Craigs Investment Partners research analyst Arie Dekker expected farmer suppliers would have been up in arms at the move that ensures the company makes a profit given it had other alternatives.
“The big concern from farmers over trading among farmers was protection of the milk price but in the face of the first extreme event Fonterra has looked to solve it by underpaying the milk price. They haven’t gone to investors to seek capital or another solution” Dekker said.
“The milk price has been adjusted for shareholders’ benefit and while there’s a significant amount of overlap between farmer suppliers and shareholders there is a degree of net subsidy going on from farmer suppliers to shareholders.”
The move had also played into the hands of competing processors as they largely produced the high returning commodities but only had to pay a farmgate milk price commensurate with Fonterra’s to secure supply.
“They’ll be earning very close to the $9.35/kg MS the milk price manual was forecasting.”
Their suppliers should also be irked given that they have an interest in the integrity of the farmgate milk price and don’t have an equity interest in Fonterra.
Dekker said while most Fonterra suppliers were also the company’s shareholders, the delineation between earnings and milk price was clearly set out and milk price sacrosanct.
“They appear to have accepted the fact Fonterra didn’t make the money so it couldn’t pay it out.”
Farmers should be asking very hard questions about how the adjusted milk prices was arrived at and why other options weren’t taken such as suspending dividends, a rights issue or other form of capital raising which would have more rightly put the onus on shareholder investors to support the earnings and balance sheet of the company not farmer suppliers.
“The level of adjustment appears to have been an arbitrary decision based on what profit the business should make,” he said.
“Should they have adjusted it by 35c/kg MS and made zero profit? How did they determine what the right level was?”
The current approach of withholding payment is relatively easy for Fonterra to execute. Shifting the onus to shareholders would require a better explanation of the reasons for Fonterra’s shortfall and what the required capital was being used for.
The 70c/kg MS adjustment calculated had a positive impact on earnings of $519 million for the half year, and if maintained through the full year it’s expected to have a $1 billion impact on Fonterra’s group earnings and balance sheet. But the end position for the farmgate milk price and level of adjustment could still be changed through the balance of the 2013-14 financial year.
The adjustment had been a positive move for investors with Fonterra demonstrating its commitment to staying on strategy and avoiding alternatives such as slowing down capital investment or implementing price increases that compromised volume/market share gains in growth markets.
Dekker said while Fonterra’s processing assets did differ to those of the notional efficient processor in the milk price manual and that in part reflected the legacy plant it took over, it also reflected deliberate decisions to continue to invest in non-milk price reference product processing and to run at relatively tight capacity at the seasonal peak, reducing product mix flexibility, something that Fonterra was now looking to address..
Meanwhile Fonterra Shareholders’ Council and its performance committee have supported the intent of the milk price adjustment because it aligns with the milk price manual rules around ensuring a return on investment that equates to a cost of capital.
A return on investment for the New Zealand Milk Products business appears to be a key determinant for the scale of the adjustment.
If the milk price adjustment hadn’t been made NZMP would have operated at a loss.
Council chairman Ian Brown said it would be continuing to monitor the level of the adjustment and how it was determined. It would report back to farmers with more detail at the end of the financial year.
There were still questions over exactly how the scale of the adjustment was arrived at and whether it had fully covered the cost of capital for NZMP or not. He accepted farmers were concerned that transparency over milk price and their representatives were asking the hard questions.
Farmers also wanted comfort that what Fonterra eventually paid as milk price was all it earned. But it accepted the board’s decision to adjust milk price down was the right thing to do for the co-operative.
