sign up log in
Want to go ad-free? Find out how, here.

Fonterra pulls up the wagons to defend its territory, but also hoping to sortie out with new nutritional endeavours

Fonterra pulls up the wagons to defend its territory, but also hoping to sortie out with new nutritional endeavours
shutterstock_94255060

Fonterra’s release of its 2020/21 annual report has occurred in association with an additional big dump of information laying out the proposed future for Fonterra.  In essence, Fonterra is confirming that it is going to be a New Zealand company owned by farmers, with the first priority being to maximise returns to farmers.

That position should in itself come as no surprise. Fonterra has been talking that language for three years as it has divested itself of various overseas assets. However, this is the first time that there is a more comprehensive laying out of the long-term strategy, including consequent policy decisions. There are multiple headliners.

Current structure is not fit for purpose

Underlying everything is that Fonterra believes that the current structure is not fit for purpose. If they don’t do something about this, then they fear losing 12 to 20 percent of their New Zealand milk supply in the short to medium term. They very much fear the business implications thereof.

So, they believe there is a need to pull up the wagons into a defensive formation from where they can then sortie out to capture new opportunities.  They believe those opportunities relate to food service and active living, with the key markets being Greater China and South East Asia. Indonesia and Malaysia rank highly in their thinking. They also see an increased future American focus, although how that might evolve is unclear given that the USA is a significant exporter of milk.

Their big fear is that farmer suppliers of milk will transfer their business to new milk processors and they do have real cause for concern.

More divestments

Fonterra has announced that it is going to divest its Chilean businesses of Soprole and Prolesur. I have advocated that for some years. Fonterra has shown many times that it does not have the skill-set needed to operate in Chile, or for that matter elsewhere in Latin America. Currently, it is a distraction and there is no longer any strategic reason to stay.

More important is the announcement that Fonterra is looking at alternatives for its Australian operations, including the possibility of an IPO but retaining a significant stake. It will be very interesting to see how the market values those Australian assets.

Some of Fonterra’s Australian assets go back to last century and the days of the Dairy Board. One of the missteps back then was purchasing the Bonlac co-operative but without doing full due diligence. At the time, I was Australia-based and in a social situation I mentioned to a Dairy Board director that Bonlac was ‘a lemon’. The reply I got back was that it was ‘a dog’, but they were confident that they could ‘turn the dog around’.

The Australian business has always been long on promise but has never achieved as it could and should have done. There has always been lots of hype and associated massaging of the proverbial, but the numbers coming out of the Australian operations were always weak.

The challenge in selling the Australian Fonterra will be that a new buyer will want to do things its own way. If Fonterra wants to retain a stake, then the investors will want to ensure that Fonterra cannot dominate the strategy.

Fonterra’s big concern in Australia will be to protect its Australian markets for products produced in New Zealand. It has been important for Fonterra to be able to present itself in Australia as a local company when selling those products.

A new share structure

Fonterra’s directors have confirmed their enthusiasm for a new share structure but with minor tweaking from the earlier proposal out for consultation in May.  It is now proposed that farmers will be required to hold only one share for every three kilograms of milksolids produced (i.e., each kg of fat plus protein, not total solids), but can hold up to four shares for each kilogram of milksolids.

Fonterra’s directors must presumably be confident from their consultations that they can get this approved at the Annual General Meeting. This will be based on farmers looking at it from their own individual perspective, and voting accordingly. The big question is where does it leave the co-operative itself?

A fundamental principle of co-operatives is that members provide capital in proportion to the business that the member wishes to transact with the co-operative. However, the proposed structure is a very long way from that. 

Once again, I will be very interested to see how this plays out. My expectation is that over the medium term through to 2030, it will not play out well.  There will be huge misalignment between groups of shareholders. 

The Fonterra Shareholders’ Fund

Fonterra is now planning to retain the so-called Shareholders’ Fund. This is the confusingly-named structure set up in 2012 by which non-farmer investors could participate in the co-operative. However, the size of the Fund will be capped to its present number of units. Back in May the stated preference was to buy it out.

The three independent directors of the Fund have reacted negatively to this amended proposal. In essence, they are saying to Fonterra that Fonterra should make an offer to unitholders to buy back the fund at a fair price.

Perhaps surprisingly, the price of these Fonterra units has risen following the announcement. Why anyone would still want to buy these units is somewhat of a puzzle, unless it is indeed on the speculation that when push comes to shove, Fonterra will still buy back the fund. In the current environment, the Fund is like a fish out of water.

More on market supply and demand

Fonterra thinks that New Zealand milk production will at best remain flat. They also think that as long as farmers are required to provide significant capital that some will be more than tempted to shift to other processors.  In that environment, a high share price becomes a problem.

That in itself is a remarkable situation. When has a company ever before wanted a low share price? This is indeed a very different Fonterra from the Fonterra of the past.

On the demand side, Fonterra sees the global demand for milk increasing. This is in contrast to some influential people in Wellington who are greatly concerned about artificial milks. My own thinking tends to align more with Fonterra on this one.

My one big caveat on the future of milk is that Fonterra has to convince its farmers to get their herds across to A2 cows and to finish the job quickly. It is a nonsense for Fonterra to be pushing the special nutrition of milk until it does this. I know of an overseas co-operative that is saying to all its farmers that the time has come to shift to A2. I also work with groups in multiple countries who are doing this.


*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. You can contact him directly here.

We welcome your comments below. If you are not already registered, please register to comment.

Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.

12 Comments

Keith an error in relation to new shareholding proposal.  

