The rising value of Fonterra dry shares and the cost of entry of wet shares has meant an increasing number of farm vendors choosing to “unbundle”.
The cost of entry is also shutting out Fonterra’s access to the burgeoning new milk supply coming on stream.
Purchasers of dairy farms are increasingly seeking a land only deal.
The selling farmer then ends up with “dry” shares - because he is no longer a supplier - which he can then convert to units and sell on the open market.
Pre-TAF (Trading Among Farmers) the market for dairy farms adjusted with the change in the value of the supply shares and farms sold on a share-inclusive basis.
The high price for shares is resulting in more and more farmers choosing to sell shares separately and move to competing dairy companies who don’t require share purchases.
Dry shares are currently $6.16 and are up from the fair value issue price of $4.52 although they have been as high as over $8. At the start up of the co-operative, Fonterra shares were $1 until the “fair value” scheme was introduced)
At $1 the impact of having to buy these shares was considered minimal but fair value which was introduced to reflect the capital structure of the co-operative has changed that.
The sale of a 'Fonterra' farm is now often made up of separate land and share components and Fonterra’s director of milk supply Steve Murphy admits that the high share price is encouraging this trend.
“There is a particular short-term financial driver that exists with the share price the way it is and for some farmers that makes sense today,” he said. “However, net-net it is a very small amount of milk solids we are talking about.”
Since the launch of scheme in 2012, the demand for units in the shareholders fund had well exceeded expectations.
Fonterra farmers are able to sell down as many as 20% of their wet shares and it is well known quite a number sold what they could when the price was over $7.60.
Certainly the process of trading has been a success with the shares coming in at number one in liquidity (sales) on the NZX even though the Fund ranked 21st in terms of market capitalisation.
In the first eight months to July 31 last year 553 million units were issued and 476 million redeemed and the Fund stood at around 7% of the cooperative’s balance sheet where it still sits today.
Loyalty to Fonterra dissolving
Much of the activity has surfaced in Canterbury and this has prompted Fonterra to change the rules over how its milk solids shares can be bought (wet shares). There are also reports of the trend emerging in the lower North Island with farmers opting to go with Open Country Dairy.
In response, Fonterra is moving to stop losing suppliers by relaxing the rules around share purchase.
One farmer who increased his output from 86,000 kg/ms to 110,000 kg/ms was given 10 years to buy the extra shares instead of the standard one season.
“Fonterra needs to be much more flexible in the terms it sets for share purchase,” Christchurch farm accountant Pita Alexander told interest.co.nz.
“They have certainly made things easier with redemptions and deferrals.”
In reference to TAF, he said there were more minuses than pluses for farmers thus far.
“With a share value of $6.16 as opposed to the old $4.52 it makes you wonder if this whole sharetrading thing is working for them.”
Fonterra had improved financing arrangements for new suppliers allowing them to buy over a period of years rather than being full shared-up from the start.
Shares were always going to present a problem when a new alternative startup dairy company competitor could offer 10c a kg/ms above Fonterra with no requirement to buy shares.
Industry commentators agree that this is “opening it up for the Chinese”.
In the South Island Synlait are taking on new suppliers as is the new Chinese-owned company in North Otago (Oceania Dairy) and they do not require share purchase to supply.
At one stage last year interest from Canterbury farmers wanting to join Westland increased noticeably but Westland was now near capacity which somewhat limited the choices of farmers to change processors.
Westland requires suppliers to buy shares equivalent to their production but at $1.50 a share
And this is “washed up” at the end of each season.
Farmers buy more shares if they have increased production or are able to cash out shares if production is reduced.
Westland says it does not encourage dry shares or shares not backed by milk production.
“It is not really surprising that if someone can get the same payout for their milk solids from another company that they choose not to pay up to millions more for a farm to fulfill the Fonterra share requirement.”
Alexander said he had yet to notice any great effect on dairy land prices.
Influential Canterbury dairy farmer and Federated Farmers dairy chairperson Willy Leferink is a Fonterra supplier shareholder and a contract supplier to Synlait. He said in an opinion piece last year Fonterra’s current model needed to change to stop in “running dry down the track”.
“I cannot for one justify the millions of dollars it will cost to purchase shares in Fonterra for a farm I am converting.” He surmised many potential Fonterra shareholders felt the same. Fonterra’s model was that all suppliers all had three seasons to share up or go into contract milk where the farmer agreed to share up in six years.
“You share up buying those bank unfriendly high-priced shares and if you cannot then you have to exit."
“Fonterra shares should be bought cash in the wallet not funded from bank debt,” Leferink wrote.
“Fonterra needs to recognise that banks and farmers will find it hard to justify the millions needed just to belong. So why not allow some form of compromise?”
The recent unbundling of shares for a Fonterra shareholder has seen the development of different supply contracts and the need to hold the shares equivalent to milk solids (wet shares) has become variable, according to industry sources.
An exiting farmer also has the option of holding dry shares as they were no longer tied to wet shares as in the past.
One of the theories of allowing the trading in dry shares was to try and address the soaring cost of dairy land.
Sources said Fonterra thought it would capture more of the value in the company’s balance sheet rather than seeing continued land price increases.
That had not been the case at this stage.
Land prices affected
Land price rises have continued to endure and some farmers have used the increase in equity from the share IPO to buy even more land and driving prices up even further.
One observer told interest.co.nz that the recent reduction in the dividend on the dry share also supported the increase in land values over share price.
It is expected by some that land price increases will be the real driver of value not the share price.
Farmers unbundling their Fonterra shares when they sell the farm can convert them to units on the shareholders fund, according to Dick Bennison a rural specialist with Duke and Cooke, a Nelson property consultancy, in comments in a property report last year.
“This way they can continue to benefit in the future capital growth of Fonterra or sell their units and pocket the cash at any time they deem to be opportune.”
He said with the value of shares rising substantially and the total value of a dairy farm unchanged there was actually downward pressure on the value of dairy land.
Traditionally, dairy farm selling prices were on value of kilograms of milk solid produced and also included the value of the shares.
The changing scene is predicted to see the value of dairy land reflect the returns on milk production solely without being affected by wider sharetrading issues.
What trends are you seeing in dairy farm sales in your area?