March 20 looms as the next milestone in Fonterra’s return to financial health and wellbeing when it declares first-half results for the 2019 year.
It will also say where asset sales, joint ventures and partnerships will be made or amended to improve the balance sheet.
The tenure of interim chief executive Miles Hurrell will depend on the apparent progress made towards his three Big Hairy Audacious Goals:
Reducing debt by at least $800m at financial year-end, July 31, 2019;
Reducing operational spending to 2017 levels by July 31, 2020 and;
Delivering a minimum return on capital of 7% to farmer-shareholders.
Hurrell told November’s annual meeting capital spending this year will be $650m, a reduction of more than $200m.
He will also ensure more realistic forecasting, along the lines of the milk price forecast range of $6 to $6.30 rather than a single figure.
Given that capex can be turned off in short order he has probably achieved that goal already.
More realistic forecasting must apply to the BHAGs as well as the milk price and he will not blow his credibility with unrealistic targets.
On the track record of his predecessor Theo Spierings and the recently departed then chief financial officer Lukas Paravicini, as their response to the most recent dairy price slump in 2014-16, operational spending can be cut on command.
Fonterra reduced opex from $2.66 billion in FY2015 to $2.33b in FY2017 or by 12.5%, helped by a 5.5% fall in milksolids collected over those two years.
But then, in Spierings’ final year, 7% was added to operating costs in FY2018 even though milksolids came down a further 1.4%.
“The increase (in costs) was planned but we also planned for earnings to be higher and this didn’t happen,” Hurrell told farmer-shareholders.
He then drew a line in the sand over operating expenses, for which he will be judged on March 20 and when full-year results are known in September, followed by the 2020 financial year.
The 2018 Sustainability Report said Fonterra had 22,358 employees worldwide, of whom 12,298 were in New Zealand.
It also had 51 manufacturing sites, 30 of them in NZ, and 38 farms, 29 of them in NZ.
Outside of NZ the biggest geographical region for employment was Latin America with operations in Chile, Brazil and Venezuela accounting for 4003 people and revenue of $2.27b.
China was the next biggest region – 1697 employees, $4b revenue and seven farms.
It was followed by Australia’s 1432 employees, $1.85b revenue and seven manufacturing sites.
Fonterra sold 45% of its total litres of milk equivalent (LMEs) in value-add products – consumer and food service goods and advanced ingredients – and 55% in dairy commodities.
In revenue terms consumer goods earned $4.6b and food service products $2.5b, collectively about a third of total revenue of $20.5b.
In volume terms advanced ingredients made up 22% of the total 22.2b LMEs.
Asset sales
Fonterra has publicly identified two major assets for potential divestment – its Beingmate part-ownership with infant formula manufacturing and distribution and its wholly owned NZ ice cream brand and manufacturing business, Tip Top.
“The first phase has been to identify assets that are no longer core to our strategy, in terms of the types of products they make or the geography in which they operate,” chairman John Monaghan told the annual meeting.
He was outlining what Fonterra’s leadership were calling a portfolio review in response to the company’s first-ever loss in FY2018.
He said Beingmate was one of three and in December Fonterra confirmed options for Tip Top are being considered.
The third as-yet undisclosed asset is in the company’s value-add portfolio, Monaghan said.
“The board’s intention is to make a decision on each of these investments and complete the transaction within this financial year.”
Fonterra will then proceed with a full strategic review of its capital needs, investments, major assets and partnerships against its strategy and targeted return on capital.
“There are no sacred cows and there’s no room for being sentimental,” he said.
It is expected the third asset under consideration will be disclosed with the interim results on March 20.
Beingmate
Fonterra has reached agreement with Beingmate to unwind the Darnum processing plant joint venture in Victoria though Beingmate will remain a long-term customer for the infant formula ingredients produced there.
It said no cash is to be paid to Beingmate for recovering 51% of Darnum, in contrast to the A$102m paid by Beingmate into the joint venture in 2016.
Since then Fonterra has impaired its $750m investment of 18.8% of shares in the Shenzhen-listed Beingmate by $439m and taken a $75m share of Beingmate’s losses over two years.
The sharemarket valuation of Fonterra’s stake is now about $200m.
Tip Top
Fonterra said it is making good progress with a possible sale of Tip Top to Australian-NZ investors.
It was reportedly talking to three private equity companies based in Australia that have food industry investments on both sides of the Tasman, such as Tegel Foods, Manuka Health and
Hellers.
First NZ Capital is running the sale process.
Tip Top has annual sales about $400m and is reported to make about $20m net profit.
Analysts say five to seven times net profit will be the starting point for business valuation, meaning Fonterra would gain less than 25% of its $800m capital target by selling Tip Top.
While Tip Top is performing well it has reached maturity as an investment for the co-operative, it said when the possible sale was announced.
“To take it to its next phase successfully will require a level of investment beyond what we are willing to make,” Fonterra said.
Tip Top reportedly needs a considerable investment in plant modernisation and a possible relocation from its historic, now-restricted site in Auckland’s Mt Wellington.
