Fonterra switch will impact on Dairy Equity scheme

Geoff Taylor says if Fonterra does adopt a new measure, he would like to see alignment between it and his company. Picture / Mark Mitchell

A likely change to the way Fonterra measures value-added returns could significantly affect the attractiveness of the $100 million Dairy Equity scheme aimed at dairy farmers and investors, industry sources say.

The scheme - fronted by former Fonterra corporate finance manager Geoff Taylor - would see farmers paid cash for a beneficial interest in their co-op shares, including the value-added returns included as part of the payout.

Dairy Equity's plan is to define value-added returns as what is left from total farmer payout once the Fonterra commodity milk price (FCMP) is deducted.

Broadly speaking, FCMP is what Fonterra can pay suppliers for commodity milk and still achieve a satisfactory return.

Under this formula, value-added payments last season were 48c/kg of milk solids. Based on a share price of $6.56, a farmer would effectively be paying 7.3 per cent a year for money if he handed over 48c/kg of value-added to Dairy Equity.

However, under the historic commodity milk price (HCMP) measurement, the value-added was less. HCMP measures the higher payment a theoretical, more efficient dairy company could afford to pay for milk and still make a good return. Under this calculation, used by the Fonterra Shareholders Council, the value-added return last season was just 25c/kg.

A senior industry source said Fonterra was considering using a measure closer to HCMP to report value-added, raising questions about how farmers and investors involved with Dairy Equity would be affected.

Fonterra confirmed yesterday it was examining such a shift and that an announcement could be made shortly.

Taylor said FCMP had been picked as the basis for assessing value-added under Dairy Equity's scheme as it was considered the most relevant to farmers.

If there was a move towards a new measure within Fonterra, he would want to see alignment between his company and the co-op.

"We don't want to become irrelevant."

It would be good if there was one standard measurement system.

Taylor acknowledged the issue could create uncertainty for people considering the Dairy Equity scheme. But he said the Fonterra share price indicated the independent valuer who set the price assumed HCMP and FCMP were going to converge over time anyway - in other words, that Fonterra would become more efficient.

Chris Kelly, CEO of Landcorp, New Zealand's biggest corporate farmer, said uncertainty over the value-added measure was one reason he was taking a wait-and-see approach towards getting involved with Dairy Equity.

Landcorp was preparing a paper for its board on "de-risking" itself over its exposure to Fonterra shares, and selling beneficial rights to Dairy Equity was one option.

The ANZ is also rumoured to be looking at a Dairy Equity-style product, although the bank says it is too soon to tell exactly what it will do.

Colin Glass, general manager of the country's largest corporate dairy farmer, Dairy Holdings, said he was watching Dairy Equity with interest but was not planning to sell rights to it.

Adding up

HCMP: Historic commodity milk price - the milk price a theoretical efficient competitor could pay and still make a good return.

FCMP: Fonterra commodity milk price - what Fonterra could pay.

Value-added: Total payout minus the commodity milk price. HCMP and FCMP produce different value-added measures as Fonterra is deemed to be less efficient than the theoretical competitor.

The closer FCMP is to HCMP, the more efficient Fonterra is.