Fast-moving consumer goods companies can command some very high multiples of earnings when being traded.
Fraser is an economist who advised the Ministry of Agriculture during Fonterra’s restructuring attempt a decade ago and has commented on the dairy industry since.
Perhaps Tip Top could bring in up to half of the $800m target because without that scale of return everything else in Fonterra is up for grabs.
“In my view Tip Top has been an orphan for some time.
“If Fonterra had a major fast-moving consumer goods business in Australia and New Zealand, like a National Foods, then Tip Top makes sense as part of the portfolio – without that portfolio it doesn’t.”
In this portfolio review Fonterra has to decide what type of dairy company it will be in the future, Fraser said.
“I don’t think it has the iron discipline to be a lean, mean commodity processor like Open Country.
“Nor does it have the flair or the money to be a high-end ingredients company like Synlait or the nimbleness or ownership structure to be a fast-moving consumer goods like A2 Milk.”
So, Fonterra risks being caught in the middle, a sort of valley of death.
He worries Fonterra cannot retain its earnings because farmers demand the highest possible milk price.
The motive of farmer-shareholders, with 80% of their capital invested on-farm and only 20% in the factory, is to cut risk in their on-farm investment in a highly perishable product, milk.
“They are entirely rational – Fonterra is an insurance policy and they don’t want their insurance policy to take risks, especially when Fonterra’s value-added returns are barely above the ingredient returns.
“Most farmers don’t really care about shareholder value because over-pricing the milk is capitalised into farm values.
“So, you could say Fonterra has been successful in driving up land values. That is where the wealth has been created.”
A related problem is that dairy debt has gone up by four times since 2000 but milk production has increased by 60%.
Fonterra can run a debt of 50% currently with a target range on the low 40s, because of payout subordination.
“Without subordination, say in the case of demutualisation as a way of restructuring for the future, I suspect their debt target would have to be low 30s.”
Fraser said Fonterra was granted legislative exemptions to become something like Kerry in Ireland.
“NZ farmers don’t want this so they have created a Ponzi scheme in land values.”
The self-imposed milk pricing regime has created a cash-starved co-operative.
“Selling the family silver and closing the wallet are pretty much the only options available right now.”
