At the release of Fonterra’s 2021 financial results this week, Chairman Peter McBride and CEO Miles Hurrell talked about the co-op’s long-term strategy and updated capital structure proposal.
This is part of what they said in an email to farmers:
The world wants our sustainably produced, high-quality milk and this comes at a time when we see total New Zealand milk supply as likely to decline, and flat at best.
On one hand, this requires the right capital structure to help ensure we don’t lose the benefits of what generations of farmers have built – a New Zealand dairy co-operative of scale. But on the other hand, it gives us more options to be selective about what we do with your milk. In doing so, we can increase the value we generate for farmers and New Zealand over the next decade.
To make this happen we have made three strategic choices:
- Focus on New Zealand milk
- Be a leader in sustainability
- Be a leader in dairy innovation and science.
Our strategy requires us to focus our capital and people on enhancing New Zealand milk and for these reasons we have reviewed our ownership of our two other milk pools – in Australia and Chile.
Soprole and its subsidiary Prolesur in Southern Chile do not require any New Zealand-sourced milk or expertise. Within that context, we are starting the process to divest our integrated investment in Chile.
Fonterra Australia is on strategy for the Co-op and remains an important export market for our New Zealand milk, especially for foodservice products and advanced ingredients. We are considering the most appropriate ownership structure for this business, one option includes an IPO, with the intention that we retain a significant stake.
Both of these decisions are critical to achieving a greater focus on our New Zealand milk and, importantly, allowing us to free up capital – much of which is intended to be returned to shareholders by way of special dividend.
There are four key value targets we’re aiming to achieve by 2030:
- An average Farmgate Milk Price range for the decade of $6.50-$7.50 per kgMS
- A 40-50% increase in operating profit from FY21 and, with the reduced interest from having less debt, this should translate into an approximately 75% increase in earnings, giving us the ability to steadily increase dividends to around 40-45 cents per share by FY30
- A Group Return on Capital of 9-10%, up from 6.6% in 2021
- Through planned divestments and improved earnings, an intended return of about $1 billion to shareholders by FY24, and around $2 billion of additional capital available for a mix of investment in further growth and return to shareholders. This is in addition to the approximately $2 billion expected to be invested in sustainability and moving milk into higher value products.
We also intend to increase our current total annual R&D investment by over 50% to around $160 million per annum in 2030, with about $60 million per annum specifically targeted at growth in Active Living.
Updated capital structure proposal
We have used the busy calving period on-farm to step back and reflect on your comprehensive capital structure feedback.
The proposed “Flexible Shareholding” structure is a progression on the preferred option we consulted on in May, but with key changes based on farmer feedback and further expert advice:
- 33% share minimum – you would only need to hold one share for every ~3 kgMS supplied
- 4x share maximum – you could hold up to four times your milk supply in shares
- Farmer-only market for shares, with a capped Fund. Farmers would decide the prices at which they buy and sell shares, without the traded price being influenced by external investors 6 seasons to share up for new entrants
- Up to 15 seasons to share down for existing shareholders after ceasing. Any new entrants post these changes would have five seasons to exit after ceasing
- A more inclusive pathway to becoming a Co-op member as sharemilkers, contract milkers and farm lessors could buy and sell shares
- Voting remains based on share-backed milk supply
- Fonterra would allocate up to $300 million to support liquidity as our farmer owners’ transition.
We are confident that this proposal would support the sustainable supply of New Zealand milk that our long-term strategy relies on. Our future success relies on our ability to maintain a sustainable milk supply in an increasingly competitive environment, and one that is rapidly changing due to factors such as environmental pressures, new regulations and alternative land uses.
As we’ve mentioned above, we see total New Zealand milk supply as likely to decline, and flat at best. Our share of that decline depends on the actions we take with our capital structure, performance, productivity and sustainability.
If we do nothing, we are likely to see around 12-20% decline by 2030 based on the scenarios we have modelled.
Farmers leave the Co-op for different reasons, but one of the most influential ones is the high level of compulsory investment that’s required to be part of our Co-op.
A capital structure with Flexible Shareholding would help to level the playing field with competitors, many of whom are foreign-backed and don’t require farmers to invest capital.
Analysis of potential milk supply scenarios we have developed shows that, based on our current operations, our Farmgate Milk Price could be 6-13 cents lower by 2030 if we make no changes to our capital structure and continue to lose market share at the rate we’ve seen over the past 5 seasons to May 2020.
Under the Flexible Shareholding structure, our farmer ownership and control would be protected by capping the Fonterra’ Shareholders Fund. This means shares in the farmer-only Fonterra Shareholders’ Market would no longer be able to be exchanged into units.
The proposed changes would also protect against the uncertain and recurring risk to the Co-op’s balance sheet that would come with having to buy back shares or units to stay within current thresholds related to the Fund size if milk supply declined under the current structure.