The publication of MG’s revised prospectus for an initial public offering (IPO) in early July has raised eyebrows on this side of the Tasman Sea for both its similarities to and differences from Fonterra’s model.
“MG is offering outside investors minimum and maximum returns based on milk prices so it is more like a bond than an equity share,” one equities analyst said.
“The structure is more stable than Fonterra’s and a lot simpler but I wouldn’t argue it was either better or worse.”
The 272-page MG Unit Trust product disclosure statement (prospectus) also contained many positive projections of revenue, earnings, market share, new processing plans and growing market demands from Asian countries for the co-operative parent.
It is worth reading for an optimistic outlook while NZ milk prices languish.
Essentially, MG is relying on business growth to deliver “distributions” equivalent to dividends with yields ranging between about 2.5% and 7.5%, fully franked, to new investors prepared to stump up about A$500 million collectively.
That new capital is going to be used to build new processing facilities, concentrated on nutritional powders including infant formula for Asian markets.
MG managing director Gary Helou said investors from Asia and Europe were lined up and keen to buy in.
Fonterra’s Shareholders Fund (FSF) units are held by mainly Australian and NZ institutional and retail investors.
Industry leader MG is twice the size of Fonterra Australia, with 37% of milk supply versus 19%, yet has the same number of processing plants.
Because nearly two-thirds of its sales were made domestically, MG expected to further process up to 70% of its milk intake in what it called the Dairy Foods division, adding value.
The milk production curve in Australia was not as seasonal as in NZ, therefore plants were better used.
MG and its advisers had come up with a profit-sharing mechanism (PSM) to ensure outside investors got a predictable return.
As the prospectus stated several times, “our structure brings an alignment of interests between stakeholders (farmers) and unit holders.”
Fonterra would argue that its value-added strategy was designed to reward both farmers and investors but there was some antagonism lately.
The MG directors had committed to distribute 100% of net profit after tax (NPAT) to both supplier shareholders and unit investors, about two-thirds and one-third respectively, based on the proportions of market capitalisation after listing.
Both groups would share equally in dividends, which would be effectively what the MG directors wanted them to be, overlaid with the PSM.
Herein were two major departures from the Fonterra model: how milk price and NPAT were generated and the much larger size of the outside investment.
Partly because of its legislative licence, Fonterra had a complicated Milk Price Manual to establish what it must pay farmers for milk supply and therefore what was left over as “earnings” and NPAT.
MG farmers and investors would receive equal dividends (or distributions) from the NPAT left over after MG had paid its 2500 suppliers for milk.
Somewhat artificially, the prospectus has pro-forma recalculations of past earnings under the new PSM.
MG directors had historically been targeting $20-$30m for NPAT, which were low profits on annual revenues of $3 billion and only about 10c earnings per share.
Apply the new formula and the true FY13 NPAT of A$29m became $45m and the FY14 $29.3m became $96.6m.
In other words, profit was what the directors made it after paying for milk.
As NZ farmers had noted recently, Australian milk prices were more stable, less volatile than NZ because of the much larger domestic consumption as a proportion of total production.
Yet, over recent history, the averages in both countries were similar.
That enabled MG to construct the PSM table, being called a matrix, with reasonable certainty it could deliver the returns investors would need.
Perhaps it could be argued that farmers would not care whether money came to them as milk payments or dividends.
But moving after 65 years from the nominal $1 co-operative share standard to a farmer-only, market-valued share, as MG shareholders had already voted to do, did have far-reaching effects.
“MG is offering outside investors minimum and maximum returns based on milk prices so it is more like a bond than an equity share.”
After the IPO, outside investors would have contributed about one-third of the A$1.5b market capitalisation but would, like FSF, have no voting rights or control.
The FSF was now about 7% of Fonterra’s much-larger capitalisation, NZ$7.6b, and its possible size was restricted by the new constitution.
MG units would be a much-larger tail on the co-operative dog.
Like Fonterra, the tradable MG supply shares and the tradable investment units were mirror images, with a “market facilitator” (Macquarie Securities) in between to make the market if necessary.
While on the surface the MG Unit Trust arrangement did seem more stable and a lot simpler than FSF and Trading Among Farmers, the Australian dairy industry fundamentals were quite different.
MG seems to have grown its milk supply, partly at Fonterra’s expense, in the past few years.
Murray Goulburn is the market leader in Australia, about twice the size of Fonterra’s operations there.
Farmers can and do switch processors from season to season and one third of MG’s suppliers had been with the co-op for five years or less.
Its growth was a result of higher milk prices and some disruption among its competitors but it was a tide which could flow out again.
MG might lose farmers when its $1 shares turn into $2.10-$3.20 shares (the IPO indicative range) and provide a once-only windfall.
Alternative processors, as in NZ, do not have a share standard, eg Fonterra Australia.
There has been no milk production growth in Australia for about a decade, mainly because of droughts, and the exportable portion has dropped to 38%.
As MG forecast its “commodities exposure” would be down to 30% of supply this year, it planned to use the new capital to target the Asian infant formula markets.
The extent to which it was successful would determine the returns available for its new class of eager investors.
