Farm Tender

Focus On The Payout Hurting NZ Dairy Farmers

This article is bought to you by McGuckin Transport

By Glen Herud - Founder Happy Cow Milk Co

The Fonterra (NZ) payout to farmer shareholders is a big deal. It makes headlines news. But maybe the co-op can’t really become a higher value business if the payout to farmers is the main measure of Fonterra's success.

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That may seem a bit backward. But the payout is an inward facing metric and the focus on the payout being high is having an adverse effect on the co-op.

But co-ops are a bit different.

If you started a 300 cow dairy farm and you wanted to supply Fonterra, you would have to buy a Fonterra share for every kg milk solids you produce. The share price at the moment is $4.33/kgms.

Assuming you know how to farm, your cows will produce 120,000kgms *$4.33= $519,600.

That's how much money you would have to pay Fonterra for the right to become part of the co-op. Theoretically, this money is used by Fonterra to pay for the stainless steel and staff needed to process & sell your milk.

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If you decided to leave Fonterra and start supplying another milk company, Fonterra would have to pay back your shares.

This is a problem for co-ops. If 5% of shareholders leave, Fonterra would have to pay back $272,790,000 and they would also have lower sales because they have lost 5% of their milk. Its a double whammy hit on the Fonterra balance sheet.

Co-ops can only get more capital from existing shareholders or the bank. They can’t easily issue more shares as a corporate company can. So “redemption risk” is a big deal for Co-ops.

This means Fonterra has to keep it farmer shareholders happy. At the moment over 80% of farmers are loyal to Fonterra.

The most important thing to farmers is the payout & the payout is the best way to keep farmers happy. So in real terms, the payout has become the measurement of Fonterra's success.

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The payout is a short term measurement that is determined by the global dairy trade event auction. Which if we’re honest, is out of everybody's control. It’s not really an indication of Fonterra moving to a higher margin business.

The metrics that would indicate Fonterra's long term success are things like, what percentage of sales are powder vs consumer products? What does it cost Fonterra to acquire a Chinese infant formula customer? What is the lifetime value of that customer? What is the market share of various products? What is the gross margin of these products? What are the sales enquiry numbers? How many retailers stock Fonterra products?

I’m sure Fonterra wouldn’t dream of sharing these figures. But if these sorts of metrics were going in the right direction and the global trade event was low, resulting in a lower payout. Farmers should still be happy because it would indicate the company is moving to higher value business.

Theoretically, the value of Fonterra should go up over time. Which is ultimately good for farmers.

When typical investors invest in a company long term, they often prefer profits to be reinvested so it can continue to grow the value of the company.

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In Fonterra's current environment, the pressure is on Fonterra from farmers to make the payout as high as possible. That's adding pressure to the already strained financials.

Obviously, there is the Dairy Industry Restructuring Act and the milk price manual which restrict what Fonterra can do. Hopefully, they will be amended in the coming years.

Imagine if every cowshed had a screen with a dashboard showing a range of key consumer business metrics. Everyone from the most junior farm worker to Fonterra managers all focusing on the measures that will determine future profitability.

The focus would slowly begin to change away from the payout.

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But what happens if the metrics don’t change? There will be nowhere to hide for the people responsible.

That's why Fonterra will continue to be payout and PR focussed.