Fonterra's capital structure review promises to attract plenty of market and shareholder attention in the coming year, but for new chairman Peter McBride, the key priority is the financial performance of New Zealand's biggest company.
"We have to keep the pressure on ourselves to deliver," he says. "We've turned the corner recently but there's more work to do. Good enough never is."
McBride, a former chairman of successful kiwifruit marketer Zespri, took on the job in November, further bolstering the spirits of Fonterra's farmer-owners, who had seen $4 billion of their wealth destroyed during the big co-operative's disastrous financial results of 2018 and 2019.
Since then they've been heartened by improved results from a major change in operational strategy under chief executive Miles Hurrell, who took over the role from Theo Spierings nearly two years ago, and with robust prices continuing for their milk. With a new chairman who helped steer the kiwifruit industry out of the devastation of the Psa disease, shareholders say they're feeling much more positive in 2021.
The fear that hovered for a while, of many Fonterra suppliers leaving the co-op and moving to competitors, has now lifted.
But as McBride says, next month, when Fonterra's 2021 interim financial results are posted, will show if that recovering faith is justified.
He says other priorities this year are further implementing the new business strategy which promotes the provenance and value of New Zealand-grown milk through value-added ingredient sales, backed by Fonterra's R&D strengths, and continuing the review of assets.
We can expect to see some more assets sold - "but in a small way".
"The main thing is to get the China Farms [sale] deal completed. We've done the first regulatory hurdle."
Fonterra invested about $1 billion in setting up dairy farms in China over 10 years, but for little return. The venture was part of the company's former strategy of building global milk pools. The farms' sale to Chinese companies for a total of $555 million was announced in October last year.
"We'll be reviewing our strategy and tactics on an annual cycle but separately we'll be going right out to 2050, visualising what the future looks like, where consumers sit and the challenges long-term, then working back," says McBride.
"If you consider 2050, it's not rocket science. Declining New Zealand milk volumes are an opportunity for us and the basis for our strategy needs to be extracting more value out of milk.
"Sustainability is a function of efficiency. You need productivity gains to be either neutral or negative [environmentally], along with making reductions. We need innovation, and R&D is critical to that. We have a strong position there so that's an area of focus for us."
McBride says key to Fonterra's future is premiumising New Zealand dairy.
"Then we're looking at how we create wealth for our shareholders more broadly than just from our manufactured products. We see the R&D and innovation we have as incredibly valuable.
"We're challenging ourselves how best we commit that [intellectual property] and how we apply capital going forward as well.
"The previous approach has been capital intensive. We are looking to change that approach."
Which brings us neatly to a "big piece of work" ahead for the board that is close to McBride's heart - a continuing review of the co-operative's capital structure.
So far the work by a board sub-committee - McBride's been on it for more than a year - has been low key but the pace has picked up with the unusual step of sending out a survey seeking farmer-shareholders' thoughts.
Fonterra's capital structure was last changed in 2012 with the introduction of Trading Among Farmers, or TAF.
TAF is a way for farmers to enter and exit Fonterra. TAF comprises Fonterra shares that can be either linked directly to milk production - known as "wet shares" - or held by farmers in excess of their wet share requirement as an investment. In that case, they're "dry shares".
TAF is made up of two parts. First, there's the Fonterra Shareholders' Market - a private, farmers-only share trading market. Farmers are required to hold the number of shares for their farm's level of milk production. They can also hold additional shares, up to a set percentage of their milk production requirements.
The shareholders' market has a current capitalisation of $7.56 billion.
Then there's the Fonterra Shareholders' Fund. This is open not only to dairy farmers, but also the public, enabling them to trade in listed Fonterra units. Those units are created when farmers decide to convert some of their shares into units and vouchers. The vouchers represent the voting rights and obligation to supply milk. The dividend-carrying, non-voting units are securities that can be traded on the NZX.
The fund enables non-farmer investors to participate in Fonterra and provides farmers with an opportunity to exchange some of their shares for additional capital.
TAF turned Fonterra into a hybrid, and the resulting tension between different types of shareholders has come in for much market criticism. Farmers want Fonterra to pay them the best milk price possible, with the share price and dividends second in importance, but the unit holders want handsome dividends.
McBride says he's constrained by what he can say about the review and possible outcome.
So why the need to review capital structure?
"We have to challenge ourselves, so we should be constantly reviewing capital structures. The board should have that discipline anyway.
"We need to understand how sustainable our capital structure is and ask is it aligned to strategy?"
As chairman, what parts of the present structure does he think need attention?
"Some structural issues. The compulsory nature of capital, the flexibility we can offer to farmers. I'm really hot on succession planning in this industry, how we facilitate young farmers into the co-operative and onto farms. If we don't, where is the future?"
So is the review asking if the cost of buying into Fonterra is too high for farmers?
"Yes. But it's also about highly indebted farmers and the implications for them as well. And that's notwithstanding [the issue of] the company's performance as well in terms of its earnings per share, dividends and share value."
Do dry shares and units have a future after this review?
McBride won't comment.
For him, the biggest challenge of the review will be getting mutual agreement between the board and the thousands of co-operative-minded farmers.
