Friday, March 29, 2024

Expanding by using the co-op’s equity

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This year Canterbury dairy farmer and Lincoln University farm management lecturer Marv Pangborn and his wife Jane have expanded their farming enterprise again but this time they’ve used equity in their co-operative to do it.
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The 17ha they’ve bought is a strategically important piece of land; it neighbours one of their two farms and can readily be watered by an existing centre pivot that had previously just been operating over a semi-circle area.

When a new farm dairy is built on the farm to replace the existing 36-aside herringbone, that land will be brought into the milking platform along with a 30ha runoff and allow an additional 150 cows to be milked.

But also, just as strategic, was the decision to draw on the equity they have in Fonterra as at $7.92/share the May supply offer was a good one.

The Fonterra Shareholders’ Fund unit price had hurtled its way from $5.50 at the launch of trading among farmers (TAF) late last year to a high of $8.09 on May 21 surprising many, and Marv considered it was probably overpriced at that level.

The supply offer price was set based on what units had traded at over a 10-day period in early May. Fortuitously for farmers it was also about the time of what has to date been the historical high.

Marv also looked at the interest rate cost on the money he’d have to borrow to fund the land purchase and compared that with the dividend return on his share investment.

His cost of funds is about 5.2% on the floating interest rate market and at 32c/$7.92 share the return is 4%.

While the difference isn’t great, in his opinion interest rates had only one way to go but the future return on his share investment was still an unknown even though he expected the share and unit price were more likely to go down than up.

That’s not to say he doesn’t have confidence in Fonterra’s strategy in the longer term.

But he does know the return on capital he has invested in his own farming business is about 10% so it made sense to take up the opportunity Fonterra was offering.

Managing risk

In terms of risk management it also made sense. The money he took from the supply offer could not only fully fund the land purchase, it also allowed the couple to pay down some debt further reducing costs.

Marv has to admit, though, that he nearly didn’t look at the supply offer. As the May 23 deadline drew nearer he hadn’t much thought about the opportunities it could create. It wasn’t until he was talking to a Fonterra area manager that he looked into what it could mean for him and the couple’s farming business.

That in itself speaks volumes about just how complex Fonterra’s capital structure and options for farmers have become.

Of all the people fit to analyse opportunities and get to grips with the myriad of flexible options in Fonterra Marv is well equipped.

As an academic and a farmer he’s almost permanently got one hand on his calculator.

“You get busy doing what you’re doing and the complexity of what you can and can’t do with shares takes time to understand,” he said.

“It’s something completely new for us.”

It also requires purposeful effort and attention.

After his analysis he applied to offer the maximum number of shares into the fund or 25% of his shareholding. But so did about 2100 other Fonterra shareholders, close to 20% of the co-op’s farmers.

That meant the offer was scaled back and farmers received a maximum of 20% of their individual shareholding. Marv and Jane have two farms and had applied to take part in the offer for both of them.

It was the money from both that was ultimately used to buy the land and reduce some term debt.

“No need to go to the bank at all, except to pay them back some money,” he said.

Milk price

In exchange for selling the beneficial rights to his shares for vouchers he will receive milk price only for the portion of milk supply now backed only by those vouchers. Unlike any other new supply options that now allow sharing up in stages he doesn’t ever have to share up and convert the vouchers to shares.

Over time though, as his total milk production grows with additional cows and any improved productivity, he will have to buy more shares to back the growth milk but he can do that at his own pace, albeit within some restrictions.

It won’t all have to happen on a set day at a set price. He can watch the market and buy shares when he considers it to be a good time as long as it fits with any growth milk contract or within a three-year period.

He didn’t jump in when the price dropped to $6.86 following the potential botulinum contamination announcement in early August (Dairy Exporter, September, page 8) but he is keeping one eye on the market now.

Watching it, though, again adds complexity to the farming business and farmers will now have to pay more attention to announcements and issues that can impact on the unit and share prices.

“It’s another thing to think about – what’s the share price doing and what are the key times it’s likely to move?”

Key Points

Farm one:

Area: 174ha

Cows: 565 cows

Production: 256,420kg milksolids (MS)

Supplement: 750kg/cow silage and palm kernel.

Farm two:

Area: 148ha

Cows: 490 cows

Production: 224,897kg MS

Supplement: 750kg/cow silage and barley.

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