Fran O'Sullivan on business

Business analysis and comment from Herald columnist Fran O'Sullivan

Fran O'Sullivan: Fonterra can't keep putting clock back

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Theo Spierings. Photo / Dean Purcell
Theo Spierings. Photo / Dean Purcell

Fonterra chief executive Theo Spierings is selling dairy farmers the proposition that the company's growth plans will not be met unless it first secures its capital base.

When Fonterra launched its capital restructuring plan 18 months ago, it signalled a shift to "trading among farmers" or the "Taf".

This was predominantly sold as a mechanism to ensure farmer share redemptions do not weaken or threaten the company's balance sheet.

Fonterra drastically deleveraged its balance sheet when the global financial crisis impacted on key markets and dairy prices and the credit crunch drove up the price of debt.

But as things currently stand, it is obliged to cash up farmers' shares if they want to leave the company or reduce milk supply.

This means the balance sheet is subject to possible future runs on capital, if dairy farmers' own finances come under pressure because of drought, market collapse or disease - or simply if they decide to supply one of Fonterra's rivals.

The problem is many of Fonterra's 10,500 shareholders are worried that the Taf - which involves issuing dividend-carrying units in farmer-owned shares to the public and listing those units on the NZX - will lead to them losing control of the company.

This is a circular argument that should have been settled months ago. But judging by the questions at last week's shareholder meetings, there is still a huge amount of suspicion among farming ranks.

Frankly, they have no option but to move forward.

Spierings' presentation makes a compelling case for why Fonterra can't keep on putting the clock back when its farmers reject capital restructuring proposals.

The plain fact is, if the co-operative doesn't firm up its capital base it will not be able to fund the big expansion that will be necessary. This is not only to secure its current position in the global dairy trade during a time of massive demand growth, but also to underpin its position in key growth markets and leverage looming opportunities such as India.

Spierings road-tested Fonterra's new strategy "at a high level" during a number of meetings with farmer shareholders last week.

Judging by the meeting I tuned into, Fonterra chairman Henry van der Heyden still has considerable work to do to quell rumbles that the upcoming "trading among farmers" platform will pave the way for privatisation of the co-operative.

It was hard not to have some sympathy for van der Heyden as he patiently reminded his shareholders that they did overwhelmingly vote in favour of the Taf 18 months ago.

What is positive is that the strategy - or "strategy refresh" as Spierings terms it - has already won broad acceptance from the Shareholders Council, according to its chairman, Simon Couper.

Assuming the strategy is approved at the Fonterra board meeting on March 28, the business will be substantially refocused.

Fonterra will divide its geographical markets into three categories.

First, the vital "cash generators" (NZ Milk, Middle East and North Africa, Australia, US and Europe) where Fonterra's branded positions will be driven hard to produce more cash. These are the "must dos" which generate cash and ebit.

Secondly, the "growth generators", the fast-growing markets such as China, Asean and Latin America already taking 50 per cent of New Zealand produced milk.

Spierings' contention is that if Fonterra does not cement its market in these fast growing regions by looking at adopting integrated models, it could lose its positioning.

But if Fonterra wants to continue to be a player in world dairy it has to take note the emerging markets will show the strongest demand growth over the next decade.

Thirdly, the "new business generators" such as India. The dairy market is currently closed to New Zealand milk. But Fonterra is looking at establishing a small operation and office, possibly a model farm. And when the bilateral FTA is negotiated and the borders open to New Zealand, it could be a "huge" play.

The fundamental point that Spierings has been making is that global dairy growth trends are galloping. He expects production to increase by 160 billion litres by 2020. Fonterra expects another 5 billion litres could come from New Zealand sourced milk (on top of the existing 20 billion litres).

But if Fonterra is to exert any influence in the global dairy trade, it will have to keep pace by securing more fresh milk overseas to service demand growth in those markets.

This all takes capital.

In China, for instance, Fonterra has to decide whether to build a production plant which will make product from fresh milk supplied from its growing farming base. Right now, its Chinese farms and its branded business are not connected. But it has the opportunity to control the chain from the farms to the factories and to good brands.

Fonterra is also focusing its attention on the special products to meet consumer demand for better nutrition for mothers and children; enabling the ageing to lead more healthy and active lives; controlling unhealthy cravings to control weight; and developing better convenience foods.

The strategy is compelling.

But as Spierings notes, the capital base can't leave.

Much of the detail of the strategy - along with proposals to restructure the business to support the "less but more focused" initiatives - will be unveiled on March 29 when Fonterra's result is posted.

The mantra makes sense: if all goes to the developing plan, Fonterra will drive topline growth to protect the milk price and produce more ebit, generate cash for growth, post a higher return on capital and maximise shareholder wealth.

Who could disagree with that?

All it takes is the kind of foresight and daring that farmers displayed when they merged two major companies and the dairy board into Fonterra more than a decade ago.

- NZ Herald

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