"There's such a diversity of thought and personal interests. This is really about meaningful engagement with shareholders. We will keep this survey open for a while and keep reminding people to submit."
So far, 16 per cent of shareholders have completed and returned the extensive survey.
"We really want to understand what's important to people," says McBride.
Asked what the potential benefit of the review is for unitholders, he says the better question is what it means for all shareholders - which is ensuring a sustainable company.
"It's about having a business going forward - that's the priority."
The lead-up to the introduction of TAF was a tortuous and divisive process among shareholders. Even McBride, who heads a large-scale dairying business, admits he voted for it reluctantly.
While then-chairman Henry van der Heyden drummed into farmers the need to protect the co-operative from a run on capital, from farmers selling their shares to supply competitors who didn't require a share stake, some shareholders saw it differently. They still firmly believe van der Heyden wanted to get Fonterra listed on the stock exchange, and had to settle for a hybrid structure in the face of farmers' strong co-operative-mindedness. Through much of the lead-up to TAF, van der Heyden was an NZX director.
Under Fonterra's co-operative constitution, its chairs must be shareholding farmers.
So how does McBride plan to avoid a repeat of the TAF strife?
"By the way we approach it. You want consensus if you can get it, but it's not always easy.
"You want people to feel they've been heard and for changes to potentially be made to proposals after hearing people, but having said that, there has to be a balance between leadership and consultation.
"And it is important we show leadership and make a recommendation."
McBride reckons there is "a significant mood" for change among shareholders.
What's fuelling that?
"They've all got their own reasons, we haven't looked into why, it's more just the mood. There will be diverse reasons - some around [a wish for] flexibility from their own personal perspectives, while others may not agree.
"We'll know more when we get [survey] feedback. Some of their perspectives may change along the way too."
An informal Herald survey of a few shareholders suggests the mood may be more for tweaking the capital structure than for wholesale change.
"Why fix something that's working?" says one.
On the timing for completion of the review and recommendations from the board, McBride says this year's annual meeting in November would be "an aspiration", but time is less important than getting a quality result.
"We also have a set of regulations to deal with so we don't want to be unrealistic about timeframe."
Fonterra is regulated by the Dairy Industry Restructuring Act, passed in 2001 to deregulate dairy exporting and enable the company to be formed from an industry mega-merger, against the recommendation of the Commerce Commission. The act has been tweaked and its reins on Fonterra loosened a little since then, but the company will still need to consult the Government on any capital structure change.
"I'm cautioning that this will take longer than people will like," says McBride. "There are parts of the time frame we can't control."
Consensus on capital won't be easy
New Fonterra chairman Peter McBride appears to be on the money when he predicts that the biggest challenge in reviewing the company's capital structure will be getting consensus among 10,000 farmers with strong opinions.
Cambridge shareholder Garry Reymer is one snag he may encounter. He won't be the last.
While some shareholders praise the Fonterra board for taking the unusual step of running a major written survey, asking farmers what they want from a capital structure, long-time shareholder Reymer is asking, what's the point?
He says the lengthy questionnaire should have started by clearly spelling out Fonterra's new business strategy, because capital structure should support strategy.
Actually, Reymer isn't sure Fonterra really has a new strategy.
"What you've got here are ideas and concepts around putting value into ingredients. That's not much different from [former CEO] Theo Spierings' Velocity strategy. I don't see much change.
"The board owned Theo's plan. Theo was told what to do, and the board let him down.
"Now they're doing it with New Zealand milk rather than [overseas] milk pools. I'd still argue it's about volume - about moving more volume into high-value [ingredients].
"TAF [Trading Among Farmers] didn't support the [then] strategy. The board signed off on it and we all took responsibility for it, but the capital structure was what we got wrong."
Reymer says recent changes to the Dairy Industry Restructuring Act (Dira) which regulates Fonterra are what's really important in the way farmers can get into and out of the co-operative. For example, removal of the obligation for the company to take all milk means it can now at least control milk growth.
"We need to know what the strategy is. Where is our vision? Where are they taking our business? The value of New Zealand milk - I get that. But I also saw the value of milk pools.
"Having one single milk pool scares me. Covid has shown us a lot. What if there is disease in our national herd and we lost it? Where does that leave us as a company and a country?"
Reymer says he 100 per cent supports McBride's quest for capital structure flexibility to help young farmers move ahead in the industry. At present, farmers need to buy shares to supply milk.
"Milk is the lifeblood of the co-operative and the co-operative in its stupidity says 'if you take your money out, you take your milk too'.
"Fonterra has to earn the right for people to want to be a member."
Reymer says the survey questions are "too narrow".
"There are so many moving parts. It's not just about capital - they need to look at it all, milk supply and strategy. They should have started by saying what the strategy is."
Another farmer, who declined to be named, believes the result of the capital structure review will be "tweaks".
"I don't see a lot wrong with what we've got. Maybe some tweaks around the edges, for example make it a bit easier for new suppliers, allow them to pay for shares over time."
And Southland shareholder Tony Paterson says the board's survey approach is "very refreshing", and doesn't believe the present capital structure needs much change.