 New minimum shareholding requirement would be set at 33% of milk supply (around 1 share per 3 kgMS), compared to the current compulsory requirement of 1 share per 1 kgMS.

not

farmers will be required to hold only one share for every kilogram of milksolids produced 

Up
0

Thanks CO

I knew what I meant to say  but I did not say it!

I will now ask David to correct my error. 

The commentary was based on the correct figure. Indeed it is the one share to three kg of MS that will, in my opinion, eventually undo Fonterra.

KeithW

Up
1

As I have said before dairy is a good industry to be involved with. The almost perfect protein, but then being Nordic will have bias, the diversity of products and ease of storage ie milk powder, gives this product a certain market into the foreseeable future. And after learning about A2 through Keith's writings that is the strategy for the future as well. I am a supporter of the Fonterra model as I remember the old reginal dairy factory model. Many dairy farmers booked up supplies etc and at the end of the year were in debt. I do worry about new players coming in and recreating the past but at the end of the day it is in the hands of the farmers themselves.

Up
1

Keith, I always appreciate your highly informed analysis. I'm not a farmer but as a layperson would be interested to know whether you think the following could be an unintended consequence of the new proposal.

My understanding is that there could effectively become 2 classes of shareholder Those that are capital rich and buy the maximum 4 shares/1kgms and new entrants/capital poor farmers who buy the minimum of one third of a share for 1kgms.

With the capital rich shareholders having up to 12 times more shares/votes per kgms than the capital poor ones could this skew payouts more towards dividend at the expense of milk solid price? 

Up
0

I too await Keith's reponse to the shareholding ratio changes, as voting is still to be backed by milksolids supplied I understand.

Up
0

StuMcP21 and Tom
My understanding is that the proposal is for voting rights to be determined by production that is backed by shares on the basis of one share per kg MS.

So, a farmer with 100,000 kg MS production  and 100,000 shares would get 100,000 votes

A farmer with 100,000 kg MS and the minimum 33,333 shares would get 33,333 votes

A farmer with 100,000 kg MS production with the maximum 400,000 shares would get 100,000 votes.

A farmer with 200,000 kg MS production and 200,000 shares would get 200,000 votes.

There may be some scaling, for example 1 vote per 1000 kg MS that is backed by shares, but  the relativities will remain as set out here.

Keith

Up
1

Keith currently shareholding is 1share per 1kg based on a 3yr rolling avg of production.  You can already own more shares (dry shares) than what kgs you supply but voting is based on production.  MyMilk currently allows some suppliers to supply without being fully shared up - they share up over time.  Then there are farmers who have sold shares (there is a max % limit) in to the FSF so who technically don't 'own' those shares and are given 'vouchers' for the shares so sold, and can still vote based on shares+vouchers.

So there is quite a mix already there - that's not to say everyone is happy about it.  There was a genuine request at meetings I attended to create a pathway for young farmers/first farm owners to become suppliers/shareholders.  Banks wax and wane on lending for shares - especially if you aren't going on to an intergenerational farm.

Up
0

C.O.

I am surprised that vouchers can provide voting rights. 

I agree that there is a strong wish to provide a pathway for young farmers.  But my perspective remains that the most fundamental principle of a co-operative is aligning member shareholding with member business.

Keith

Up
0

Having some vouchers in our business, I'm pretty sure they are non voting and attract no dividend either.

They just give entitlement to supply.

Up
0

The owner of the FSF unit gets the dividend. 

Vouchers
Vouchers are accumulated (subject to limits) by a shareholder when they sell shares into the FSF. These vouchers, to the extent to which the Board permits them to count, are essentially equivalent to Shares in the areas of share standard compliance, voting and share-backed milk payments. However, vouchers are not tradable and do not receive a dividend.

https://www.fonterra.com/content/dam/fonterra-public-website/phase-2/ne…

 

Up
0

Tom,

Currently there is a complex formula used to calculate the milk price, with this then determining profit, and that in turn influencing dividends. The Government keeps an eye on the calculations and even has a representative on the milk price committee.  Presumably that system will continue.  But yes, I do see considerable tension if shareholders approve these changes. There will also need to be Government agreement to change the DIRA regulations which lay out some of the things Fonterra, given its dominance within the NZ dairy industry, can and can't do.

My overall impression remains that this will not end well. In trying to understand why Fonterra is making these changes, I think it has to come back to Fonterra's belief that the current structure is not fit for purpose in an environment where Fonterra's supply of milk is likely to decline. I think that fear is leading them down a dangerous path that will lead to even more trouble in the long term. The irony is that both Fonterra and I remain overall optimistic about dairy in the global context.

Keith

 

Up
0

As a relatively recent dairy farm owner we signed on to  the 3 + 3 years share purchase option. We carry a reasonable amount of debt so sentiment has little sway in our business decisions. We were not in a position to purchase the shares at the start as our bank had limited interest in them when Fonterra had no consistency of dividend to cover the additional cost. 

The negative for us was that with the requirement to share up over years four to six, at that stage over $1.6m after tax, our bank built this into our cashflow forecasts so limiting our ability to make capital improvements to the farm.

Allowing us the ability to hold 1 share per 3kg ms, which we have now done, removes a huge contingent liability off our farming business. At least for the near future.

The negatives are that being only farmer traded the shares will end up being valued relative to the bank funding costs of the most indebted/ vulnerable farmers and the well capitalised established operators with bank support will increase their shareholding off a lower or nil funding cost. This transfer of equity will be increased by the intention to make capital repayments over the next three years. Roughly 50-60c? per share using Fonterra's own forecast

 

Up
1