Fonterra Brands NZ has a new managing director, Brett Henshaw, formerly Griffins chief executive and with worldwide experience with Unilever and Colgate-Palmolive.
The NZ side of Fonterra’s Oceania consumer businesses has not performed well over the past two financial years. Earnings fell by $30m or 30% and most of the reasons lay in NZ.
Sale of Tip Top will be a handicap for Henshaw in his drive to improve NZ performance.
Soprole
The Latin America operations performed comparatively better in FY2018 than the rest of Fonterra, posting normalised Ebit of $117m, up 28%.
Soprole, the Chilean milk processing and consumer business, showed strong growth and maintained its earnings by optimising the product mix.
Although Soprole has always been part of Fonterra its has been mentioned by analysts as a candidate for sale in the quest for the $800m capital injection.
Fonterra’s balance sheet discloses about $1b in non-current assets (property, plant, equipment, brands) in Latin America, of which Chile is the greater share.
Soprole has its own brands and is not reliant on Anchor and the other major Fonterra brands.
China Farms
Seven large dairy farms in China had an enterprise value of slightly less than $1b when Fonterra estimated in mid-2018 its total business activities in greater China were worth $4.7b.
Fonterra has long argued Beingmate and China Farms are types of investment essential in the integrated, politically acceptable presence in China, its largest market for NZ exports.
NZ milk provides 11% of China’s dairy consumption and Fonterra could not hold such a dominant position with imports were it not also actively invested in the country, with local partners.
Milk production from 30,000 cows on China Farms is about 25m kilos MS annually.
“Our strategy for China Farms is to deliver the highest value through integrating them into our ingredients and consumer and food service businesses in China,” the company said.
Fresh milk feeds into partnerships with Hema Fresh, Starbucks and McDonald’s restaurants, though volumes are low.
Fonterra’s joint venture dairy farm development with Abbott is separate from the China Farms two-hub, seven-farm structure and not included in the portfolio review but it provides a model for possible divestment.
Given the intricacies of land ownership in China and the involvement of local councils, any property and livestock valuations of China Farms and their possible contribution to the debt reduction target are pure speculation.
NZ farms
We are on stronger ground when estimating the value of the 29 NZ dairy farms, all next to processing plants mainly for the purpose of waste water distribution through irrigation.
Assuming a standard NZ herd size of 430 and farm size of 150ha effective, the 29 farms have a collective value of about $140m.
Using the reasoning that Fonterra is a processor, not a farmer, its farms could be sold to existing suppliers with caveats to maintain the plant water irrigation.
Farm Source
The nationwide network of 71 Farm Source stores has a similar property value to the dairy farms, assuming they are all company owned rather than leased.
The goodwill attached to turnover is harder to estimate because Fonterra doesn’t disclose Farm Source revenue.
Fonterra has already demonstrated a willingness for divestment in this area by selling the non-core Farm Source livestock division with about 27 agents to Carrfields for an undisclosed sum.
However, Farm Source, as structured five years ago when renamed from RD1, has a farmer loyalty factor claimed to be worth 10c/kg MS annually in discount pricing and partnership buying.
It is unlikely Fonterra’s farmer-directors will agree to sell the merchandise and servicing division to one of Farm Source’s competitors.
Sri Lanka
Fonterra Brands Lanka is a wholly owned subsidiary with a 40-year history that began with the NZ Dairy Board.
It has an undisclosed business value that is certainly in the hundreds of millions of dollars.
Anchor and Anlene are major brands in Sri Lanka so selling the processing and distribution business would have to safeguard the future of those brands.
Anchor is the number one brand in full cream milk powder, the largest dairy retail category in a country where most homes do not have refrigeration.
Fonterra employs 750 people, collects milk from more than 4000 small farms and makes consumer goods like liquid milk and yoghurt as well as packing imported NZ milk powder at the Biyagama plant in Colombo.
Nationalistic elements in Sri Lankan politics would love to see Fonterra sell the business into local ownership but that would be a very big call for what Fonterra characterises as one of its four leadership markets in the world.
Australia
Fonterra Australia is another of the leadership markets, called by Spierings a home market that will not be abandoned.
But it has been chopped and changed during Fonterra ownership, including consumer business and brand purchase and rationalisation in attempts to find the right mix in a very competitive market.
Farmer loyalty is low and milk market shares fluctuate with price differences and regular droughts.
Fonterra Australia collects milk from 1100 farms, employs 1432 people in eight locations including its Melbourne head office and revenue in that market is $1.8b annually.
Past rationalisations and unsuccessful forays have left Fonterra Australia without obvious divestments and the recent Darnum move is an addition not subtraction.
Europe and the US
Fonterra trades in whey protein out of Europe and the US as a by-product of cheese manufacture by commercial partners in Britain, The Netherlands and Lithuania.
The alternative protein sources are part of new product developments, particularly sports and age-appropriate drinks, and risk mitigation should major milk pools in NZ and Australia be compromised.
Although international milk pools were big in Spierings’ strategy to grow Fonterra to 30b litres and $35b turnover a year, that has now been abandoned by Hurrell and Monaghan.
None of the European or US partnerships is big enough to contribute much towards the $800m debt reduction goal.
