Fonterra needs to be more transparent on the numbers

In the NZHerald a business analysis column by Brian Gaynor: NZ’s dairy giant deeper in debt adds a note of caution to general New Zealand mythology of us being the kings of the dairy universe.

As Gaynor notes in his own very measured way. The dairy sector have their debt loadings all backwards and compared to a bunch of utilities which could have higher debts in relative safety Fonterra is a basket case (in my words.)

Of course he doesn’t say it in quite that way but to my mind there are a number of big headlines in his column that should be on the front page of the paper. He frames the debt ratios like this:

“There is a strong argument that infrastructure companies, telcos and electricity generators with relatively stable earnings can have much higher debt levels than commodity producers. However, it is the other way around in New Zealand as Fonterra has much higher debt levels, both in relative and absolute terms, than Auckland International Airport, Spark or Meridian Energy.”

 
And they need much more analysis and review. Gaynor’s weekly column ( for me) is usually the best piece of writing in the entire newspaper each week.

I got three main points from the Gaynor column today.

  1. Fonterra need to be more transparent about how they are financing an absolutely giant business which has huge influence on the public psyche ( right or wrongly). We all need to get past the fixation on the price of milk paid to farmers. There is a lot more going on here. That was the first example regarding debt levels.
  2. Fonterra has some massive business outside New Zealand. In particular the International business which is largely focussed on China is losing money.
  3. Gaynor who is the most influential finance analyst being published in the media says the numbers don’t really add up and the quality and transparency of those numbers is lacking. Of course there are other finance analysts but none of that commentary gets published in a widely read newspaper.

Fonterra is looking very much like a too big to fail albatross around the neck of NZ. Regarding the Chinese market Gaynor says:

“The co-op’s 2015 annual review stated that it had seven farms in China, which have the ability to produce 200 million litres per annum compared with its New Zealand 2015 season uptake of 18.1 billion litres.”

 
I wondered if there was more background to that so looked over to the Fonterra website to see what they have said about their international business.

“Fonterra collects around 18 billion litres of milk each season in New Zealand, 1.5 billion litres in Australia, 500 million litres in Chile. We also have access to 600 to 800 million litres in Europe and are targeting a milk pool of 1 billion litres in China.”

 
So 3.6-3.8b litres (roughly 20% of milk supply) is outside New Zealand which means the business is substantially spread across and number of countries as a producer as well as the 100 countries it sells products to. So far so good. But what that means is that Fonterra probably has much more in common with transnational oil companies than any of the local utilities.

What is so frustrating about general news coverage of Fonterra is that it is all ankle deep headlines and no real insight. We have ringside seats at some form of psycho drama starring farmers as both villains and victims. And that just doesn’t seem very useful for anyone.

Fonterra itself loses out when farmers do well, and then when farmers do badly Fonterra makes more of a profit mostly because of the way that they pay their farmer suppliers. The simple version is that the difference between commodity products and say “dairy nutritionals” is vast in profit terms. So if you pay your farmers based on the commodity value of the “reference products” used then you have what I call a structural conflict of interest at the industry level.

There is possibly some clever counter cyclical reason for this  paradoxical misalignment of interests but given that the shareholders in Fonterra are also the same farmers who are losing money it does seem a very odd way to run New Zealand’s largest single global business?

In this 2013 profile on one of the current senior Fonterra directors Judith Swales the following comment is made.

“For example, the dairy nutritionals for infant formula are valued at $111 per kilo compared with whole milk powder or butter, which is valued around $5.”

 
Despite this 3 years later the Australian business is still losing money  which is a puzzle.

I was able to find another analysis of the Fonterra financial results which comes from Keith Woodford in a post titled Fossicking in Fonterra’s annual report from October last year.

“Fonterra’s international farming operations are almost totally in China. Two years ago, things looked rosy, but somehow the wheels have fallen off since then. This last year the losses are $44 million EBIT. Once interest on borrowed capital is added in, the losses become much greater.

In this last year, Fonterra’s farms in China produced about 160 million litres of milk and 12 million kg milksolids from 25,000 milking cows. Those production figures would be good if they were from New Zealand pastoral style farming, but from intensive housed free-stall farms they are awful. (italics my emphasis)

Chinese farmers are currently receiving about 3.4 RMB per litre for milk of about 3.5 percent fat and 3 percent protein. This equates to about $NZ 0.85 per litre.

Fonterra’s China farms will be getting paid more than this. My estimate is that they will be getting at least $NZ1 per litre for milk of about 7.5 percent milksolids. So they are getting about $13 or a little more per kg milksolids. Yet they have still made a loss of $3.67 per kg milksolids, with interest still to be accounted for.

The overall message from Fonterra’s accounts is that once one scratches below the surface there is plenty to worry about.”

 
Keith Woodford is “Honorary Professor of Agri-Food Systems at Lincoln University, New Zealand” and his analysis of the dairy sector is much more detailed than what we have from Gaynor. They both seem to be saying that Fonterra is in very serious trouble.

Surely New Zealands’s largest company needs to be managed much better than what it is. At the very least they need to be more transparent about what their numbers actually mean. And the news media needs to ask them some hard questions.

Update:
See below. Here is the interview with Alison Dewes which coincidently was just broadcast.

And Keith Woodford again on global competition. This supports Alison’s comments on structural changes in the industry which has made NZ less competitive. NZ produces 18b litres of milk annually and just one country – Canada can exceed that. The Trans Pacific Partnership (TPP) gets caught on American rocks

“If Canada does join the TPP, then over time it will surely have to dismantle its dairy industry regulations. However, the notion that NZ will benefit from this is greatly flawed.
Currently, Canada produces about 8 billion litres of milk per annum of which nearly all is consumed within the country. Take off the production shackles, and Canada could soon produce 20 billion litres, with much of that going to exports. In any case, it will be the Americans who will ship fresh milk across the border while the new Canadian industry gets itself organised, rather than New Zealand sending milk powder across the sea.”