Keith Woodford delves into and behind the official Fonterra disclosures for the 2014-15 year and finds some unsettling developments

Keith Woodford delves into and behind the official Fonterra disclosures for the 2014-15 year and finds some unsettling developments

By Keith Woodford*

The release of Fonterra’s annual report on 24 September coincided for me with a long plane trip back from China. I used the time trying to work out what all the numbers really mean.  It was not an easy task.

Fonterra’s annual report – like most reports from large companies –provides masses of numbers. Some are clearly there for public relations purposes. Others are there to meet the required rules of the International Financial Reporting Standards (IFRS). And then there is another set of numbers which Fonterra constructs according to its own rules. These are called non-GAAP measures; i.e. ‘non-generally accepted accounting measures’. Fonterra itself acknowledges that these measures are not standard between companies, so comparison must be made with caution.

Some might say that none of these sets of numbers are designed to illuminate the true kernel of the situation. So interpretation can be challenging. To get to that kernel, one has to do lots of fossicking.

Along the way one comes across cash and profit measures, pre-finance and post-finance numbers, pre-tax and post-tax profit, and normalised and non-normalised items.  No wonder most people get confused.

To further complicate matters, definitions change throughout the report. For example the term ‘Greater China’ sometimes includes China farming operations and sometimes does not, depending on whether Fonterra is referring to an ‘operating segment’ or a ‘strategic platform’. And the ‘Asia segment’ actually includes Africa and the Middle East but excludes ‘Greater China’.

Borrowing jumps

One notable figure – which is not highlighted - is that borrowings have increased from $4.9 billion at 31 July 2014 to $7.6 billion at 31 July 2015. Clearly, big things have been happening.

Throughout the report, comparisons are made between 2014/15 and the preceding year. This is normal procedure.  However, neither year could be described as a typical year for Fonterra, so the foundation for comparison is wobbly.

In 2013/14, record prices were achieved for both whole and skim milk powder. This made it an excellent year for farmers who are paid the commodity returns minus the cost of processing. But it was a very difficult year for corporate Fonterra.

The key reason why 2013/14 was such a bad year for corporate Fonterra was that high commodity prices squeezed the margins on value-add consumer and food service products.   As a consequence, Fonterra made a profit of only $179 million on assets of $15.5 billion and shareholder equity of $6.5 billion. Indeed Fonterra would have made a loss if farmers had been paid the full milk price using the pricing formulae as set out in the Milk Price Manual.

At the time, both commentators and investors cut Fonterra some slack for the poor performance. The message from Fonterra was that it was just a short term thing and that profits would soar once commodity prices dropped.

In contrast to one year earlier, 2014/15 has been disastrous for milk powder prices. Accordingly, farmers are suffering greatly. In theory, the flip side of this should have been that the 2014/15 year would have been outstanding for Fonterra’s profit from consumer and food service goods. In practice, it has not turned out that way.

The reported after tax profit for 2014/15 is $506 million. Somewhat surprisingly, this is $82 million more than the pre-tax profit.  Yes, that is right: Fonterra is not liable for tax this year and the Profit and Loss Account shows a tax credit of $82 million. Last year there was also a tax credit, but only of $42 million.

Four versions of return on capital

Fonterra provides four different versions of its return on capital: 9 percent, 8.9 percent, 7.5 percent and 6.9 percent.  The 9 percent figure is the one Fonterra highlights, but it is the 6.9 percent figure in fine print that takes all of the equity capital into account. On a per share basis, the return is 29c. Fonterra is committing to pay 25 cents to shareholders leaving 4c for reinvestment.

This retention of 4c per share is consistent with Fonterra’s track record that it typically retains only a small amount of profit. Most companies retain a greater percentage of profits as a growth driver.

Given that Fonterra’s corporate profits are so modest in what should have been a good year, I decided to drill down and see what went well and what went poorly.  To do so, one has to look at the pre-finance and pre-tax numbers which are known as EBIT (earnings before interest and tax). This is because interest is only charged and tax is only calculated at the overall company level and not for individual segments.

This year, Fonterra has made an EBIT profit of $974 million after normalisation. Using the ‘strategic platform’ figures, ingredients and operations contributed $973 million.  In contrast, consumer and food service contributed $408 million.   However, this leaves some $363 million of unallocated costs, plus $44 million of losses from international farming. 

