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Fonterra, again

Written By: - Date published: 9:15 am, September 29th, 2019 - 24 comments
Categories: climate change, Economy, Environment, farming, Free Trade, global warming, Globalisation, trade, uncategorized - Tags:

So, finally, Fonterra have released their annual results, and they are $600 million in the red. They are selling most international ventures off, rapidly shrinking their ambition, and focussing on basic ingredients rather than more capital intensive product lines. No apology for wasting two decades of near-monopoly position and the weight of that lost opportunity upon New Zealand.

Our largest business is in full retreat, although Fonterra calls these massive losses and global retreats a “strategy”:

New Zealand – and its government – need to engage much harder about Fonterra.

Why?

Since it clearly needs re-stating, Fonterra is a massive contributor to the New Zealand economy and to achieving the Government’s objectives for sustainable economic development. Fonterra is New Zealand’s largest business and the only New Zealand-based multinational firm with global scale and reach.

Our largest private entity has its profit and revenue streams captured in New Zealand by its New Zealand-based shareholders, unlike most other businesses of any size here. Reason enough for government to engage hard when that’s tens of thousands of New Zealanders with their welfare deeply tied to Fonterra’s rise and fall.

When it was merged, the government was advised that the entity would be a near monopoly accounting for about 7% of the entire GDP, around 20% of total exports, and 96% of dairy exports. They knew the collective national risk to us.

It’s still incredibly important to New Zealand.

The presence of Fonterra’s head office, innovation and manufacturing facilities in New Zealand have huge impact upon the wider New Zealand economy, society, and environment.

There is simply no question that there is a national interest associated with Fonterra and its performance.

But the question of how this national interest should be guided and protected is clearly not being grasped by this government. Only those with small imaginations fail to see how it could be done.

There was a time when government would lead by focussing all agricultural and food production business leaders together, with common funding and common goals.

Rural people see this, and I’m sure Fonterra’s fortunes are a factor in some of the worst business confidence levels and farmer confidence levels we have had in living memory.

Sure, there’s no political incentive for government to engage when they will probably not gain any more rural seats or rural vote. They’re throwing petrol on opinion that’s already on fire.

But.

Fonterra’s accountability for its strategy, structure and performance lies with its private owners, but the Government does have a critical role to play with Fonterra.

The first obvious area of engagement is with regulation and trade. Just summarising these set of levers shows massive areas in which engagement with Fonterra and government is so essential.

Regulatory Certainty and Outcomes

A basic job of government is to ensure regulatory certainty to enable Fonterra, its farmer-shareholders, and all other industry players to plan and operate in line with their chosen long-term strategic direction and environmental limits.

A useful example of this is the proposed regulations around fresh water and streams of August 2019. Fonterra thought they had good story to tell about this through the Dairying and Clean Streams Accord of 2003 between Fonterra, the Ministry for the Environment, the Ministry of Agriculture and Forestry, and regional councils. The new regulations would not have been needed if that 17 year old accord had worked. There’s some new instrument needed that prices environmental damage to dairy company profit besides regulation of farmers.

Fonterra itself is pretty clear why it needs to build its reputation about being good to our environment.

I’d be reasonably happy if the New Zealand government were able to produce a sustainability report about its own environmental impact as well as Fonterra does here.

A smart government could actually learn lessons from Fonterra – positive and negative.

Market Access

Protecting and enhancing international market access for New Zealand dairy exports. There’s no doubt the New Zealand government has tried, but over multiple international trade agreements most notably CPTPP there’s been limited improvement in forming the deregulated and de subsidised international milk market that would have enabled Fonterra’s production advantages to be really profitable. There’s been nowhere near enough return for the dairy industry despite all the negotiation effort. This is despite MFAT turning into practically the diplomatic arm of Fonterra.

Research and Development

Providing targeted research and development incentives to promote innovation and development of higher value added dairy products and market development opportunities has been weak and uneven. A few years back Fonterra had a thing called Fonterra Ventures, which sought active high value partnerships with universities. Commercialised successes were rare, and the government tax framework around research and development was cumbersome and ineffective for too long. An example is Foodspring through Goodminton AG: bought, then flicked 18 months later.

Another example is Fonterra’s recent sale of its 50% stake in DFE Pharma.

But it was evident from the first years of Fonterra that there was huge potential to improve the entire dairying sector through a comprehensive partnership with New Zealand universities. Hence, the Helen Clark government formed the Fast Forward Fund in 2006-7. This was intended to be a 50-50 multi-billion government-industry funded contestable fund for dairy pasture productivity, by encouraging deep research partnerships between dairy company research arms (at that time almost entirely Fonterra) and the Crown Research Institutes and universities. It was killed off by the 2008 National government. It would take an effort to resurrect something similar. The limited partnerships between Fonterra and CRI’s and universities have not turned New Zealand into a global powerhouse of nutritional research that they should have.

