BusinessDesk: 'Fonterra’s assumptions appear to be both practically feasible for Fonterra and reasonable for efficient processors'

By Jonathan Underhill

Fonterra Cooperative Group’s method of setting its farm gate milk price has been given an initial, conditional tick of approval by the Commerce Commission in a dry run of its proposed oversight role set out in the Dairy Industry Restructuring Amendment Bill.

Fonterra’s setting of the farm gate milk price “is not inconsistent with the purpose and principles of the milk price regime set out in the DIRA Bill,” Sue Begg, the regulator’s deputy chair, said in a statement released with the 111-page report.

“Most of Fonterra’s current assumptions appear to be both practically feasible for Fonterra to achieve and reasonable for efficient processors to replicate” and they “will provide incentives for Fonterra to operate efficiently,” Begg said. The monitoring regime can’t provide certainty over how the milk price will be set or how it might change over time and Fonterra “retains significant discretion.”

The way the farm gate milk price is set is key to the changes planned for Fonterra, including Trading Among Farmers, because it is one of two variables in the payout to farmers – the milk price and the distributable profit. If TAF proceeds, a new class of outside investor will be able to own the dividend rights to Fonterra’s shares. The cooperative’s 10,500 farmer-shareholders are being sent a voting pack on TAF this week, ahead of a vote on June 25.

DIRA will enshrine Fonterra’s price setting manual in law and the regulator wants to be sure the world’s largest dairy exporter is encouraged to operate more efficiently and not freeze potential rivals out of the industry.

The commission said its initial review was a limited version of what it would do in reality. While most of Fonterra’s assumptions were reasonable and practically feasible, it did identify “a number of Fonterra’s assumptions or approaches that do not appear to be both practically feasible for Fonterra and reasonable (ie able to be achieved by another efficient processor),” the report says.

Among the most significant were Fonterra’s use of depreciation rates to calculate tax expense that are below the rates specified by the Inland Revenue Department, which the commission said could have the effect of decreasing the base milk price.

Fonterra also uses debt premiums in the US in determining the cost of debt “but makes insufficient or no allowance for the additional costs incurred by NZ-domiciled operations” such as cross-currency swap costs and debt issuance costs.

The commissions also identified another category of assumptions, such as sales and labour costs, where it didn’t have enough information to conclude if they were reasonable and feasible, the report said.

It makes recommendations for tweaks to the milk price manual, including more complete disclosure of key quantitative information used to calculate the base milk price.

In a table it lists 12 issues related to Fonterra’s revenue and costs, of which in concludes half are deemed not transparent to third parties, while under the heading ‘Gaps in Fonterra Information and Analysis”, seven of the 12 note limited data or analysis, or lack of reconciliation between modelled and actual figures.

The commission did the review at the request of Primary Industries Minister David Carter and is seeking submissions by June 29.

(BusinessDesk)