Keith Woodford explains why Fonterra’s strategic reset depends on board personalities as well as strategy

By Keith Woodford*

Fonterra’s December update shows that the strategic reset is under way, albeit at an early stage.

Key indicators include that the Beingmate JV is being unwound and that Fonterra’s China Farms are under heightened scrutiny. The big shock is that Tip Top is on the market. The ownership of Soprole in Chile must also be under scrutiny, although little has been said publicly.

I will return to those issues within this article, but first it is necessary to understand something of the dynamics within the new Fonterra Board.

Farmers spoke very clearly when they recently elected renegade director Leonie Guiney, who was previously ousted in 2017 in what was essentially a Board room coup by fellow directors. One year later, Ms Guiney scored a 63 percent vote in the 2018 director elections. It was a stunning rejection of the Board’s own recommendations for those 2018 elections.

Fonterra has this year lost three experienced farmer directors. First there was the departure of John Wilson for health reasons. Then longstanding director Nicola Shadbolt missed out on being renominated by the official selection process. Then Ashley Waugh just failed to make the required 50 percent minimum support by farmer shareholders.

So, at the time of writing, Fonterra is left with only six farmer directors, with only Monaghan and Guiney having more than two years of experience.  Monaghan has been on the Board for 10 years and Guiney had a three-year term from 2014 to 2017. Another director will soon be added in a runoff between two of the previously unsuccessful candidates in the 2018 election.

There are multiple lessons to be learned from recent events at Board level. The first obvious lesson is that the farmers have clearly voted for change. The massive farmer support for outgoing Zespri Chair Peter McBride to become a Fonterra director provides further confirmation of that.

The second lesson is that the current system of voting for directors is a shambles. To some of us, this insight comes as no surprise – it was inevitable that the system would lead to power politics, group-think, and eventual shareholder rebellion.

Underlying those messages is the largely unspoken reality that the old Board had become dysfunctional. There was an inner and an outer Board, and Guiney was clearly on the outside during her first term. However, the friction went much deeper than that.

There is an old saying that there is only room for one bull in a paddock, and for the least ten years there have been multiple bulls in Fonterra’s Board room. Of course, corporate bulls do not necessarily all have the same gender. The point at which strategy and personality differences intersected was often opaque.

Whereas internal frictions were held well in check in the early years of Henry van der Heyden’s tenure, by the time he left in 2012 the situation had become unmanageable. There have been tensions ever since.

One would hope that Fonterra’s new chair, John Monaghan, will have reflected on the need to welcome diversity of thought and to manage that diversity. It won’t be easy. The alternative leads to group-think.

When Guiney was first elected, I recall a discussion I had with some wise Fonterra farmers who recognised that the highly intelligent and forceful Ms Guiney would need to choose her battles. Whether or not that occurred is not clear to those of us on the outside, but she sure rubbed some other directors up the wrong way.

The issue now is that recent outcomes have demonstrated very clearly that Fonterra has been performing poorly. That can no longer be denied. However, there is room for debate as to whether the fundamental problem has been poor strategy or poor execution or both. That debate may well shape the chosen path ahead.

My own view is that the seeds of the problem were sown a long time ago, and I have been writing about those issues for many years. The fundamental flaws have been fifteen years of insufficient retained profits, combined with muddled understanding of the China opportunities, together with poor choice of China partners and associated strategy. There has also been fifteen years of failure to identify the forthcoming A2 revolution.

It is incredible to think that The a2 Milk Company, which generates nearly all of its profits from a2 Platinum infant formula produced under contract by Synlait and sourced from around 70 Canterbury farms, now has a greater capital value than Fonterra. This is despite Fonterra having held a 50 percent share in the original A2 milk patent.

Fonterra’s historical errors are now going to haunt Fonterra for quite some time. Finally, Fonterra has recognised that it is capital constrained and that it needs to reduce debt. The stated target, at least initially, is to free up $800 million.

A key issue is whether Fonterra will now focus on simply trying to strengthen its balance sheet, or will it reposition for another foray into value-add.    

Sorting out Fonterra’s messy relationship with Beingmate is likely to have unanimous support from the new Board. But that will not release a lot of funds, given the need to buy back Beingmate’s share of Fonterra’s Darnum Park in Australia as part of the overall divorce proceedings.

I have previously discussed the issues around the sale of Fonterra’s China Farms and so I won’t repeat them here. Suffice to say, that despite lingering and incorrect assertions that Fonterra had no option but to originally make this investment as part of the political cost of extricating itself from San Lu, it is now a costly indulgence. Fonterra does not have the necessary skill-set to be a Chinese dairy farmer.

A key question with Fonterra’s China Farms is that the value of the assets remains unknown until the market is tested. But it could go a long way to satisfying Fonterra’s bankers.

The other obvious asset to sell is Soprole in Chile, and indeed all of Fonterra’s South American assets. These assets have been earning good profits but in the new Fonterra they have minimal strategic value. Their sale may well realise something around $1 billion. However, their sale will also highlight how important Chile has been in buttressing Fonterra’s public relations messaging about its value-add strengths. Once gone, some of the emperor’s value-add robes and value-add profits will drop away.

Given the above context and sale opportunities, it is remarkable that Fonterra is exploring the sale of Tip Top.  It seems to say that Fonterra no longer sees itself as a consumer-focussed value-add company.

CEO Hurrell has stated that Tip Top is in a mature New Zealand-based market, and that Fonterra is unwilling to make the necessary investment to take it to a new level. Yet, if the new Fonterra were to have an international consumer focus, then Tip Top could well have been the vehicle to take A2 consumer products to Asia.

The biggest question of all for Fonterra to resolve as it searches for its future path is to work out how to manage the A2 issue. Many of the A2 trains have already left the station, and Fonterra is not well organised, but the last trains are still to depart.


