Fonterra moves on strategy and stucture

Fonterra pulls up the wagons to defend its territory, but is also hoping to sortie out with new nutritional endeavours

Fonterra’s release of its 2020/21 annual report has occurred in association with an additional big dump of information laying out the proposed future for Fonterra.  In essence, Fonterra is confirming that it is going to be a New Zealand company owned by farmers, with the first priority being to maximise returns to farmers.

That position should in itself come as no surprise. Fonterra has been talking that language for three years as it has divested itself of various overseas assets. However, this is the first time that there is a more comprehensive laying out of the long-term strategy, including consequent policy decisions. There are multiple headliners.

Current structure is not fit for purpose
Underlying everything is that Fonterra believes that the current structure is not fit for purpose. If they don’t do something about this, then they fear losing 12 to 20 percent of their New Zealand milk supply in the short to medium term. They very much fear the business implications thereof.

So, they believe there is a need to pull up the wagons into a defensive formation from where they can then sortie out to capture new opportunities.  They believe those opportunities relate to food service and active living, with the key markets being Greater China and South East Asia. Indonesia and Malaysia rank highly in their thinking. They also see an increased future American focus, although how that might evolve is unclear given that the USA is a significant exporter of milk.

Their big fear is that farmer suppliers of milk will transfer their business to new milk processors and they do have real cause for concern.

More divestments
Fonterra has announced that it is going to divest its Chilean businesses of Soprole and Prolesur. I have advocated that for some years. Fonterra has shown many times that it does not have the skill-set needed to operate in Chile, or for that matter elsewhere in Latin America. Currently, it is a distraction and there is no longer any strategic reason to stay.

More important is the announcement that Fonterra is looking at alternatives for its Australian operations, including the possibility of an IPO but retaining a significant stake. It will be very interesting to see how the market values those Australian assets.

Some of Fonterra’s Australian assets go back to last century and the days of the Dairy Board. One of the missteps back then was purchasing the Bonlac co-operative but without doing full due diligence. At the time, I was Australia-based and in a social situation I mentioned to a Dairy Board director that Bonlac was ‘a lemon’. The reply I got back was that it was ‘a dog’, but they were confident that they could ‘turn the dog around’.

The Australian business has always been long on promise but has never achieved as it could and should have done. There has always been lots of hype and associated massaging of the proverbial, but the numbers coming out of the Australian operations were always weak.

The challenge in selling the Australian Fonterra will be that a new buyer will want to do things its own way. If Fonterra wants to retain a stake, then the investors will want to ensure that Fonterra cannot dominate the strategy.

Fonterra’s big concern in Australia will be to protect its Australian markets for products produced in New Zealand. It has been important for Fonterra to be able to present itself in Australia as a local company when selling those products.

A new share structure
Fonterra’s directors have confirmed their enthusiasm for a new share structure but with minor tweaking from the earlier proposal out for consultation in May.  It is now proposed that farmers will be required to hold only one share for every three kilograms of Milksolids produced (i.e., each kg of fat plus protein, not total solids), but can hold up to four shares for each kilogram of Milksolids.

Fonterra’s directors must presumably be confident from their consultations that they can get this approved at the Annual General Meeting. This will be based on farmers looking at it from their own individual perspective, and voting accordingly. The big question is where does it leave the co-operative itself?

A fundamental principle of co-operatives is that members provide capital in proportion to the business that the member wishes to transact with the co-operative. However, the proposed structure is a very long way from that. 

Once again, I will be very interested to see how this plays out. My expectation is that over the medium term through to 2030, it will not play out well.  There will be huge misalignment between groups of shareholders. 

The Fonterra Shareholders’ Fund
Fonterra is now planning to retain the so-called Shareholders’ Fund. This is the confusingly-named structure set up in 2012 by which non-farmer investors could participate in the co-operative. However, the size of the Fund will be capped to its present number of units. Back in May the stated preference was to buy it out.

The three independent directors of the Fund have reacted negatively to this amended proposal. In essence, they are saying to Fonterra that Fonterra should make an offer to unitholders to buy back the fund at a fair price.

Perhaps surprisingly, the price of these Fonterra units has risen following the announcement. Why anyone would still want to buy these units is somewhat of a puzzle, unless it is indeed on the speculation that when push comes to shove, Fonterra will still buy back the fund. In the current environment, the Fund is like a fish out of water.

More on market supply and demand
Fonterra thinks that New Zealand milk production will at best remain flat. They also think that as long as farmers are required to provide significant capital that some will be more than tempted to shift to other processors.  In that environment, a high share price becomes a problem.

That in itself is a remarkable situation. When has a company ever before wanted a low share price? This is indeed a very different Fonterra from the Fonterra of the past.

On the demand side, Fonterra sees the global demand for milk increasing. This is in contrast to some influential people in Wellington who are greatly concerned about artificial milks. My own thinking tends to align more with Fonterra on this one.

My one big caveat on the future of milk is that Fonterra has to convince its farmers to get their herds across to A2 cows and to finish the job quickly. It is a nonsense for Fonterra to be pushing the special nutrition of milk until it does this.  I know of an overseas co-operative that is saying to all its farmers that the time has come to shift to A2. I also work with groups in multiple countries who are doing this.

About Keith Woodford

Keith Woodford is an independent consultant, based in New Zealand, who works internationally on agri-food systems and rural development projects. He holds honorary positions as Professor of Agri-Food Systems at Lincoln University, New Zealand, and as Senior Research Fellow at the Contemporary China Research Centre at Victoria University, Wellington.
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4 Responses to Fonterra moves on strategy and stucture

  1. peter vause says:

    Am I missing something here? Fonterra is hard selling its preferred re cap option that appears to discount our existing “share” (or more correctly milk supply entitlements) investment, at a stroke, by 75%. For a 200,000 shared farmer who bought in at $4.50 per share that represents a significant loss of capital.
    Fonterra’s road show flannel suggests we shareholders will want to keep our original shares due to great dividends that will be coming from some future “pie in the sky” down stream product growth.
    Great! but who is going to buy my 3X overshares back when I want to quit?

    • Keith Woodford says:

      Peter,
      I do not think you are missing anything.
      Personally I think it is a huge mistake by Fonterra.
      If I were a Fonterra farmer I would be down-selling my shares as fast as possible, hopefully before the price crash happens.
      Even if the dividends are very high, there will be a share liquidity problem some time down the track.
      Given all the smart people in Fonterra, I find this incomprehensible.
      At some stage the share price will collapse – this may take several years, and I don’t have a specific timing in mind – but when Fonterra has a rough year and some farmers are in difficulty then there are going to be a lot more sellers than buyers.
      It will also mean that a few farmers who do buy up to the level of four shares per kg MS are going to have very large voting power.
      [I need to clarify that their voting still has to be production backed. So their voting power will only be three times those of a farmer who ‘down shares’ to one share for 3 kg MS. But these shareholders will want to see ‘profit’ transferred across the dividends, whereas farmers who sell down their shares will want to see it in the milk price.}
      Keith

  2. Arie Dekker says:

    Under the proposal, voting will still be limited to share backed supply

    • Keith Woodford says:

      Arie,
      Yes, and in the context of all the other changes, I think that is the correct decision. However, the internal tension between shareholders will now be very considerable. A key question for the long term will be where can Fonterra get new capital from when it eventually needs that capital. And thank you for alerting me that my previous reply to Peter Vause was misleading – I have now updated that!
      Keith

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