Friday 30 November 2012 was a historic day for Fonterra. For the first time, non farmers could buy rights to Fonterra dividends and capital gain (but not voting rights on the shares themselves) through the Fonterra Shareholder Fund (FSF). Some 95 million shares were issued at $5.50. But within a few hours, more than 25% of these had traded at a price premium well over 20%, and the market closed with the shares priced at $6.85.
Fonterra will no doubt be very pleased with the successful launch of the FSF, as will all of those who managed to obtain shares at the issue price of $5.50. But the full implications of the new world at Fonterra will take some time to digest.
The opportunists who quickly traded their new shares made an immediate cash profit of over $32 million. In effect, this was a transfer of wealth from Fonterra to these transient investors. On reflection, Fonterra will recognise that the $5.50 issue price was somewhat low.
The share brokers will also be smiling broadly with their first day commissions on the traded $179 million dollars of shares. These Fonterra trades on a single day exceeded all other trades on the stock exchange for the whole week. The brokers would also have scored commissions on the initial $525 million purchase of shares into the fund.
Many Fonterra farmers will also be pleased. Their shares which only a week ago were valued at $4.52 are now worth $6.85. However, this value will now be subject to daily fluctuation, dependent on how non-farmer investors in the FSF view those shares.
Only time will tell whether or not the FSF works as intended, with so-called ‘fungibility’ between this fund and the separate Fonterra Shareholders Market on which farmers buy and sell their production shares. [By ‘fungibility’ is meant that the price on the farmer and non-farmer markets (the FSM and the FSF) should always be close to each other, through transfer mechanisms between the two funds.] But it is a complex scheme, and there is definitely scope for the unexpected.
Some of Fonterra’s competitors for the supply of milk will also be somewhat pleased. When new dairy farm conversions occur, if those new farmers now want to supply Fonterra they will have to buy their production shares at the new price; i.e whatever it is on the day of purchase. These new farmers will have to think carefully as to whether or not they might be better to supply another company that does not require these share purchases.
For example, farmers in several parts of the country, including Southland, Waikato, Taranaki and the Manawatu can supply Open Country without making any share purchases. Similarly, in most parts of Canterbury they can supply Synlait. The Westland co-operative is also taking on suppliers in Canterbury, and although purchase of production shares is required from Westland suppliers, their productions shares only cost $1.50 per kg of milksolids. (‘Milksolids’ – written as one word – is the industry term for the amount of fat plus protein; it is not actually the total quantity of solids in the milk as there are also lactose and minerals, whose presence is ignored in the pricing formulae.)
A typical new dairy farm is of about 700 cows. This farm will produce 250,000- 300,000 kg milksolids. If shares are priced at $6.85 then the capital outlay for these shares will approach $2 million dollars.
Although Fonterra farmers have made a book capital gain of about $2.33 ($6.85 minus the previous fixed price of $4.52 prior ot November 30)) on each share, their overall wealth gain may be somewhat less. When farms are sold, the buyers, and the banks who fund the debt, have to factor in the price of Fonterra shares when working out what they can afford to pay for the land. For a farm producing 1200 kg of milksolids per hectare, the extra outlay for the shares is close to $2700 per hectare. All other things being equal, then the per hectare price of the land will drop accordingly.
A big question is where will the price of the shares now head. My own thinking is that it may still trend upwards but with some volatility. The projected dividend (32 cents for the coming year) gives a cash return of about 4.7% on the current price of $6.85. This might be seen as low, but it reflects that Fonterra’s milk pricing mechanism leads to a considerable proportion of this dividend stream being low risk. This is because it is determined by accountants as a cost of capital calculation on the Fonterra processing assets. I expect that overseas institutions in particular will be keen to increase their holdings, and that most of the short-term opportunists were quickly flushed out on the first day of trading. With the prospect of non taxed capital gains, it still looks like a low risk investment that could be better than other low risk investments such as holding cash in the bank.
Fonterra farmers have been far from united in their endorsement of this new system of so-called Trading Amongst Farmers (TAF). To start with, it is a misleading name for the scheme, given that non farmers are also involved through the FSF, and it is these non farmers (and increasingly overseas institutions) who will have a major influence on the share price. As the weeks and months unfold, I sense that there will be increasing unease amongst some farmers about the way that their own farming businesses are now being influenced by what happens in the FSF.
If we go back five years, then all farmers in Fonterra had common interests. What was good for one farmer was good for all farmers. However, with some farmers now having non-production shares (on both the FSM and the FSF), that is no longer the case. Accordingly, my ‘sense of things’ is that, in the world of Fonterra from now on, there will always be factions within the governance structure.
2 December 2012