Fonterra signals u-turn

By PHILIPPA STEVENSON

Fonterra is switching from its widely touted game plan of growth by acquisition to building revenue from new products and services.

The giant dairy co-operative with $12 billion of assets and ranked fourth in the world has espoused a mergers and acquisitions strategy since its formation was first mooted more than two years ago.

It was in tune with trends in the global dairy industry which in the last five years had a merger, acquisition or alliance every three days, or 592 deals.

But chief financial officer Graham Stuart said Fonterra's re-drawn strategy would focus on "organic revenue growth".

"People looking to Fonterra for big bang acquisitions will be disappointed," he told the Business Herald.

Stuart ruled out keenly awaited further big investments in Australia but said Fonterra could reconfigure some of its holdings there.

"We won't be putting significant capital in consumer business in Australia," he said.

The company had enough capital in Australia now with a $2 billion stake covering ownership of Peters & Brownes, 50 per cent of Bonland, 18 per cent of National Foods, and its Mainland and Tip Top business, Stuart said.

The company had budgeted $1 billion for new investments over the next five years and would be looking for opportunities in Asia, as well as continuing a self-funding programme of expansion with Nestle in the Americas.

Fonterra's founding strategy included an ambition to achieve $30 billion turnover but Stuart said the new plan, which emerged from the company's Project Galileo, had not set a revenue target.

Instead the company would aim for a 13 to 15 per cent annual profit improvement by boosting revenue in food service, consumer nutritional products and speciality milk components.

One of the industry's expert advisers has long said that boosting sales from internal growth was a risky business. Professor Bruce Anderson of Cornell University's department of applied economics and management in New York and director of the Cornell cooperative enterprise programme advised the New Zealand dairy industry on the establishment of Fonterra.

In a Business Herald report last year he said the economic power giant retailers were exerting on smaller sellers, such as the New Zealand dairy industry, was forcing many food manufacturers to pursue acquisitions and mergers as their primary means of growth.

"One of the key reasons for growth in the food industry is the need to cover rising costs," Anderson said.

The main problem was fixed costs, of which the largest was depreciation. New plant or replacement equipment usually cost significantly more than the originals, leading to an increase in fixed costs.

"Without growth, increasing fixed costs will erode profits and turn them into a loss. The primary strategy is to spread increasing fixed costs over a greater volume of sales."

Anderson said the only two ways to increase sales were by internal growth such as new products and processes - which had only a 30 per cent probability of success - or through external growth via mergers and acquisitions.

Fonterra's continued need to spread future increased fixed costs would mean more foreign joint ventures, strategic alliances and acquisitions as well as possibly mergers with foreign co-operatives, Anderson said.

Yesterday, Dairy Farmers NZ chairman and Fonterra shareholder Kevin Wooding was surprised to learn Fonterra was dropping its acquisition plan, especially as the company spelled out its new strategy to farmers at meetings only last week.

The company might simply not have the cash, he said. "I don't think the balance sheet is strong enough to do a lot of acquisitions, and I'm not sure whether there are buckets of returns in acquisitions."

Wooding said farmers had been told of the goal of 13 to 15 per cent annual profit growth and they would be pleased to see it achieved.