*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. He can be contacted at kbwoodford@gmail.com

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22 Comments

KW, a great article. Your view - outside the tent but inside the wider paddock, is an invaluable counter to the turd-polishers in the PR department(s?) of the Big F.....

Big ships are hard to turn.

We could think of Fonterra as being similar to the Titanic...

Good article Keith. Not that I know anything about Fonterra. But at the time I did note the shareholder uprising and how they returned Leonie Guiney. That was a thing that rarely happens in corporate world. I would like to see it more, and that shareholders are owners and should be respected as such.

Hi Keith I always read your articles and find them to be sensible and well thought out.

Thanks Keith, great article.
I keeping thinking Fonterra problems will work on down to troubles on the farm, especially corporates and then onto banks.

I had a friend who was working with banks this winter on several large dairy farms, he told me breakeven is too high with many over $6.20 and irrigated farms even higher. He said many irrigated dairy farms are facing a world of woe.

Keith what happens to the value of Fonterra shares? I though most farms had 2k plus a cow in shares. I remember when a friend of mine who banked with BNZ, got a free holiday every year when the shares went up and the BNZ lifted his O/D by the same amount. Because Fonterra shares were as good as gold.

Andrew
When shares were at $6.20 or thereabouts it seemed obvious to me that they were overvalued.
Now that they are around $4.70 it is not quite so clear cut.
One of the fascinating things is the extent to which the FSF has declined in size (number of shares) over the last year. This has been driven by farmers sharing up - presumably the My Milk crowd - and these shares are taken from the FSF. I had not factored that in. Otherwise the share price would have drifted even lower.
I agree that there are farms that now require a milk price of around $6.20 - typically large highly indebted properties and also some tier 3 properties. I am aware of some debts that range from $30 to $40 per kg MS. Now, these numbers may not be large, but it does not take too many forced sales in an environment of a lack of buyer demand for land prices to drop precipitously.
The only link with irrigation and viability is that some of these irrigated properties have high debt because they are relatively recently converted to dairying. So far this year, the irrigation pivots have largely been sitting idle because of the amazing spring. Ironically, the South Island irrigation farms need a good old North island drought to push up the milk price - those are the years they do particularly well.
I am reminded of a great line from Goodbye Pork Pie. "There's only one sure thing is this life, and that's doubt. I think"
KeithW

Keith, there was a dairy farm auction North of Pahiatua a couple of weeks ago, really nice farm, Schroders family, my bank manager told me no one turned up to the Auction.

Andrew,
There are some Waikato farmers who have been paying high prices for runoff blocks. Elsewhere there seems little evidence of prospective buyers for dairy farms.
KeithW

Supplement block asking $65k/ha sold within a couple months:

https://www.bayleys.co.nz/2310101

There are multiple dairy farms within 10 mins of this place that are asking less and have been on the market much longer

We have a large corporate handy to us. One of the equity managers told me once one of his biggest bills was the money he had to pay towards the depreciation of the irrigators. Even when they sit still, costs mount.

This could be one of the great MBA case studies. From my non-dairy eye, Fonterra were lured offshore by shiny trinkets of Chinese gold when the transformative innovation was happening at home under their noses and they missed it. Add some management hubris to the mix and voila.

by shiny trinkets of Chinese gold

And in today's world I wouldn't be surprised if there had been a Panamanian bank account set up in there somewhere too.

LOL - I've moved to decaf from mid day onwards.

Fonterra should get Tip Top to manufacture A2 Ice Creams and export the $%$# out of them. The Chinese would lap them up, literally.

What about CBD A2 milk?

Westie
If I were in the tent then that would be very high on the priority list for fmcg product development.
KeithW

Chinese Icecream sales are growing year on year. China is now the worlds biggest ice cream market. Sales were USD 14 billion in 2016. But around 90% of Chinese are lactose intolerant. One of the main claims of A2 milk is that it helps with digestion of dairy for those people who are lactose intolerant. Seems like a match made in heaven,

URL please for 'One of the main claims of A2 milk is that it helps with digestion of dairy for those people who are lactose intolerant.'
The A2 website Q & A states 'Does a2 Milk™ contain lactose?
Yes, a2 Milk™ contains levels of lactose comparable to that of standard milk. If the switch to a2 Milk™ allows you to enjoy dairy again, this is occurring in the presence of lactose.
https://a2milk.nz/questions-answers/

I was advised by a child health professional that if your child is truly lactose intolerant then any milk from an animal mammary gland - sheep, goat, cow etc will affect you. If you can drink milk from these animals then you are not lactose intolerant.

Casual Observer
The issues are somewhat complex:
1. All milk of mammals contains lactose
2. Many people do have intolerance to lactose
3. Many people who think they are intolerant to lactose are actually intolerant to A1 beta-casein
4. One of the effects of A1 beta-casein is to slow down the passage of food through the digestive system.
5. Lactose intolerance(caused by insufficient lactase enzyme) leads to fermentation of lactose and this is the root cause of the lactose problem.
6. Slowed passage of food due to the digestive products of A1 beta-casein exacerbates the fermentation of lactose prior to final expulsion in the faeces.
7. Hence, people with a tendency to lactose problems suffer more when consuming A1 beta -casein.
8. Here is a relevant url. https://academic.oup.com/advances/article/8/5/739/4772179
9, Here is some additional evidence. https://nutritionj.biomedcentral.com/articles/10.1186/s12937-017-0275-0
10. The issues of A1 beta-casein extend well beyond intolerance issues. I write about these other issues periodically at https://keithwoodford.wordpress.com (see A1 and A2 milk category). More will be forthcoming.
KeithW