The above are the kind of engagement any decent government could make with Fonterra if it was trying. They could still do so, if they wanted.

What they have gone for is …

Legislation

This is of course the most forceful and effective form of government engagement with Fonterra. The Dairy Industry Restructuring Act 2001 allowed the creation of Fonterra Dairy Cooperative Group Ltd. The Act has the provisions to promote the efficient operation of dairy markets in New Zealand by regulating the activities of Fonterra to ensure New Zealand markets for dairy goods and services are contestable, even though in 2001 it was a near-monopoly.

I’m not going to bother summarising the changes to the DIRA Act that are going through parliament right now. Look them up if you want to.

Suffice to say that even Fonterra, and its Farmer shareholder council, were both disappointed it didn’t go far enough, and said so.

But wait ….

What I want to get to briefly is just some of the other areas this Government could really positively shape Fonterra and the other big dairy players if they wanted to.

Transport

Almost by chance, the Kiwirail effort to pull out of decline and into something with some heft has been good for Fonterra. Kiwirail is engaging with Fonterra about rail sidings beside major processing plants to enable as few as possible heavy trucks exiting site. I think there’s just one more Fonterra processor that’s not connected to rail in New Zealand, somewhere obscure in the Waikato. Kiwirail have also pushed ports to enable easier track and offload access for rail in and out for milk-industry trains.

But there’s so much more it could do. The biggest pressure to use trucks is of course that Fonterra are required to take all the milk that they are offered. The way to turn down the volume of milk trucks to Fonterra is to turn down the requirement that they always take milk from everyone all the time. Cabinet has ruled that out in the Bill.

Should the government want to, it could force Fonterra to think about how it wants that product delivered to Fonterra and to ports through transport costs. Larger dairy farms could be strongly encouraged to dry their own milk to powder and other core ingredients with smaller dryers on site. This could be done if the RUC for dairy transport vehicles was significantly increased. Government needs to look much more carefully about how to use an integrated NLTP to require Fonterra to use rail not road as the dominant form of bulk transport, price harder what it can’t get to rail, and pull the total volume of dairy products transported in the first place.

Starting to move out of coal is one thing; there’s a place for Government to lead Fonterra out of oil.

Skills and Immigration

According to Dairy NZ, the dairy sector needs around 5,000 new people each year. The New Zealand education system simply doesn’t generate enough of them, so it’s critical that they continue access to migrant employees.

Apart from on-farm worker supply, just imagine if a fully-firing Fonterra hovered up a great percentage of the food technology, food engineering, and nutrition graduates that we produce, rather than importing them. There are always exceptional anecdotes, but government through the tertiary sector has a much stronger role to play in inspiring people to graduate targeting dairy companies. Currently there is no such inspiration in Fonterra.

Tax

Dairy is the oil industry of New Zealand. It’s uniquely valuable to us, and represents a similar cost, risk, and opportunity to that of the oil industry to Norway. The proceeds of oil taxes and revenues to Norway’s dedicated fund have been massive. In time, the fund has decreased investment in oil and is diversifying. At the moment this government dances around the income dairy generates for New Zealand, and the special place it holds in the national income and national costs. According to the IRD it’s just another business. Fonterra can’t go anywhere, and is loading societal effects upon us all. So arguably it should have higher company taxes upon it to pay for its higher social license-to-operate. Arguably dairy needs a super-tax to transition us away from dairy.

Then there’s the question of how to further tax its supplier farmers. For example if a farmer had a spare $20,000 per year to invest, what tax incentive is there to discourage buying another vehicle or replace the barn roof, and encourage planting a 2km riparian strip with 5 metres of native plants? This years’ Tax Working Group would have been a better place to put that question, rather than through more oblique means like water quality regulation. Incentivising where you put your own money is always more effective than penalising.

Innovation

From the 2001 Cabinet paper, a key risk that troubled Cabinet concerning innovation has been borne out.

The proposed merger’s main risks were that “the continued under performance of innovation, including the evolution of new and higher value products, through insufficient diversity and competition in the production, marketing and exporting of New Zealand dairy products”.

Whatever innovation they were investing in simply hasn’t had rewards. In 2018 the Fonterra annual report showed that the farmgate milk price had fallen 20.4% since 2014, and the co-op’s dividend was the same in 2018 as it was in 2014, and its shares had a dividend yield of only 1.7%. The co-op’s share price continues to decline. And of course, A2 Milk and Synlait have soared in multiples over the same period.

