Heartland: Fonterra needs a circuit-breaker to restore confidence

In the run-up to releasing its half-yearly results on Wednesday, Fonterra did a considerable amount to ensure that its financial position looked strong, that it was doing the right thing by its farmers, and that decisions were in safe hands.

Maury Leyland, recently departed managing director of people, culture and strategy, fronted the move to the starry new building in Auckland; CFO Lukas Paravacini explained the decision to change the payment time to some suppliers; and for anybody wanting to know Fonterra’s theories behind why the milk price has fallen, managing director of global ingredients Kelvin Wickham is on the Fonterra website explaining at the click of a button.

Sales and expansion
Since the last financial report, Fonterra has sold its shares in Bega cheese (October), the shares in DairiConcepts to Dairy Farms America (November), its Australian yoghurt and dairy dessert brands to Parmalat (December), and announced the Kaikoura cheese plant will close.

It has also remained committed to expansion.

The governance review, which shareholders have likened to rearranging deckchairs, appears to be predicated on becoming a 30 billion litre company with milk pools around the world.

Fonterra has confirmed that more calves from New Zealand are being prepared for China “because herd expansion has been planned.” This is despite the fact that the Chinese farms appeared to lose $44 million last year (before interest costs and tax).

The investment in China has been estimated at $364 million in farm development and livestock purchases. Some shareholders are questioning the expansion strategy; others are pointing out that leaving would involve sunk costs, loss of face and damage to Kiwi-Chinese relationships.

This is the moment for leadership and confidence building in the shareholders and Fonterra employees. But an increasing number are concerned the right decisions to ensure a strong Fonterra are not being made.

In particular, the chief executive and chairman of the board were noticeably absent in the run up to the interim report announcements.

It is possible they were in meetings with, for instance, the credit rating agency Standard & Poor’s – but shareholders simply see a void.

S&P meetings are important. Last year’s credit rating downgrade was associated with Fonterra’s investment in Chinese infant formula company Beingmate. Product is expected to be exported from Fonterra’s Darnum plant (in Australia) to China later this year.

In the annual report last year, it appeared the Australian operations were in the red. Professor Keith Woodford, honorary professor of agri-food systems at Lincoln University, calculates the loss in 2014/15 was probably of the order of $200 million once one-offs were included – but comments that “given the way Fonterra bundles New Zealand and Australian operations together, it is impossible to be precise,” which echoes the difficulties other analysts have expressed.

From his “fossicking” in Fonterra’s annual report, Professor Woodford concluded that “once one scratches below the surface, there is plenty to worry about.”

Investment analyst Brian Gaynor appears to have reached the same conclusion. In February he calculated Fonterra’s debt at $7.56 billion and net finance costs at $518 million.

This implies an overall interest rate of 6.85%. That being the case, any suggestions that farmers should take an interest free loan from Fonterra overlooks the fact that Fonterra is paying a higher interest rate than farmers can achieve themselves.

Confidence from changes in culture, strategy, people
What is needed is what has been described by shareholders as a circuit-breaker – a change in culture, strategy and, in some cases, people, which would allow confidence to return.

Mr Gaynor states, “Fonterra may be trying to be too many things to too many people.” He suggests Fonterra “has the ability to reduce its farmgate milk price to maintain its A- credit rating but may be reluctant to do this because it could put some of its loans to farmers at risk.” But Fonterra did drop the milk price and another loan is back in the mix. The effect on the S&P rating will be interesting.

What farmers want is a decent dividend to offset a low milk price, or a milk price that covers costs of production. Neither is apparent.

And “what they want, what they really really want” is a strong co-operative. The jury is still examining the accounts.

Requirements for fossicking aside, the Spice Girls had it right: Get your act together, we could be just fine. The clue is leadership and leadership is enabled through governance.

Jacqueline Rowarth is professor of agribusiness at the University of Waikato,

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