Fonterra fails to add value

‘‘For example, the initial investment in China was expected to be loss-making in its early years, before generating target returns after the business matures and reaches the required scale. Higher returns from these investments may yet be realised.’’ Shareholders Council report

Fonterra has failed to deliver ‘‘meaningful returns’’ on shareholders’ capital since inception in 2001, a new Shareholders Council report says, which questions the value-add strategy.

The much vaunted value-add business has returned only 0.2 per cent a year more than ingredients or commodities, ‘‘significantly below the 1.3 per cent a year premium needed to justify the increased risk’’.

‘‘This is important because the valueadd business units are now using an increasing share of Fonterra’s capital. For the first five years since inception – 2002-06 – the value-add business accounted for 36 per cent of Fonterra’s capital. This has increased to 50 per cent of Fonterra’s capital over the last five years.’’

Recent returns in the value-add business segment have been ‘‘severely’’ affected by the Beingmate write down of $439 million.

The report pointed out the recent investment in consumer brands and other value-add opportunities might take time to generate the expected outcomes.

‘‘For example, the initial investment in China was expected to be loss-making in its early years, before generating target returns after the business matures and reaches the required scale. Higher returns from these investments may yet be realised.’’

A shareholder who invested $1 in Fonterra in 2001 would find it worth $2.84 today, representing a 6.3 per cent a year pre-tax return. But if invested in the New Zealand Stock Exchange, that same dollar would be worth $4.79, a 9.6 per cent pre-tax return.

The report was prepared by Northington Partners on behalf of the Fonterra Shareholders’ Council, the body that represents the interests of the 10,500 farmer shareholders. It focused just on farmers’ return on capital invested in Fonterra, and not the farmgate milk price and dividend.

Fonterra could not easily be compared to other processors for a number of reasons: its obligation to supply competitors with milk; the fact it has to collect milk from a large catchment; its large scale; and its product mix.

Of all local processors, Open Country Dairy is the most comparable because it is the largest competitor and focuses on commodities. Over the past 10 years, OCD has delivered a pre-tax return of 7 per cent, compared to Fonterra’s 8.3 per cent.

The report also notes farmers have benefited considerably from increases in their land value over the period since Fonterra’s inception.