[This is the third of five articles on Fonterra written in early 2015 and published in the Fairfax NZ Sunday Star Times. This one was published on 15 February 2015. Earlier articles in the series were titled ‘The evolution of Fonterra’ and ‘Fonterra’s Journey’ ]
Within Fonterra, there is inevitable tension as to its role on the global stage. From a farmer perspective, Fonterra is a business with assets of about $20 billion (about half equity and half debt) which processes the milk produced by five million New Zealand cows. It then markets the resultant dairy products across the world.
Most of the value of these dairy products lies in the farm gate price of the milksolids contained therein. Accordingly, ask any of Fonterra’s farmer owners as to what they most expect and demand of Fonterra, it is likely to be that this farm gate price is maximised.
For every kg of milksolids, it costs farmers anywhere from about $3.50 to more than $5 in farm working expenses. Then there is interest on debt which on average takes up about another $1.50, and then with luck there is some profit left over. In years like 2013/14 there were big profits. In the current year there will be some big losses. So let there be no doubt: it is the farm gate price of the milksolids that is on the mind of every farmer.
In total, Fonterra’s New Zealand dairy farmers have assets of about $100 billion (about 70 percent equity and 30 percent debt). This is five times Fonterra’s assets. So for most farmers the economic health of their farms is more important than the economic health of Fonterra itself. They see Fonterra’s prime role as being to service their need for a high milk price.
However, Fonterra’s decisions affect a lot more people than the approximately 10,000 dairy farmer owners. Indeed Fonterra’s fortunes affect everyone in New Zealand. Depending on the year, Fonterra’s export earnings comprise anywhere from 20 percent to about 33 percent of national export income. That is somewhere between $2500 and $4000 for every person in New Zealand. We also know that each of these dollars of export income supports several dollars of internal economic activity.
As well as processing New Zealand milk, Fonterra processes and markets a lot of milk that has nothing to do with New Zealand. Currently, about 27 percent of Fonterra’s milk is sourced from overseas. Australia and Chile are the biggest supply sources, with China now becoming increasingly important. The difference with China is that Fonterra owns the farms rather than purchasing the milk from local farmers. Currently, Fonterra does not process its own Chinese milk, although that will likely change in the future.
Fonterra’s Australian milk processing business goes back to the Dairy Board days. Back in 2000, the Dairy Board agreed to take a 25 percent share in ailing Australian co-operative Bonlac. At the time I suggested to a Government-appointed Dairy Board director that Bonlac would prove to be a ‘lemon’. This director disagreed with me. ”No, it is not a lemon, it is an absolute dog. But we will turn it around!” Well, turning Bonlac around proved more difficult than expected.
Eventually Bonlac became 100 percent owned by Fonterra, and it became the foundation for Fonterra’s Australian operations. But being a dairy processor and marketer in Australia is a tricky business. In structural terms, the industry there has had over-capacity issues consequent to national production declining since the turn of the century from about 13 billion litres down to about 9 billion litres.
Fonterra’s Australian challenges have had remarkable similarities to the processing overcapacity and farm gate competition issues of the New Zealand red meat industry. To keep up the supply, Fonterra on occasions has had to pay more for milk than they would have liked. Fonterra does not publish separate accounts for its Australian operations, but there is no doubt that at times there has been plenty of red ink.
In Chile, Fonterra owns Soprole, which once again is consequent to a Dairy Board legacy investment. Fonterra’s partner there initially was a trust controlled by the Catholic Church. Eventually the Catholic Church decided to quit, and fortunately for Fonterra they did not see the opportunities ahead. So Fonterra came out of those negotiations rather well, and it has been a highly profitable business.
Soprole is the largest dairy processor and marketer in Chile. Depending on how the calculation are done, their market share is anywhere between about 22 percent and 30 percent.
Fonterra also has interests elsewhere in South America, and Fonterra’s Brazilian plans in particular are worth watching. But at this stage, in regard to South America, it is Chile that is Fonterra’s ‘cash cow’.
The story of Fonterra’s China operations is too big a story for just a few paragraphs. So that can wait for another time. Suffice to say that the San Lu debacle reinforced the importance of having the right partner. In contrast, Fonterra’s milk production farms near Beijing have met most of their key performance indicators, both physical and financial. Further expansion is planned.
In the modern Fonterra, the profits or losses from global operations are supposed to go to the dividend and not the commodity milk price. But the last financial year did not work out that way. It was a great year for commodities but a difficult year for value-add. If Fonterra had paid its New Zealand farmers the commodity price as calculated by the formula, then Fonterra itself would have made a considerable loss.
So Fonterra held back money from the milk price, and it still paid a small dividend. That dividend was necessary to keep the non-farmer investors happy. And there lies the tension in the modern Fonterra.