Farmers are getting more milk from each cow – they deserve a much better performance from Fonterra

This   is the second  chapter  in the  woes  of  Fonterra, and  behind  it   the  dairy industry,  on  which the  New Zealand  economy is  so  dependent.

Point of Order   listed  some of those  woes    last  week.  Now, in the  wake  of  the latest  revelation,  Fonterra  will  have to absorb a loss of between $590m and $675m for the current financial year.

Critics   of the industry have  sprung  to the attack:  Minister of Regional Economic Development Shane Jones is calling Fonterra’s management “corporate eunuchs” and labels Fonterra’s board as “grossly inept”.

Greenpeace    has  a  simple solution:  halve  the   dairy herd, a move that would cost the country $8.3bn in lost exports, and lower the standard of living  of every  New Zealander.

Jones’ ideas  to resolve  Fonterra’s financial  difficulties  are hardly  more  realistic.

Sacking the board  won’t   solve anything:  nor  trying to  recruit  a new  executive team  (though it might be worth  asking Chris Luxon  if he’d take a look).

Jones   (and other  critics)  contend  the board,  if it  wants a  quick  fix,   will  have to insist  farmer-suppliers   accept a   lower  payout:  perhaps  by as  much as  50c a kg/MS.  The risk   is  that with credit  conditions tightening in the rural  sector,  many  suppliers  might  go to  the  wall.

They are   already  having to  forgo  a  dividend  from the  NZX-listed   Fonterra Shareholders’ Fund,  whose   market  capitalisation  has slid  28% to  $367.47m over the  last  12 months  (in the same  period  as  AT2 Milk   has seen  its  market capitalisation soar 48.9%  to  $11.79bn.)

There’s  a  fair  bit  of grumbling  in  the  dairy sheds   about  Fonterra, but it is  unlikely    they’ll be looking   to  the  Beehive for solutions.

Jones  likes  to  think   of himself  as a  bit of a  whiz   in the  field of business, having  once been chairman of the  Treaty of  Waitangi Fisheries  Commission.   So he  blames  Fonterra’s board  for  its “hubris”   and suggests   they  might  soon  come  knocking  on the  door  of  politicians  to get Fonterra  out of the financial  pickle  it  finds  itself in.

But he  also   notes a  good crisis   often  can open  a  well of  creativity.  And certainly  Fonterra   will have to go in search of  creativity.

There’s  no point in  shouting  back  at  the  politicians   they are  responsible   for  the legislation  that has been  such an incubus  for the co-op, insisting  Fonterra   take  every litre of  milk its  suppliers  offer it, and  making Fonterra   supply  milk to  some of its  big competitors in the retail industry.

In forecasting a loss of between $590m and $675m for the year current financial year, Fonterra said it expected to write down the value of four significant overseas ventures in South America, China and Australia by more than $600m.

The writedowns come as it reviews its business from top to bottom and looks to cut its debt by $800m this year.

CEO Miles Hurrell, said as a result of the review it has been undertaking of the entire group, it became obvious certain assets were overvalued relative to what they would earn in the future.

It has become clear that Fonterra needs to reduce the carrying value of several of its assets and take account of other one-off accounting adjustments, which total $820-860m.  While the co-op’s FY19 underlying earnings range is within the current guidance of 10-15c per share, when you take into consideration these likely write-downs, we expect to make a reported loss of $590-675m this year, which is a 37 to 42c loss per share,” he said.

The major asset writedowns were:

  • The DPA-Brazil joint venture with Nestle, written down about $200m because of economic conditions in Latin America. The business is under review and possibly up for sale as Nestle has indicated it wants to quit
  • A $135m adjustment following the closure of its Venezuelan operations
  • A $200m writedown in the value of its China Farms fresh milk operation because of underperformance
  • About $200m in the revamp of its NZ consumer business. It has already sold the Tip Top ice cream business as part of the restructuring
  • About $70m for the restructuring of its Australian business including the closure of its Dennington factory

Fonterra has been reviewing its business over recent months as it looked to cut its debt by $800m this year.

Hurrell   says  these are tough but necessary decisions to reflect today’s realities.

“They do not, in any way, impact our ability to continue to operate.  Our cashflow remains strong, our debt has reduced and the underlying performance of the business for FY19 (fiscal year) is in-line with our latest earnings guidance of 10-15c per share.”\

Whether   the  co-op    will  need  to  take  even  more drastic   steps  to  avoid  the   fate   of  becoming  one of   NZ’s  corporate  dinosaurs   (remember  NZ  Forest  Products  Ltd?   Or  Carter Holt Harvey?)   remains to  be  seen.

Presumably  the  board and   Hurrell   are  getting  the  corporate structure   (and salaries)   back   to realistic  levels    after  the departure  of  Theo  Spierings    set the pace    with  his  multi-million-dollar  sackful  and ensured  others  close to him  were paid    far beyond   any  skills  they brought to the co-op.

Dairy farmers  themselves   have  been  doing  their   bit to  increase  efficiency:  even    though the  number of  dairy  cows  has  become static and  may even  been falling, output  per cow  is  rising.  And thanks  to genomic  tools it could  keep rising.

What   Fonterra   needs is   similar   creativity,   both in  managing  its  capital  structure  and in  marketing  new  products.

Some authorities   believe  it has become too  bureaucratic  and  needs a  top-to-toe  overhaul,  perhaps    splitting   off   high-performing  businesses  in a  separate entity   which  could  attract   the capital it needs (or  find a  product   as  A2 Milk did  which  captures  both  a  premium  in its sales   as well  as delivering  health benefits).

It is   clear   Fonterra   needs a   new business  model,  as well  as   that  creativity  Jones  spoke about.


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