Failure to add value to production behind Fonterra’s continued losses
AUCKLAND: The contrast between Synlait Milk’s record firsthalf profit and Fonterra Cooperative Group’s interim loss suggest the world’s largest dairy exporter has not just got trouble with Beingmate Baby & Child Food, but a longrunning inability to move away from commodity production.
Last week, milk powder and infant formula maker Synlait Milk posted a firsthalf profit of $40.7 million, four times more than it earned a year earlier, as sales jumped 50% to $439 million. And Synlait is not the only New Zealand dairy company on a stellar track. Earlier this month, its key customer a2 Milk reported a 150% gain in firsthalf profit, as sales surged 70%.
Fonterra posted a firsthalf loss of $348 million for the six months ended January 31, after writing down its 18.8% stake in Beingmate, its Chinese infant formula distributor, and paying $183 million in settlement to Danone over the 2013 whey protein contamination scare.
But even before the onetime charges, Fonterra’s performance was less than spectacular. Volumes fell 11%, margins contracted by 6% and earnings before interest and tax dropped by 25%.
Comparisons between Synlait/ a2 Milk and Fonterra are not simple.
Fonterra is a complex business. Its cooperative structure, its vertical integration, its sheer size in the market, the fact it is reliant on not one but several commodity price structures, all come together to make the company, as Harbour Asset Management senior research analyst Oyvinn Rimer says, ‘‘like a machine with a million moving parts’’.
But still, it is a puzzle why Synlait and a2 Milk can deliver such strong financial results while Fonterra cannot. After all, the weather’s the same for everyone’s cows, they eat more or less the same stuff, and basic milk prices are the same. So what is different?
There is one thing that stands out strongly from the two sets of financial results: valueadded production. Making and selling innovative, highermargin products.
It is not a new idea at Fonterra — the company even has a name for its movingupthevaluechain strategy: V3 (‘‘Driving more Volume into higher Value at Velocity’’). As chief executive Theo Spierings said in 2017’s fullyear results presentation: ‘‘V3 is at the heart of our ambition and provides the foundation for us to fund and drive innovation and sustainable value creation.’’ Fonterra’s ‘‘V3 strength’’ had enabled the company to deliver ‘‘solid earnings in an environment of rapidly increasing milk prices’’, Mr Spierings said.
That was last year. But search back through previous financial results and Fonterra’s performance appears disappointing when it comes to driving more volume into higher value, let alone with any velocity. The company has three different categories of sales which fall into the ‘‘value added’’ basket: ‘‘consumer’’ (branded products for households — Anchor butter, Anlene adult milk powder, Anmum baby formula etc); ‘‘food service’’ (specialist Anchor branded products for restaurants, hotels, cafes etc); and ‘‘advanced ingredients’’ (clever stuff like pharmaceutical ingredients and designer proteins).
Those three categories combined made up 43% of Fonterra’s total volume in the latest half, up from 42% last year. Fonterra has changed the way it categorises its business units and only split out advanced ingredients as a separate item last year, making earlier comparisons tricky.
But consumer products made up 12% of Fonterra’s sales in 2014 and that has not changed since. Fonterra argues that total volumes increased over that time, so even though the percentage has not increased, the amount of valueadded product has. Still, it seems Fonterra did not manage to transform any of its commodity sales to consumer valueadded.
Even in the first half of this year, when Fonterra’s total milk volumes fell 11%, which should have given the company an opportunity to increase the proportion of valueadded sales compared to the total, the percentage in the consumer category only rose fractionally — to 13%.
Meanwhile, in the ‘‘advanced ingredients’’ category, the percentage has not moved from 19% over the last two results, even with the lower overall volumes this year.
In food service, the company has managed an increase. The percentage of sales has crept up every year, from 6% in 2014 to 11% in 2018. The company announced last year that food service had reached $2 billion in revenue. At the time, chief operating officer Lukas Paravacini said that if the category was a standalone company, it would be New Zealand’s sixthlargest export business.
Still, putting the higher valueadded consumer and food service categories together, Fonterra’s financial performance was disap pointing in the firsthalf result. Gross margin fell to 23.6%. Fonterra attributed the decline to the impact of rising butter prices that deterred consumers. Normalised earnings (ebit) fell almost 40%, and the result was even worse in Asia.
In its presentations, Fonterra uses a wheellike pie chart to illustrate the change from commodity dairy and base ingredients to valueadded. Marc Rivers, who started as CFO this month, says the wheel is turning, as the company moves more milk (measured in liquid milk equivalent, or LME), into consumer and food service.
‘‘Sometimes the wheel turns faster than other times. The reason we saw it slow down in the first half of this year is because our overall volumes were down 11% for the half year versus the same period last year. In consumer and food service we had another dynamic play out which was as customers responded to higher prices, especially for butter, we saw our product mix move away from butter towards cream, which uses less LME.’’ — BusinessDesk