By Jonathan Underhill
Fonterra Cooperative Group's farm gate milk price will get greater public scrutiny under a bill that attempts to limit the dairy giant's ability to game the market and heralds its plan to introduce tradable shares.
The Dairy Industry Restructuring Amendment Bill was tabled in Parliament yesterday by Primary Industries Minister David Carter. Among changes to existing law, Fonterra will be required to disclose information on how it sets its milk price, a process that will be monitored by the Commerce Commission.
The bill “will oversee how Fonterra sets the price it pays its farmers, thereby ensuring a competitive and innovative dairy industry,” Carter said. Fonterra's dominance means the price it pays for milk at the farm gate "effectively becomes the default price that all dairy processors must pay to attract supply from farmers.”
Fonterra releases its first-half results tomorrow and is likely to use the opportunity to comment on the bill and also progress with TAF, which has been getting a mixed reception at farmer meetings around the country.
Fonterra Shareholders’ Council chairman , Simon Couper yesterday reserved judgment on the bill, pending a deeper reading of the 30-page document that would amend Fonterra's enabling legislation, the Dairy Industry Restructuring Act 2001.
The cooperative won a mandate from its farmers in 2009 to overhaul its capital structure which would see the creation of a farmer-only share market for trading Fonterra shares, known as TAF.
Farmers could also sell some of their shares into a fund, for cash and a voucher, and external investors would then be able to buy the rights to dividends from the shares. A second market would exist where the rights, or 'fund securities' could be traded. They wouldn't carry voting rights in Fonterra.
The plan envisages market makers who would buy and sell shares and ensure adequate liquidity.
Alongside the bill, the Ministry of Agriculture and Forestry released a regulatory impact statement on Fonterra's milk price setting, capital restructure and share valuation.
The RIS includes a section on consultation which notes that the majority of Fonterra farmers who commented on TAF weren't supportive of the proposal.
"This is largely due to concerns about a lack of information supplied by management and suspicions that farmers will no longer have 100 percent control of the cooperative," the MAF document says. "A number of farmers consider that another vote on TAF should be held."
The RIS says TAF is "a highly novel concept, which is likely to take some time before its potential could materialise."
Risks include the potential for TAF to be poorly designed, keeping institutional investors away from the fund and leaving the markets illiquid and unable to function in allowing farmers to buy and sell shares in a timely manner. It could also damage the reputation of New Zealand's capital markets.
If it works as hoped, the TAF system would deliver "deep, liquid, transparent, well informed and fungible markets for Fonterra shares" with the potential to be "an effective substitute to Fonterra issuing and redeeming its shares."
Listing the shares and fund securities on a registered exchange such as the NZX would bolster the transparency of Fonterra's milk-setting process because of the levels of disclosure required under the Securities Markets Act and the likelihood that financial analysts would add to the scrutiny.
Fonterra bases its milk price setting on what is called its Milk price Manual but until this was voluntarily disclosed last September there had been "a complete lack of transparency" in how it set the price. Without a legislative imperative, "Fonterra may choose to withdraw it at any time," the RIS says.
(BusinessDesk)
5 Comments
'Emperor's clothes' come to mind reading this. One official when asked why the line is being taken on TAF is basically holding a gun to Fonterra shareholders saying 'vote this in or we will not only set your share price, but also the milk price' an official candidly replied - 'because we need something to bolster the NZX. '
It will be Emperor's Clothes, soon farmers are going to realise
1 - Fonterra's milk price is the world's lowest. Significantly poorer than Murray Goulburn or any real fair comparable.
2 - The return on invested capital in Fonterra. i.e. the business performance is exceptionally poor. Building massive driers which are used at capacity for 3 months in 12, an investment in a rubbish CRM system in the mid 2000's, Sanlu, an Australian processing business - Bonlac which is a dog, a legacy of cowboy FX positions...
This is a dog of an investment and should be treated by external investors with skeptism and priced like a fixed interest item just worth the dividends and a risk of capital loss i.e. Dairy Equity
Yes, more right than not, though the future may not be as poor.
Without going through where the money has gone, it appears Fonterra could do with more equity in its present balance sheet (be it increased retentions or new equity).
The golden age, seems to have been about volume. This expansion of capacity from factory back to to farm appears to have been funded by mostly debt (farm-wise the conversion activity since 2006 especially). Comment on these pages has steady state farm gate price $5.5 to $6.0 kgms.
The combined earnings of factory and farm do not appear sizeable enough to see the P&I repayment of this industry debt (factory commissioning, Fonterra working capital and farm debt). This in turn has then reduced the accepted value of all equity in the system, and that places more pressure on the all debt position (farm-wise its the leverage $15 kg and above I suggest).
The banks are at the table as their balances sheets are not well enough to accept a swift mark to mark the debt (think the pre-war mortgage act, or Rural Bank p write-offs of the 80's).
Fonterra seems to be tanking steps to move forward. Start the traded market, secure some equity, boardroom changes, use the volume commodity trade (low price milk powder) as a launch pad into the nutrition business. (no one expected the GFC, but events like this will always crop up).
The risk is in implementation, and having ppl the calibre to mix it with Nestle, Pepsico, Govt. Chile and China etc.
At the farm level. Crafar and Dairy Holding seem inconclusive as to where farm pricing in volume is. If you assume the milk price, and what people can borrow are both "givens", then it will take a further step down in asking sales prices before the property market clears. Issue is that step down may take more than a vendors equity in some laggard properties.
Medicine is best not avoided?.
Possible successor to Henry van der Hayden as chairman of Fonterra is Colin Armer, who is majority shareholder in Dairy Holdings. Don't know how this will affect milk price and farm debt/value.
The government and board have been trying to unshackle the dairy industry from the time honoured success of a co-operative structure, in favor of a corporate structure, with all the negative practices and consequences that come with it in terms of farmer shareholder soverignty, as evidenced by history.
An insight into the setting of milk price (manual) from the insider knowledge of a supplying shareholder. Supplying shareholder chooses to supply milk to the co-operative. Upon acceptance, given costs and logistics for the co-operative, he purchases shares preferably nominal, and accepts need for retentions to maintain capital flow for processing and marketing. The co-op collects, processes and sells the suppliers milk. The cost of this is taken off the value recieved from milk sales, and what is left over is distributed to supplying shareholders. That's the price we get paid for our milk.
The price of dairy farms in NZ is very high when compared with other developed countries, particulary when many other countries subsidise their farmers. Global demand for agricultural products is going to keep growing and growing. The problem for NZ farmers is the cost of land means much of the farm revenue goes in interest. Who knows what continues to drive the price of land in NZ, its not economics, farmers have generally surrvived via capital gains, should these cease to arrive in the future, the industry will suffer.
The current dairy model suffers in my opinion, due to the continued growing milk supply require ongoing capital investment in processing equipment, plus the pressure to ship volume to ensure sales of perishable products. Over the years this has taken away the focus from developing premium brands that can take some volitaility out of the milk price and increase the margin made.
Maybe the answer lies in farmers limiting the amount of new milk to be process by their dairy company, via a tiered milk pricing model, this could reduce the demand for new capital and allow investment in branding rather than processing. It may have the effect of down ward pressure on land prices initially, which I am sure would not be popular with farmers or bankers!!
Maybe the best option is to invest in cheaper farmland outside the country, taking advantage of the NZ dollars strenght! http://j.mp/GXdBhD
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