Using the ‘operating segment’ information, ingredients and operations contributed $699 million of the $974 million total EBIT. But this is clearly an underestimate given that not all ingredients are included in the ingredients segment.

All we can say for sure in relation to ingredients (essentially commodities) and operations, is that they contributed something more than $699 million to EBIT. In contrast, the rest of the business (including consumer goods, food service and international farming) contributed something less than $275 million to EBIT. 

When interpreting these figures, it is important to remember that finance costs totalling $517 million have still to be deducted.


On the surface, the profit dominance of ingredients and operations is remarkable. Recall that earlier I said that corporate Fonterra is expected to do well when commodities are low in price, but that is because of the increased margins on consumer and food service goods. But here we are seeing excellent profits from the commodities themselves. There are two reasons for this.

The first reason is that Fonterra calculates the returns to its farmers from five reference products. These are whole milk powder, skim milk powder, butter, buttermilk, and anhydrous milk fat. Fonterra then deducts processing costs from the sale prices for these products, and pays its farmers on the assumption that all milk was converted to these products. However, the reality can be quite different, and Fonterra also produces other commodity and ingredient products called non-reference products.

This year Fonterra has done well from these non-reference products, including cheese and casein. The prices have not been good, but they have been better than the prices for milk powders. And for corporate Fonterra, in contrast to the farmers, it is this relativity that matters. Fonterra has also been buying lactose cheaply from overseas, which it adds to the milk powder and thereby increases its margins.

The second reason is that the processing charges that Fonterra deducts from the market price of the reference products include an allowance for return on capital. Therefore, Fonterra makes considerable profit each year simply by toll-charging for processing of commodities. By definition, this part of the business is very low risk, given the commitment to supply by farmers, and the automatic charging of a return on capital.

Struggling overseas

There are two business segments where Fonterra is struggling badly. One is Australia. The other is international farming.

In Australia, Fonterra purchases about 19 percent of Australia’s milk. To do this, it has to pay market prices as its Australian farmers are not bound to the company like New Zealand farmers. Quite simply, Fonterra is making a loss on these operations. Given the way Fonterra bundles NZ and Australian operations together, it is impossible to be precise, but it is probably of the order of $200 million for 2014/15 once ‘one-offs’ are included.

The Australian operations have been problematic ever since Fonterra was formed. Fonterra took over poor quality Australian assets from the NZ Dairy Board, and then compounded those problems with further strategic errors.

Fonterra’s international farming operations are almost totally in China. Two years ago, things looked rosy, but somehow the wheels have fallen off since then.  This last year the losses are $44 million EBIT. Once interest on borrowed capital is added in, the losses become much greater.

In this last year, Fonterra’s farms in China produced about 160 million litres of milk and 12 million kg milksolids from 25,000 milking cows. Those production figures would be good if they were from New Zealand pastoral style farming, but from intensive housed free-stall farms they are awful.

Chinese farmers are currently receiving about 3.4 RMB per litre for milk of about 3.5 percent fat and 3 percent protein. This equates to about $NZ 0.85 per litre.

Fonterra’s China farms will be getting paid more than this. My estimate is that they will be getting at least $NZ1 per litre for milk of about 7.5 percent milksolids. So they are getting about $13 or a little more per kg milksolids. Yet they have still made a loss of $3.67 per kg milksolids, with interest still to be accounted for. 

Plenty to worry about

The overall message from Fonterra’s accounts is that once one scratches below the surface there is plenty to worry about.  The operating returns at the corporate level have depended on an imbalance between powder prices relative to cheese and casein. Purchasing cheap lactose has also helped. Australian operations remain a worry with much still to be sorted out. And the China farms are bleeding profusely.

Another issue of note is the extent to which Fonterra is building inventory. The accounts show that in 2013/14, Fonterra’s NZ operations produced 138,000 tonnes more product than were sold. And in 2014/15 Fonterra produced 126,000 more tonnes of NZ product than were sold. This suggests that at 31 July 2015 there were 264,000 tonnes of additional inventory compared to the same date two years earlier.


