SOURED DREAMS
What’s gone wrong at Fonterra?
Part one of a three-part series
Text for Today
New Zealand dairy goliath Fonterra had a silver spoon birth nearly 18 years ago. Today the co-operative is looking a bit like the family’s overweight, lazy teenager hogging the remote on the biggest couch in the room. And the credit card bills are coming in. Andrea Fox has a look at its issues in the first of a three-part series
As big years go, 2001 was a monster. Top of mind is what has come to be known as 9/11, a date that changed our world. But other than the US terror attacks, the human genome sequence was revealed, 20,000 died in a huge earthquake in India, China entered the WTO, the Oklahoma city bomber was executed, and the US refused to sign the Kyoto agreement on climate change, to name a few events.
In New Zealand a dairy juggernaut business called Fonterra was launched. The new enterprise was to be a national economic champion.
Enabled by special legislation called DIRA which also deregulated dairy exporting, Fonterra was the result of an industry mega-merger which swallowed dairy co-operative companies responsible for 96 per cent of New Zealand’s raw milk collection and manufacturing, along with the single-desk exporter, the Dairy Board.
Industry thinking was “united we stand, divided we fall” and the hype was it would lift annual export revenues from about $12 billion to $30b within 10 years. For farmers, who pay to supply milk to Fonterra through the purchase of shares, the carrot was they’d never again see a milk payout with a lowly $4 in front of it. (They did.)
Fast forward nearly 18 years and Fonterra’s performance is in the spotlight — not for good reasons.
Last year it posted a historic first net loss of $196 million. Debt was $6.2b. More than $1.5b was written off its farmers’ balance sheets — the effect of a 27 per cent fall in the share price and a constrained dividend. The board then switched 5c/kilogram of milksolids from the farmer milk price over to its balance sheet to ease “a strained gearing position”. Credit rating agencies took notice.
The grim result brought to a head growing concerns about Fonterra among farmer-owners, economists, politicians and market analysts.
Now Kiwis, paying $5-plus at the chiller for butter and wondering if cheese is laced with gold, also joined
the chorus of questioners. How could this market dominator, still handling 80 per cent of New Zealand’s raw milk, be making such a hash of things?
Minds boggled at such huge debt — largely the result of investment losses in China and the cost of new stainless steel plants thrown up to meet a milk flood the company encouraged.
With environmental regulations and dairy farming debt of $40b continuing to concern the Reserve Bank, that milk flood has eased, sparking speculation about stranded assets. What happened to that magic figure of $30b annual revenue by 2011? Last year Fonterra’s normalised revenue was $20b.
And who on earth is making investment decisions at Fonterra?
Last year it had to write off $439m of a $750m investment in Chinese baby food company Beingmate made three years ago.
It has spent $788m developing dairy farms in China which have made a loss for at least five years. The loss for the 2019 half year was $21m.
For Kiwis, it seems the only things on the up at Fonterra — apart from debt — have been pay packets and staff numbers, now at 22,000.
Former chief executive Theo Spierings, who left last year, took home $8.2m in 2017, a year Fonterra posted a net profit drop of 11 per cent. Last year 6000 staff were paid more than $100,000 a year — 750 more than in 2017.
Fonterra has new leaders who have pledged to turn the ship around.
Seasoned farmer director John Monaghan has succeeded the late John Wilson as chairman, and Miles Hurrell is chief executive, on, we’re assured, a much smaller salary package than Spierings.
So what’s wrong with Fonterra? Agriculture Minister Damien O’Connor, whose first order in the job in 2017 was a review of DIRA, says one core problem is the debt level. Another is “the confusing signals coming from the company regarding its strategy and direction”.
“They need to be clarified for shareholders, for unit holders, for the wider country, given Fonterra’s importance to our future. Don’t look to the DIRA review outcome or the Government to fix Fonterra.
“Ultimately shareholders have to pay more attention, take a greater interest and be more actively involved in Fonterra at every level.”
