers, what's P actually worth if it were to be marked-to-market now? And the chaser: is F gonna haveta write it down in this year's accounts, or can it mark-to-fantasy and keep up the pretence?

Waymad,
I am reasonably confident but not certain that the Prolesur drying plant in Osorno is already stranded, with all Prolesur production going either to cheese or direct to Soprole. However, I know that Fonterra looks at its overall Prolesur business when it considers valuations rather than looking at individual plants. It also does this in Australia and presumably also in NZ. So this does create potential for write-downs to be either avoided or delayed, depending on the chosen valuation multiple applied to profits. The crunch could be when Soprole assembles its next set of accounts which will be at the end of December - they work on a calendar year. My guess is that Soprole will not have strong profits this year. My guess is also that Chile will go into recession as direct effect of the current unrest, with this showing up particularly in the economic stats for 2020. That unrest is tragic for Chile. Not only have 16 people been killed in the riots of the last week, but the underground rail system in Santiago has been devastrated and will take a long time to get back to normal operations, with significant implications for the economy. Three million Chileans rely on this system every day to get to work.
Unfortunately, I don't think I can separate out Prolesur from Soprole in the Soprole accounts. What I do know is that the Prolesur minority interests are very unhappy with Fonterra as they think that the transfer pricing system from Prolesur to Soprole is to their disadvantage and there is an investiagation of this currently under way.
KeithW

Thanks, Keith. In short, Trouble at Mill, dead ahead.....but surely the Prolesur asset valuations should be split into the usual categories - land, buildings, plant & equipment, software, goodwill etc - and one or more of those if stranded should be held on the books at a much reduced amount? Or can F get away with an income-multiple-style 'valuation' after paying some clevver consultants to come up with an acceptable multiple that somehow skates past the Auditors?

Waymad
I can see from the accounts that the minority interests in Soprole are about $NZ50 million and these will relate to Prolesur. So Prolesur's book equity is about $NZ300 million of which about $250 million is Fonterra's. But I cannot break this down into components from the Soprole accounts. Soprole's assets total about $900 million (inclusive of Prolesur) but about half of this is current assets including inventories, accounts receivable, and about $150 million of cash. The cash is from profits which Soprole is holding in Chile and on which it will have to pay some additional tax if remitted. If Fonterra used the cash to pay off Chilean debt then it would seem that Fonterra would have about $700 million of assets and no debt. But one confusing item in the accounts is a 'related party account receivable' non current (i.e.>1 year) asset of about $NZ160 million. This appears to be to Fonterra itself and should therefore also show up as a liability in Fonterra's parent accounts. In amongst all of this complexity, one apparent fact is that profits in 2018 calendar were about $NZ55 million on equity of about $NZ700 million, which looks skinny. I expect the profits will be considerably lower in calendar 2019. Accordingly, and with the current political mayhem in Chile, I expect at some stage Fonterra will have to bring substantial asset revaluations to account. But I cannot quantify that, nor put a timing on it.
KeithW

Keith - that $160m term receivable in Soprole is likely to be consolidated away in F's accounts as an interco or some other type of elimination. So what I would take from that is that Soprole's asset book value excluding current assets is about $450m, less the $160 = $290m or around about the $300m you note, with F's share of that book value is around $250m. At least this bit of bush accounting makes sense. The real question is what S is actually worth in a fire sale.....particularly if the fixed assets are tired or obsolete, and always assuming that the current assets are in fact 100% collectable....

Thanks for the insight Keith. Do you know what land values are doing there? NZ farmers have been going there for many years, but in mid 2000s a consortium of dairy farmers some of whom had high profiles in the industry purchased a large farm, presumably based on relatively low land values.

Omnologo
From the perspective of the 'land business' I think it has been very successful and an excellent investment. And that is how the Chileans see it. Neither I nor the Chileans are so sure about it from the perspctive of the specific farming systems. The Kiwis may still send some milk to Fonterra but much of it goes to other processors.
KeithW

Speaks volumes, included in the consortium are ex Fonterra governors who directed Fonterra investment into Chile.