Fonterra is now in no mood for expansive and expensive innovation. As Fonterra retrenches, so does its R&D programmes that focus on higher value products. It is of course always fraught for a government to pick sectors it wants to dedicate particular chunks of R&D funding to. It doesn’t need to. But it is proposing to restructure all polytechs, and has had to rescue many existing rural polytechs from death. Government could at least incentivise universities to ask and asnwer the question: what can universities and polytechs do to give us the highest-value and lowest-impact dairy industry in the world? Ask sectoral questions like that, and pretty soon everyone will want one. That is the job of government.

Focus

As far as the eye can see, dairy is here to stay in New Zealand as a powerful part of our economy. Fonterra’s size and its massive retrenchment will impact upon farm businesses and upon every town and city in which Fonterra has a large presence. You get a tiny sense of things to come from Kapiti.

That means that the national interest of government engaging with Fonterra should change as well.

In previous years, there was great optimism, as in Dairy NZ’s DairyTomorrow site.

Back in the day, with a fully sectorally engaged government, there were massive cross—government long term initiatives that engaged dairy as part of the food and beverage sectors.

Such optimism and sectoral engagement are a distant memory now.

It shouldn’t be.

There are far more levers this government can operate around Fonterra than it does. It’s highly likely that for the foreseeable future, Fonterra doesn’t have the strength to rise itself up again.

Fonterra needs a cross-government plan that prepares for the negative impact of its current decline and contraction, for the massive social, economic and environmental costs and opportunities that it generates within New Zealand, and for a future that turns Fonterra and the dairy industry into a greater success in the interests of New Zealand.

What is needed is a government prepared to lead the dairy industry, using everything it has.

24 comments on “Fonterra, again ”

  1. Dukeofurl 2

    in the Red is just an accounting measure, by writing down the value of assets.

    Dairy farming is still producing rivers of cash, and as a Cooperative its designed to deliver that money tax free to farmers pockets ( and more commonly now corporate farmers) rather than through company dividends.

    The red numbers , are tiny for a $20 bill per year revenue company . A similar amount ,$607 mill was written down by Sky TV , yet their revenue was $800m per year.

    The wringing of hands over Fonterra dividends wont change anything as its really doing very nicely thank you in what was intended – the milk price to Farmers.

    • Pat 2.1

      Their problems are far wider than asset write downs….and they are problems shared by many companies/industries worldwide…and all compounded by their co operative structure. At the basis of it all is…too much debt.

      https://www.interest.co.nz/rural-news/101797/keith-woodford-sets-out-how-seeds-fonterra%E2%80%99s-current-situation-were-sown-long-time

      "My calculations quickly showed that Fonterra was highly indebted, with inventories apparently overvalued, and almost certainly running up against its bank covenants"

      https://www.interest.co.nz/rural-news/101888/guy-trafford-predicts-some-quiet-years-ahead-fonterra-it-regroups-and-seeks-regain

      "The general view is that Fonterra has the support of its shareholders. However, I would suggest this is only because there are effectively no other viable options for most."

      https://www.newsroom.co.nz/2019/09/29/830948/fonterra-way-forward

      "Moreover, what it doesn’t add is that milk volume for the whole sector will, at best. only edge ahead because dairying has reached its ecological limits in many parts of the country. Worse, Fonterra’s share of that milk supply could fall if it fails to rebuild its rewards to, and loyalty from, its farmer-shareholders. They would be ripe for picking off by competing processors."

      https://www.rbnz.govt.nz/-/media/ReserveBank/Files/Publications/Financial%20stability%20reports/2019/fsr-may19.pdf?revision=47e0d60a-bdca-4fbb-bddc-2ad9f20a4b2d

      "Most dairy farms are profitable at current prices and should have been able to repay debt. However, around a third of dairy debt is held in farms with high DTI ratios. Many of these farms struggle to make profits and repay debt, despite good milk prices. This is particularly concerning as the costs of the dairy sector may rise in response to longer-term challenges, such as environmental and climate change policies. Restoring resilience in the sector will be a challenge for farms and their lenders. The willingness of banks to continue supporting the sector will be an important determinant of how smoothly the current risks will be reduced."

      • Dukeofurl 2.1.1

        Thats the dairy farmer operating model – struggle to make profit , because they would pay tax on that. They will increase borrowing against the farm as an asset to buy a holiday home etc, as tthat way the interest is tax deductable.

        Fonterra is fine as far as borrowing goes, except where the asset is secured against shares in Chinese companies, which is a minefield for anyone.

