The forthcoming asset write downs of more than $800 million announced on 12 August by Chairman John Monaghan are clearly damaging to Fonterra’s balance sheet. It also means that Fonterra will now make a loss for the year of around $600 million. However, the implications go much further than that.
The losses mean that Fonterra will need to sell more assets to bring its ‘debt to asset ratio’ under control. The losses also ping back to the balance sheets of its farmer members, where the Fonterra shares are assets against which these farmer members have their own debts. Many dairy farmers are already struggling with their balance sheets, with banks now requiring debt repayments on loans that used to be interest-only.
If these write downs are the full story, then Fonterra will survive. The big question is whether these are all of the write downs, both for now and the foreseeable future.
It will be no surprise to those who have been analysing Fonterra that asset write downs would wipe out this year’s operating profits. For analysts, the surprise will be the extent of the losses and where they have come from.
In contrast, most of Fonterra’s farmers had no prior insight as to the emerging situation.
One of the worries is that Fonterra has made no comment about its Chilean endeavours with Soprole and Prolesur. There is a risk these may prove to be considerably overvalued.
There is also concern that we have only seen the first stages of necessary Australian rationalisation. Not only is Australian dairy production in decline, but Fonterra has been losing market share to its competitors. It would be remarkable if the $70 million Australian write down, which includes the $50 million loss associated with closing Denniston, was the end of that story.
Beingmate is another worry. This is currently in Fonterra’s books at around $244 million. However, based on current share-value of around 5 RMB, a value of around $190 million looks more appropriate.
I don’t know anyone who foresaw the announced loss of around $200 million for DPA Brazil. That would have been well below the radar for most of us who try and figure out what is happening at Fonterra.
Similarly, the overall projected write down of $200 million for New Zealand consumer-based activities seems totally remarkable. This figure is net after allowing for Tip Top having been sold well above book value. The other consumer-based activities in New Zealand must be in big trouble.
There are now increasing questions to be asked about what is going to happen to the Fonterra Shareholder Fund (FSF). This is the entity where non farmers purchase a financial interest in Fonterra, and it is this entity that determines the price of shares at which farmers also purchase and sell their shares in the Fonterra Cooperative Group (FCG).
The FSF has been shrinking in size and even more so in value over the last 12 months. The reduction in size has come about because farmers were wanting to buy FCG shares to meet their production requirement for shares, and these shares have come units in the FSF.
This need for purchase of shares by farmers has coincided with a loss of confidence by institutional investors in the FSF. To a large extent it is now the small retail investors who have been left as unit holders. They tend to be less well informed than institutional holders, but there must surely be a limit to their patience.
It is now increasingly difficult to see how Fonterra will be in a position to pay a dividend, not just for the year just ended for which there is now definitely no dividend, but in the immediate years ahead. It is easy to see a further weakening of the price of units and hence also farmer-owned shares as this reality dawns on the retail unit investors. Why would any non-farmer investors want to retain units in the present environment?
Farmers have a right to be angry at being blindsided by these losses. There was no hint from Fonterra that these losses were likely until now. Rather, Fonterra has been resistant to the perspective of a range of commentators that things were not all well at Fonterra, and that Fonterra’s challenges were greater than had been admitted. In these situations, farmer instincts have been to trust the leaders of their company.
Fonterra has also now announced that the Board is looking again at its capital structure. Serious attention will need to be given as to whether the current capital structure is fit for purpose. Any move to undo the current structure of farmer members and non-farmer unit holders is likely to be messy.
The problem that Fonterra now has is that it needs more capital but there is no obvious source. This is not a new problem but it has now got worse.
I have always been sceptical as to whether the current capital structure, implemented in 2012, would be long lasting. Until now, it has not really been tested given the benign environment of the last few years. It certainly is going to be tested now!
Currently, there is not enough information to make any further definitive judgements. We will have to wait until September when Fonterra publishes its annual accounts. Even then, there are likely to be more questions than answers. I expect that farmers will be much more demanding of both Chair John Monaghan and CEO Miles Hurrell than they were at the last AGM.
(My previous Fonterra articles can be accessed at https://keithwoodford.wordpress.com/category/fonterra)