Keith Woodford is Honorary Professor of Agri-Food Systems at Lincoln University. He combines this with project and consulting work in agri-food systems. His archived writings are available at

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Useful analysis. And this derisory return on capital rests on accelerating and extensive national environmental degradation, together with the undermining of trust in the New Zealand brand and our business competence and trustworthiness, via Fonterra's botulism bungling - forgotten by no-one of account in the international foods sector. If this is the way we intend to build globally important businesses, we have a lot to learn.

"There is good transparency on business performance across the different parts of our business, with explanation of what is going well, and where we have work to do".( John Wilson)
This is an out take of the email that John Wilson sent to farmers yesterday.
With this article above and the Tatua final payout and the recent wage debacle Speirings and Wilson had better hold their heads in shame.
Farmers all across the nation now want that 53c/Kgms that was taken from them in the 13/14 season.

Well these are financial or statutory accounts, they are not management accounts, reporting dashboards or otherwise used by mgt.
As such these reflect on a CFO or Finance Director. Think treatments, policy, assumptions, timings etc.

In this case for example how should the share purchase in Beingmate be treated? Is it a JV, or a PIPE? There is a market for shares, there are exchange lodged annual reports, how linked to product sales was the on market share purchase. The purchased was 100% debt funded.

Optimists have thought there would be avenues to a set of Beingmate accounts in English, and a industry/business commentary on the china farming (similar to the other scale - but HK listed - farming operations) with discussion on who was buying the farms' milk and market policy/outlook as others have.
see page 18 and onward
see page 20 onward

Well said d123. fontera , in NZ, can hide behind its statutory monopoly (which at the moment it is trying to gold plate in the review of its Act). Not so in Australia where the Two supermarkets also face competition.

Supermarkets on the sell side, bonlac ss agreement on the buy side (making MG the otherwise noted "market price"- nothing to do with actual sales). As noted before..

and from a suppliers ozzie possie (JS is Judith Swales the Oz Fonterra boss)

MMM: Why has Theo chosen to telegraph a change in Fonterra’s dealings with Australian farmers via the media rather than by opening a conversation with farmers?
JS: Theo was commenting on the global dairy situation and its impacts for Australia. He was putting a voice to issues that many in the industry are well aware of. These are difficult issues and shouldn’t be shied away from, and as an industry we need to address them.

MMM: Are there any inaccuracies in the article you would like to correct?
JS: The headline was unfortunate. The main issue to point out is that the problem is not around Australians dairy farmers being overpaid – as stated in the headline – but rather the impact global volatility is having on the sustainability of current dairy pricing in Australia. What’s important, is that we’re sending the right price signals to our farmers to avoid any surprises and so that they can budget for various scenarios.

read more:

If Fonterra was a public company, with significant institutional shareholders, Fonterra would either be held to ridicule or be avoided (by institutional investors) for those annual reports

This type of stuff used to be my bread-and-butter

Keith Woodford's review says a great deal about Fonterra's regard to its stakeholders

Here's a for instance

Exchange listed companies are required to report to the Stock Exchange any price sensitive information that may have a material effect on its share price

When the GDT price was falling at 10% per auction and the per-tonne price had fallen from $3,000 per tonne to $2,000 per tonne, the consequences of those price falls have an immediate financial impact on the value of stocks being carried. With Fonterra carrying 264,000 tonnes of stock, each price fall had a serious impact on the value of those stocks. A loss of $264 million. Enough to wipe out half the profit of $500 million. Is that material or not? I think it is

Yet Fonterra remained silent. I was watching and waiting for the announcements. Not even a peep

So a 'Clayton's' cooperative will be the result if this deal goes through.

I wouldnt worry too much about it Aj. SFF did the dirty back when they demanded we take shares for livestock. I still havent seen these shares. I wasnt allowed to use them to vote a couple of years back. I would call them Claytons shares. Just a different type of claytons shares to cas ob. As in totally worthless. Soooo it has been a while since I supplied SFF. And it will be a cold day in hell before I supply them again. Thats the power we have as farmers. SFF sh@t in their nest a number of times. The share thing was the icing on the cake. Good luck to the chinese. They will need it. Anzco, Greenlea, Crusader, TeKuiti Meats, Cabernet Foods, Progressive,Universal....lots to pick from.