        Ask sheep farmers or beef farmers how it works when you only get the price the freezing works likes to offer – and you pay to truck the stock to the works.

        Dairy farmers get paid the same wheter they are 2km from the factory or 90km.

        With with Fonterras suppliers being 'picked off', those suppliers can get regulated Milk from Fonterra too as written in the ACt applying to Fonterra.

        Why are new factories being set up that will use that provision ?

        • Pat 2.1.1.1

          "Thats the dairy farmer operating model – struggle to make profit , because they would pay tax on that. They will increase borrowing against the farm as an asset to buy a holiday home etc, as tthat way the interest is tax deductable."

          Nor confined to dairy farms..and only works as long as the asset grows and banks are willing

          "Fonterra is fine as far as borrowing goes, except where the asset is secured against shares in Chinese companies, which is a minefield for anyone"

          Obviously not..which is why profitable assets are being sold

          "With with Fonterras suppliers being 'picked off', those suppliers can get regulated Milk from Fonterra too as written in the ACt applying to Fonterra."

          The requirement is for up to 250 million litres p/a….a drop in the bucket of 16 billion litres of processing

          • Dukeofurl 2.1.1.1.1

            That 250 mill litres per year is Goodman Fielder alone

            "Under the Dairy Industry Restructuring (Raw Milk) Regulations 2012, Fonterra must make up to 795 million litres of the milk it collects each season available to independent processors at either an agreed price or a regulated price."

            You are comparing Fonterras nationwide supply ( where it MUST take ALL milk offered by its suppliers and who are allowed to supply 20% of each farm to other than Fonterra) with its dozens of plants.

            250 mill litres is a lot of milk when you only have single plant making a higher value product .

            The French Danone group now effectively owns the Chinese based Yashili Pokeno plant which will make only make infant formula

            In Victoria , their main farmer owned coop ( Muarray Goulburn) came to grief ( along the same lines of Westland) when they got corporate whizz kids in to run the business – what could go wrong.

            We have the instance of Westland here who built a new plant in Canterbury thinking they could compete with Fonterra an attract big corporate farmers to supply that plant. The debt overwhelmed them

  2. Stuart Munro. 3

    One of Fonterra's major weaknesses is a lack of shareholder activism. In principle, large corporates like Fonterra are held accountable by shareholders, and the clowns who lost the value of all those foreign assets would be not long for this company. But NZ companies are rarely held to this standard, which is why cowgirls like Shipley and other former Gnat parasites are larded into so many of them.

    I don't really pay much attention to Fonterra, but they're not offering products that have become very popular overseas, like Yakult, nor do they seem to recognize the value available from niche or organic products. Mass commodity production is not the mark of a world-leading company, never mind its capitalization.

    • Ad 3.1

      Agree.

      Their Shareholder Council was supposed to enable farmer-owners to hold Fonterra to account.

      They were obviously weak and ineffective.

      • Dukeofurl 3.1.1

        For years they believed also the Bumpf about conquering the world. Yet the reality was dairying is a highly protected agricultural product where the high value products are often branded and specific to individual countries usually with 'cultural' connections

        Kerry from Ireland hasnt bothered with more milk supply and instead branched out into every variety of food and ingredients in Europe and US ( helped by Irelands tax minimisation)

      • Stuart Munro. 3.1.2

        I think they may, being tied to the land, not be well placed to recognize international norms as well.

    • greywarshark 3.2

      SM Your comment keeps us up with the 'play'.

      Love that cowgirls allusion, but 'larded in' comes from beef! Thinking about dairy and butter, I think Fonterra is readjusting after having butter put on its paws (you do that to help cats get used to the smell and taste of home).

      But why sell off Tip Top and not have useful little value-addeds, are they not grand enough for the moguls of milk? The value-addeds made here appealing to the overseas market and profitable, would help our economy, our employment (giving farmers sons and daughters jobs off the farm!) and i don't like this root and branch feeling of sweeping change that I get. Failing enterprises often try this cleaning up, rearranging the furniture – eg the Titanic meme.

      If you can drop in your opinion FTTT it would be helpful to understand where we stand, or slide.

  3. Blazer 4

    The proud and resourceful dairy farmers of NZ hardly need the interference of the Gummint'!

    Private enterprise and initiatives are the cornerstone of the Market'….so we are constantly told.

    The current model creates employment and profits for a few.

    If its broken,they can fix it.

    NZ commercial operations must be the jewel in the crown as far as margin goes.

