Fonterra must learn to be driven by  profitability, not  volume 

Fonterra  chairman  John Monaghan  sought to   cheer  up  the  co-op’s farmer-shareholders  by telling them  at what was reported to be a “packed” annual  meeting  that  “For a time this year, NZ farmers were paid this highest milk prices in the world.”

He  insisted there has been a structural change in  the co-op’s milk prices since Fonterra was formed.

We’ve gone from being paid about half as much as our global peers to the point now where we are consistently paid the same or thereabouts.It sounds arrogant to say it, but the fact is that simply never would have happened without a strong Fonterra”.

Whether he succeeded in raising the spirits of  Fonterra’s  suppliers  is not clear. For, in what  was  a masterly  understatement,  he had  to  confess  the performance in the past year of the dairy giant  had been “disappointing“.

After  delivering  a  $196m loss for the year ended July compared with the previous year’s profit of $734m, largely due to writedowns of $439m in its investment in Chinese dairy company Beingmate and a $232m payout to French food company Danone after the botulism contamination scare, the co-op is now  seeking to protect its  balance  sheet by  reducing  its  debt  level by  about  $800m.

In the  process  it  may have to  flog  off some  assets, though Monaghan argues  it  won’t be  a  “fire sale”.

(At  that  point,  some of the farmers  present  might have whispered  to themselves:  “God help us”)

Fonterra,  after all, is supposed  to  be  the   “national  champion” but the  unpalatable fact  is  that shares in  Fonterra   are worth  only  28% more than in  2001—against the  400%  increase in the NZX50 index (and its predecessor).  Over the past  10 years , while  production on the average farm  has increased  40%, term borrowings have nearly doubled.  Annual  return on assets  has averaged 5.7%.

The painful lesson,  yet to be  fully  absorbed  by either  Fonterra’s  governance,  or its suppliers,  is that the business  has to be  driven by  profitability, not  volume.

Fonterra’s  interim  CEO Miles Hurrell   had the   task of  explaining   that in  seeking  to  cut  the  co-op’s debt level  the aim is to improve earnings so the debt-to-earnings ratio returns to  the target range.

“We are reviewing all discretionary incentives in the pipeline and challenging all spending to help us achieve this.

Fonterra has set its capital expenditure at $650m – a reduction of $221m

It is working to reduce its operational expenses to the levels of the 2017 financial year.

Hurrell said that operational expenditure had risen by 7% – or $161m – in the last financial year. The increase was planned but it had expected its earnings to be higher – “and this didn’t happen”.

Balancing our expenditure and earnings is a key focus for us going forward.”

Monaghan identified three assets that it may exit as part of its review of its operations, as these are no longer considered core to its strategy.

One of  these investments is in Chinese dairy company Beingmate.  But he did not identify the other two.

“At this stage nothing is off the table and if we choose to divest the ownership of an asset it could be in full or in part,” he told the meeting.

“The board’s intention is to make a decision on each of these investments and complete the transaction within this financial year.”

 Monaghan said the second phase of the Fonterra review is to take stock of all assets, investments and partnerships.

We are taking a clinical look across our business.There’s no room for being sentimental.This may mean exiting certain investments that are no longer core to our strategy, reallocating capital to new or existing ventures, or simply reducing debt. We have some tough decisions to make.

Good luck with that,  say the  rest of us.

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