I haven't supplied SFF ever. Just not my kind of company.

agree Belle, a cold day in hell for me also. I have only heard bad things about them.

While I struggle to follow a lot of what Keith is saying, it's a wonderful piece of work. We need to see more of this in other media.

What this shows once more is that numbers can be shown in many ways. Keith has done a great job pulling them apart and showing some of the flaws.
From an outsider's point of view one would have to say that a company that pays about 85% of it's earnings in dividend while increasing it's borrowing by billions and thereby massively increasing future interest payments even when money is cheap, using it's local monopoly type supply situation to fund international losses and almost doubling it's stock level without doubling sales volume is controlled by emotions and hope rather then sound business practices.
While there may be a sound plan in place in regards to the international operations and turning that to profit soon, the huge increase in borrowing while not addressing the dividend payout ratio and not being able/willing to relatively quickly reduce it's raw material in-flow (emotional reasons again?) make it look like the company is on the road to death by many cuts.
Every business has an emotional element to it specially owner operated ones which makes the farming industry top heavy on that front but Fonterra needs to find a way to separate that from it's operations to make the most of it, which ultimately will improve the returns for it's shareholders more then the way it is going now.
The old "short term pain for long term gain" scenario.
To Theo Spierings: wishing you all the best with changing that.

think through some of the local legislation that obliges certain activities.

What New Zealand needs is a resolute strategy to reduce its dependence on this company and this industry. The damage these are doing to the country’s current reputation and future prosperity is incalculable. Its impacts on freshwater and vulnerable landscapes are nothing short of an unfolding national catastrophe. Its dependence on palm kernel feed is an environmental, health and biosecurity scandal – let alone an enormous failure of market intelligence.

And commercially? The industry is up to its eyeballs in debt. It depends on thousands of minimum-waged immigrant workers. The company itself? In the 14 years since its formation, Fonterra has met none of its industry-transformational goals. Its portfolio of low-value commodities rise and fall in price with tides totally out of its control. All that it is, is large – just as the phosphate industry on Nauru was large. And it is just as unsustainable. Yet we continue to dig away at the same deepening hole.

I have never heard any industry anywhere in the world talk so much about ‘rescue’, and ‘being rescued’. It is an attitude that is hard to believe, yet it appears to have the weight of a business strategy. Professor Keith Woodford (quoted NZ Herald, 28th August), is "very confident that in the longer run, China will come to the rescue and that our dairy industry will flourish". This is the constant refrain, whether to do with China or the TPP negotiations. All we need, it is said, is a new market. This is a self-referential world of short-term commercial, environmental and economic idiocy.

Perhaps we should have followed the Swiss way of selling farms and some of our industry issues wouldn't have arisen. Not sure how well it would go down with the NZ capitalist view of commerce ;-)

Farmers' children pay less for land
Selling farmland here is also very different. The land is given a yield value based on different factors such as topography, climate, size, distance to farmyard, etc. When passing on farmland to children, they must give their parents the yield value of the farm. Investment credit can be obtained from Swiss banks to help pay for this if you are under 25 and have an agricultural education.
However, if the farm is sold to someone outside the family, they must pay three times that value. This system prevents land prices from rising exponentially, as they have done in Ireland.

First NZ Capital
Fonterra reports a NZD 1 Billion fair value loss on foreign exchange derivates
They are gambling and lossing our money.

Where was that shown in the accounts?

Have a look at the Cash Flow Statement in the 2015 annual accounts - page 74

That statement declares a gain of $700,000 - not a loss

Of more concern is the increase in inventories of $1½ billion - huge

You are foolish if you believe anything written by Fonterra
Last year they lost 750 mill on derivates and hid it .
This is a coop that will unravel infront of us all.
Poorly managed poorly governed
Us suckers are there for the slaughter.

That is serious, if you are right, the auditors should be charged, disbarred, and fined

First you say they lost $1 billion on derivatives
Next I say - look at the audited accounts
They say they made a gain of $700 million on currency derivatives
It's there on page 74 of the above annual financial accounts
Then you repeat the claim they made a loss, this time $750 million

Which is it?