Fonterra has updated its earnings guidance for the 2022 financial year that ended on 31 July 2022, indicating that earnings will be towards the top end of its current guidance of 25 – 35 cents per share.
Augmenting a capital structure with the diversity of stakeholders and complexity as at Fonterra is a significant challenge. That said, change is needed and the proposal on foot is sensible and coupled with a refreshed executable strategy.
Fonterra has been plagued in the last decade with what I call an 'ambition to ability' mismatch. In short, it didn't have the skills and necessary humility to take on the world; the business was well over its skis.
Directors were wowed by overseas visits to shiny plants and promises of unlimited riches in new markets by overpaid, misaligned executives. Board members had, at times, questionable conflicts 'frontrunning' ventures in new markets and unworkable factions existed. Visions and dreams were created, however, they were only that - a fantasy or maybe even an hallucination.
Execution was lacking. Poor choices were made around strategy. A lack of quality thinking and diligence characterised investments.
Fortunately, change at Fonterra is well afoot; the turnaround is underway. Whilst challenges persist in the regulatory framework domestically, the necessity of Fonterra - and more broadly dairy to New Zealand - is now more important than ever.
It is often forgotten what would happen if Fonterra didn't exist in its cooperative format. It is very simple - farmers would be squeezed down to accept lower milk prices just above their breakeven. The profits made on farm from high milk prices and dividends delivered to those farmers by Fonterra would be lost to overseas corporations. Money wouldn't end up back in local communities - in rural communities - in local rugby and netball clubs, small businesses and to local employees and contractors. Tax and GST takes would immediately impact government.
This on farm economic multiplier effect, delivered by an efficient cooperative is more important today than ever to New Zealand. This despite continual pressures from government on farmers' capacity to operate.
The need for quality nutrition underpins the new Fonterra strategy. It is the right strategy that plays to Fonterra's strengths, one that takes account of likely New Zealand production declines (mostly from said regulatory pressures), the benefits of New Zealand pasture-based milk (both environmental and nutritionally) and Fonterra's world-leading research and development capabilities.
Unfortunately, Fonterra has learnt the hard way that it is not a consumer products powerhouse. Those businesses are hungry for capital and don't match a risk profile of farmer shareholders seeking high annual dividend payouts.
Regardless of the new strategy, there is one thing that Fonterra needs to deliver - performance. You can have any capital structure, however if a business doesn't fundamentally perform it will fail.
Behind performance are three clear requirements:
- A clear, articulated strategy
- Capable people
- Measured execution against the plan
It is clear to me that elements of this are coming together. Fonterra needs to complement its number - both at board level and within management - with world leading experts who know how to deliver.
Execution previously lacking must be held to account by the board and failing that by shareholders playing a more active role. We cannot afford more mind numbing thought experiments using shareholder capital.
There is a lot that needs to be done. Sensible enduring partnerships need to be entered into. R&D needs to be focused and targeted. The manufacturing footprint needs to be reduced and positioned towards value, while still retaining some flexibility around commodity/volume like it has in the past.
The board needs to be held account for performance and in-turn continually test and challenge the management team.
Credit needs to be made for work done already. The business is rightly moving back to its core - New Zealand milk provided by New Zealand farmers.
Why will I be supporting the proposed capital structure? Put simply, the status quo doesn't work for a declining milk volume environment. The capital structure needs to better suit supplier flexibility and succession. There will always be elements we don't like. For me it is farmer leavers (not retirees) continuing to get the benefits of 'dividends' once they leave the cooperative - i.e. extracting the value premium and getting a commodity milk price elsewhere.
Notwithstanding it is best structure available under the current regulatory framework. We must remember the past lessons hard learnt and not fall into the same traps. Regardless it is time to either get on the bus or get off it.
This new capital structure, more importantly with an executable strategy, gives us confidence to invest on farm and let Fonterra do for future generations what it has for past - deliver prosperity and wealth to rural communities significantly to New Zealand's global standing.
Charles Whiting is a Waikato-based, former finance executive with investments in dairy and other NZ businesses.