Fonterra share price shackles growth

By LIAM DANN

Fonterra has identified its own soaring share price as a deterrent to the growth of the dairy industry.

Chairman Henry van der Heyden yesterday outlined tensions the company has found within its capital structure.

Fonterra's share price has climbed 21 per cent to $4.69 in the past two years - a reflection of strong commodity markets and successful internal restructuring.

While that would have shareholders in most listed companies smiling, it could eventually create some serious problems for Fonterra, van der Heyden said.

The high share price created a barrier for young farmers wanting to get into the industry.

It also encouraged established Fonterra farmers to cash up.

There was already evidence of dairy farmers selling land for residential subdivisions or alternative farming operations. About 400 farmers left last year and that trend was likely to accelerate as the share price rose, van der Heyden said.

The emergence of new competitors - like Wyatt Creech's Open Country Cheese - would also allow farmers to cash in Fonterra shares and sell their milk elsewhere.

Another area of tension was evident in the way Fonterra paid its farmers.

Lumping together the direct payment for the amount of milk supplied with the "value-added" payment - based on the success of Fonterra global brands - did not give farmers an accurate pricing signal on which to base their on-farm investment.

Fonterra has spent the past few weeks consulting farmer shareholders before it embarks on a comprehensive review of the structure.

Some industry commentators have speculated that listing New Zealand Milk - the value-added part of Fonterra's business - might be a way to address the conflict between the two parts of the business.

Van der Heyden ruled out any chance that non-farmers would be able to invest in Fonterra as a result of the capital structure review.

A person could "never say never" but the company did not need any outside capital in the foreseeable future, he said.

Within a three- to five-year time-frame, there were no acquisition targets anywhere that Fonterra could not afford if it wanted them.

Bringing more transparency to the share price and the milk payout was likely to be a key part of any capital structure change.

There would be robust debate about the extent of that change but three basic pillars were non-negotiable.

They were: that Fonterra remain a farmer-owned co-operative; that it continue to be the lowest-cost mass-producer of dairy products in the world; and that it continue to expand its value-added activities.

Van der Heyden said the board would also try to ditch the complicated peak notes component of its capital structure next year.

It will be the second time management has tried to ditch the system. Farmers voted down the last attempt at the annual meeting last year.

Peak notes are a way of reflecting the relative cost of processing farmers' milk.

Farmers who supply more of their milk to Fonterra at the peak of the season cost the company more because of the investment needed to handle and process that milk. In order to reflect those costs, farmers who supply more milk at the peak are required to hold more capital in the company.

The system means that farmers must keep complex accounts at the end of each season and are often faced with big one-off bills.

Van der Heyden said he wanted to see the costs associated with the milk supply curve stripped out of the capital structure and reflected in the milk payout instead.

Capital concerns

* Fonterra is consulting shareholders about possible changes to its capital structure.

* Because it is a co-operative, Fonterra shares can only be bought or sold when farmers enter or exit the industry. The share price is set once a year by independent valuation.

* Some farmers have concerns about the amount of capital they have tied up in shares relative to the payout they receive for producing milk.

* Fonterra will present farmers with a range of capital structure options by the end of the year.

* They will vote on those options later next year.