Analysis: Crying over Fonterra's spilt milk

8:55 pm on 13 September 2018

Analysis - There's no point crying over spilt milk. Does that apply to the first loss in dairy giant Fonterra's 17 year history? Probably, writes Gyles Beckford.

Dairy cows in a milking shed in New Zealand.

Dairy cows in a milking shed in New Zealand. Photo: 123RF

Amid the wailing and gnashing of teeth caused by the $670 million abnormal costs from its compensation payout to Danone, and the writedown in the value of its investment in Chinese dairy concern, Beingmate, it's easy to lose sight that this is a company that had a revenue increase, and has paid its farmers the third best payout in the past decade.

But, legitimately, people are asking how did this happen and what's next?

Fonterra looks like it's adrift. Its abandonment of the search for a chief executive to replace Theo Spierings, the nonsensical trading halt to announce a five cent reduction in its milk payout, the scrapping of a final dividend, all point to a company that has turned a bit gun shy and sensitive.

For once, Fonterra has accepted at least some of the blame: "we did not meet the promises we made to farmers and unitholders," chief executive Miles Hurrell said.

That has prompted a review of the co-operative's partnerships, assets, use of money, product mix, returns of investment, among other issues.

There are some important issues to be confronted.

Declining earnings

Its underlying earnings - a good measure of performance - have fallen by nearly a third over the past couple of years to around $900m, and it's not expecting much of an improvement for the coming year with a forecast range of $850-950m. That points directly to its management of costs, its ability to sustain margins, as well world dairy prices.

It needs to sort out China, its biggest and most lucrative market. But it has lost a milking shed full of money over more than a decade, first with San Lu after the melamine scandal, and now with Beingmate, a company that seems to have been out of control for too long.

Chairman John Monaghan has said nothing is off the table in the review - so quitting and licking its wounds is possible. But if not Beingmate, then who and in what form.

It needs to reduce its debt, which has risen to close to half the co-operative's equity value. Unlike other companies it cannot readily call on its shareholders - 10,500 dairy farmers - to stump up more money. And as a co-operative it cannot readily go to outside investors and sell them a slice of the business.

That leaves a sale of assets and, more likely, a severe cut back on capital spending.

But Fonterra remains a hostage to its structure.

As a milk producer it is one of the most efficient in the world - hence the care it takes of its farmer suppliers and its efforts to get the best farmgate price. However, as a dairy food company, looking to sell high end consumer products around the world, it would like lower milk prices and maximum margins.

Mr Monaghan has made it clear he backs the co-operative structure, but at some stage it's an issue that needs to be revisited.

And while the calls fly for the suspects responsible for the losses to be rounded up - namely the former chief executive and chairman, not to mention the thousands of staff earning more than $100,000 a year - it should be remembered that Fonterra's farmers are generally doing well, the milk payout is forecast to be higher this year, and a softer New Zealand dollar is helping to improve export returns.

The good ship SS Fonterra may be adrift but it's not sinking.