Fonterra’s capital structure is the focus of what the minister calls “commercial hyenas”. They’re kept at bay by Fonterra’s collective cooperative strength, he says.
But calls are heating up for Fonterra to be split up and a company, perhaps listed, spun off it, open to outside capital investment to chase high-value product markets.
Brian Gaynor, of Milford Asset Management, says even major shareholders are telling him it’s time for change.
Breaking up Fonterra to chase capital is not a new idea. Shareholders have previously rejected it — their major concern, and still likely to be, how do they retain control of the breakaway?
Fonterra is a co-operative, 100 per cent owned by about 10,000 farmers.
There are myriad views why it isn’t performing but general agreement that lack of capital for growth is a major.
In a bid to retain capital and deter farmers from selling their shares to defect to emerging competitors which don’t require shares to supply, Fonterra in 2012 launched Trading Among Farmers (TAF). It saw Fonterra shares listed via the Fonterra Shareholders’ Fund (FSF) and dividend-carrying, non-voting units offered to outside investors.
Monaghan says TAF has been successful, but he’s a lonely voice. The shares listed with a hiss and a roar at $6.08, as investors seized a first opportunity to participate in the performance of the world’s largest dairy exporter.
Lately they’ve been trading around $4.32. Dividends have fluctuated wildly. No dividend was paid in the 2019 first half. Prospects of a full-year dividend aren’t bright.
Among the disillusioned is Craigs Investment Partners, which last year ditched FSF, citing volatile earnings, poor cash generation, limited transparency and lack of improvement despite capital expenditure of more than $3b in the previous eight years.
Craigs also noted the tension Fonterra’s oddball capital structure creates between shareholder classes.
As a co-operative, Fonterra’s reason-forbeing is to pay its farmers the highest possible milk price each year. This is the priority call on earnings.
FNZC managing director of institutional research Arie Dekker says TAF actually allowed Fonterra to take on extra debt.
“Fundamentally it did not provide Fonterra with a capital structure for the growth it looked to be targeting under the previous volume/value strategy of the last five years.”
Even Fonterra Shareholders’ Council chairman Duncan Coull asks: “How on earth can you grow a valueadded business when you starve it of capital? My personal view is it’s no wonder it hasn’t performed . . . given we as investors in the business expect that most, if not all, of the profits are paid out every year.”
Monaghan and Hurrell say Fonterra’s greatest challenges are reducing debt and rethinking its business strategy. Assets seem likely to be sold but this should not be confused with Fonterra addressing its capital squeeze, Hurrell says.
“One of the areas of concern I have … is we do a lot of things in a lot of markets. Some of them very well and some of them poorly. We are spread too thin.”
FNZC’s Dekker says Fonterra has disappointed with its inability to increase earnings and share value over a long period of time — despite an increased pool of New Zealand milk supply in the past 10 years and “reasonably material investment over and above what is required to maintain and support” that supply.
“Complexity appears to be an issue, as does a series of reasonably material — for Fonterra’s size — offshore investments that have not performed well.”
Monaghan says the first conclusions from the review will announced this month.
For Massey University business school senior lecturer Dr James Lockhart, Fonterra’s problems are the milk price/earnings retentions dilemma — and its attitude.
To counter Fonterra’s domestic market power, DIRA obliged it to accept all milk offered to it and to sell raw milk to competitors at a regulated price. The current DIRA review is addressing both obligations.
“Fonterra uses DIRA as an excuse for their strategy (not working) and for their pricing….that’s grossly misleading. That’s when Fonterra shows its ugly side,” Lockhart says.
Federated Farmers vice-president and shareholder Andrew Hoggard says farmers want change.
“A lot of farmers feel it’s time to be a kick-arse New Zealand cooperative and sell the story of New Zealand milk and all its grass-fed attributes grass-fed attributes. When you’re effectively putting Australian, Sri Lanka, Chilean, New Zealand and Chinese product all under the same brand you can’t really sell (that) story…”