  4. Weasel 5

    It is grossly rich to blame the government for Fonterra’s problems when the company has scored own after own goal – Sanlu, Beinggate, the rejection by the farmer owners of a new structure that could have provided necessary capital, Brazil, Venezuela, the botulism scare, overpaid CEOs etc etc

    Many of these disasters can be sheeted to hubris that in turn arises from Fonterra’s PR long standing firm that has been the tail wagging the dog.

    And to say that the government has created regulatory uncertainty is as rich as a cow pat. The Dairying and Clean Streams Accord 2003 has been marked by a catastrophic deterioration in our water quality almost entirely due to dairy farmers who treat their and our land like shit. Far from being outliers, the Crafar brothers were typical in cokkies’ attitude to land. The only thing that has changed dairy farmer behaviour is regulation and proper policing which to date has never happened.

    Your whole contention that Fonterra is more important to Aotearoa than other companies of size is unsupported. With its decision to return to being a pure commodity company it is actually a millstone around our the neck of the economy and the government would be best to leave it to its own gradual demise.

    • Ad 5.1

      Nowhere did I blame the government for Fonterra's problems.

      Fonterra's problems have been analyzed elsewhere in the media.

      Fonterra has been for 18 years, and continues to be, our largest business.

      Fonterra dominates our physical landscape more powerfully than any other business has in our history. No other single entity comes close.

      Whether you view that as a good or bad thing, there's no arguing with my actual contention that the government needs to engage Fonterra with more strength and with more powerful coherence around it.

    • Weasel wisdom – Why didn't you come forward with it earlier and saved Fonterra's shame?

  5. Weasel 6

    You state there is national interest associated with Fontera an go on : “But the question of how this national interest should be guided and protected is clearly not being grasped by this government.”

    That looks to me like pointing the bone at the government.

    [Corrected typo in e-mail address]

    • Ad 6.1

      Only a most paranoid hairless Weasel would think so.

    • mike 6.2

      if fonterra is to big to fail then there to big to exist.

      the value added that fonterra was to do is being done by a2 milk

      if fonterra and farmers want a bailout there going to have to share the profits make a case to kiwisaver funds not the tax payer. then again would you invest in fonterra or a2

  6. Gosman 7

    Are you suggesting the Government starts supporting a private business in a twilight industry more?

    • Dukeofurl 7.1

      Well , National did with Chorus, to structurally realign it to the tune of $950 mill by buying 45% of the shares.

      The Telecom that remained – now Spark- took advantage of that by loaded up far too much debt with the business that ran suburban telephone exchanges and the lines to customers , surely which was built over the previous 75 years
      And that was just the beginning of the subsidys where each household fibre connection – say $1k each was paid for by the taxpayer

    • Well, thinking of you Gosman. I think that would be the right thing to do.

  7. Ian 8

    What a load of twaddle.You all should be worrying about the country going down the gurgler ,and look in the mirror to find the reasons why.

    Fonterra has had the reset and the milk payout to suppliers is very good. It is totally undervalued and many dairy farmers have been snapping up the cheap units that short term investors are giving away.

    City dwellers are in for a rude awakening when the costs of cleaning up their waterways hit home. Decontamination of heavy metals is very expensive,and just stopping human raw sewerage from entering waterways is going to cost ratepayers tens of Billions.

    The sooner we clean up our shitty cities the better.

    • Drowsy M. Kram 8.1

      The idea that each of us should pay for our individual environmental footprints is excellent. The idea of dairy farmers paying the full cost, year on year, of damage done by all the shit and urine their animals produce is very appealing.

      Dairy and beef cattle outnumber the human population of NZ, and each cow/cattle beast produces ~30 times the effluent of an average human (~2 L urine and ~0.2 kg faeces).

      "The standard figure for dung and urine production of an average dairy cow is 70 litres per day." [not to mention all that lovely methane!]

      That's literally a shit load of business byproducts for responsible farmers to deal with to protect/conserve NZ's ‘100% pure’ clean green image. I wish farmers the very best in their endeavours, I really do, and hope the NZ environment can continue to soak up their business byproducts. I'm sure it can; after all, the environment is huge – there's no way a few million cows could affect it, right? wink

      I understand the dairy and beef sectors agreed to fund 32% of the cost of attempting to eradicate the Mycoplasma bovis disease from their businesses. wonder where the other 68% is coming from? And the ‘ground zero farmers’ are bleating again.

      https://www.newshub.co.nz/home/rural/2019/10/we-just-want-what-s-fair-farmers-demand-mpi-compensation-after-mycoplasma-bovis-outbreak.html

  8. mike 9

    farmers and fonterra have dug there own hole let them lie in it

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