PAUL MCBETH: Fonterra’s mission impossible becomes mission accomplished

Paul McBeth is the editor of The Bottom Line and Curious News, and previously worked at BusinessDesk for 15 years.

Fonterra Cooperative Group chief executive Miles Hurrell is leaving the dairy giant on a strong note, doubling the pace of returns for farmer shareholders and streamlining the business to focus on its traditional areas of strength in ingredients and food service.

When Hurrell was handed the reins in late 2018, the cooperative was reeling from red ink as it had to accept the empire-building under chief executive Theo Spierings and chair John Wilson hadn’t panned out as planned.

The goal of building milk pools around the world to keep supply close to the exporter’s customers turned out to be much harder to execute than Fortress Fonterra had anticipated, not helped by a global recall of whey protein concentrate in 2013 when there were fears a contaminated batch had entered the supply chain.

And provisions forcing Fonterra to accept all comers to the cooperative meant some of its local investment decisions weren’t necessarily up the value chain where the dairy group wanted to be playing – especially when the still-recent China free trade deal saw whole milk powder fly off the shelves until those inventories were full.

Meanwhile, the 2012 launch of the Fonterra Shareholders’ Fund – allowing the dairy exporter’s owners to sell rights to the earnings stream to outside investors – had alleviated the redemption risk but still left the cooperative needing to borrow money to pay for its grand plans.

Life is changin’ every day

Fonterra, like many before and legions still to come, discovered that lenders are fair-weather friends.

So, when Fonterra veteran Hurrell was tasked to steady the good ship Fonterra in tandem with a refreshed board led by Peter McBride – who’d enjoyed success steering kiwifruit marketer Zespri International – there were a multitude of tasks on the to-do list, which obviously would take some time.

Getting the balance sheet on an even-keel was at the top of the list, with a raft of assets sold and much tut-tutting by the commentariat about how Fonterra was turning its back on that value-added promised land.

The sale of the Tip Top ice-cream business rankled more than some of the international exits – think the Chilean Soprole business, the exits from the Brazilian joint venture with Nestlé and European pharmaceutical partnership with Royal FrieslandCampina, and of course the problematic China farms and Beingmate formula company.

Sure, the sale of the Mainland consumer business tapped into that rich vein of Kiwi nationalism by those with no skin in the game, but there’s a reason why Fonterra’s 8,100 or so shareholders backed the exit – they’ve accepted that what the cooperative’s been doing hadn’t worked as they watched their peers switch to other processors.

I know I’ve felt like this before

That’s something to be applauded, as NZ Shareholders’ Association chief Oliver Mander rightly pointed out in the latest The Long and the Short of It podcast, Fonterra’s board under McBride’s chairmanship showed the ability to accept the harsh lessons of the past and adapt to build a more resilient and streamlined business.

That’s something to be celebrated and for Hurrell to accept his dues of accomplishing exactly what the board and the cooperative’s owners wanted.

And it shows not just in the cooperative’s earnings metrics and stable balance sheet, but also in the rewards for its owners, with the farmer-owned cooperative shares climbing to an adjusted $6.22 from $4.09 when Hurrell started, and paying $2.07 per share in dividends, plus the upcoming $2 capital return from the Mainland sale.

That’s roughly a 14% compounding annual growth rate including dividends and capital returns over the past seven years, not including any returns from the final two half-year results under Hurrell.

And, with $56.54 per kilogram of milk solids paid to suppliers over the past seven years, they’ve averaged an $8.08/kgMS payout at the farmgate.

A different way to be

It’s not a like-for-like comparison with Spierings, whose initial share price in 2011 was the fair value used before trading among farmers gave Fonterra a more transparent price, but through the late Dutchman’s time ending in March 2018, the cooperative shares rose to $4.93 from $4.52, with $1.89 per share paid in total dividends, for a compounding annual growth rate of roughly 7.1%.

Meanwhile, the farmgate payments amounted to $41.43/kgMS, for an average $5.92/kgMS per season.

Understandably, Hurrell’s fans aren’t just the corporate watchers sitting in Auckland, even if the cooperative is exposed to more volatile swings in the farmgate price than the likes of the Netherlands’ FrieslandCampina or Dairy Farmers of America.

And for all the wailing about how New Zealand’s dairy champion gave up capturing value as it shifts its focus to ingredients and foodservice – where it’s traditionally been strong – the fact is that consumer businesses are hard and Fonterra’s owners have simply never shown the gumption to fund them appropriately.

Building sales and marketing teams to drive growth of certain brands isn’t something you can do from Fanshawe Street in Auckland. It requires people on location where you’re trying to convince regular folk to hand over their hard-won money and struggles in a cookie-cutter environment as the vagaries of regional tastes require a bit more nuance in winning over customers.

Impossible to ignore

As much as people like to look at the Beingmate experiment as being doomed from day one, it at least recognised that China’s less affluent tier two and three cities – with populations of less than 10 million – needed a different approach to what worked in the likes of Shanghai and Beijing.

And let’s be clear, Fonterra’s capital structure has always meant it’s taking on the world with one arm tied behind its back.

If you cast your mind back to the late-2000s when the merged dairy group was still relatively shiny and new, the then-board chaired by Henry van der Heyden was keen on creating a listed vehicle, controlled by the cooperative, to tap capital markets for the money needed to drive that growth.

Farmers didn’t want a bar of it, leading to the halfway house of the shareholders’ fund that mitigated redemption risk without providing an avenue for new equity to flow on to the balance sheet to avoid those uncomfortable conversations with bankers.

Never quite as it seems

We can ruefully look at Ireland’s Kerry Group spitting out fat dividends and ponder those ‘what if’ questions, but the simple fact is Fonterra’s farmers weren’t willing to accept the overblown risk of getting squeezed out by big money financial institutions to chase that goal.

Whoever takes up the mantle of chief executive does so with a largely clean slate, able to focus on managing those key relationships with big international buyers and focusing those heavy research and development programmes to delivering more valuable ingredients and foodservice staples. All within a tight fiscal envelope of earnings and a tolerable level of debt.

And by doubling down on New Zealand’s milk pool, they’ll need to make sure they don’t lose farmers to their local rivals again – after all you can’t sell something if you don’t have the raw material.

Hurrell’s success in managing down those expectations for Fonterra to be an all-encompassing dairy beast is a healthy reminder to not lose sight of doing what you’re good at.

Image from Fonterra.