Fonterra woes have been years in the making

Almost 20 years ago, New Zealand’s dairy industry was not so different to what we have today in Ireland. At the time, New Zealand dairy farmers were producing 11bn litres of milk, which was supplied to four co-ops for processing.

New Zealand legislation required that all dairy products exported from New Zealand must be sold through the New Zealand dairy board (NZDB), a marketing and export body somewhat similar to Ornua.

However, the merger of New Zealand’s two largest dairy co-ops in 2001 – Kiwi Co-operative Dairies and New Zealand Dairy Group – along with the NZDB, created the super co-op we know today as Fonterra.

Since its creation, Fonterra has grown into the world’s largest dairy export company, selling more than 4.5m tonnes of dairy product each year. The co-op had sales in excess of NZ$19bn (€11.3bn) and net profits of NZ$745m (€437m) last year. Fonterra now processes 24bn litres of milk every year, with processing operations in New Zealand, Australia, China and Chile.

But all is not well at the New Zealand dairy giant.

Last week, Fonterra released financial results showing the co-op had recorded a €203m loss after tax for the first six months of its 2018 financial year. The massive financial loss came about after the co-op was forced to take a €236m write-down on the value of its investment in Beingmate, a Chinese infant formula company.

Fonterra first invested in Beingmate in 2015, taking an 18.8% stake in the company for €440m. The New Zealand co-op has now revalued its stake in Beingmate to just €142m. On the back of the latest half-year results, Fonterra also announced that chief executive Theo Spierings will step down from his position later this year after seven years at the helm.

The Dutch native, who arrived at Fonterra from FrieslandCampina, has been under growing pressure over the last year as the extent of the problems at Beingmate became clear. The Chinese company is set to rack up losses of between €100m and €130m for its full financial year, despite originally forecasting to make profits of €2.5m.

Disappointed

After the extent of these losses was made public, Spierings said he was “extremely disappointed” by the performance of the company and was seeking more financial information from Beingmate as to the reasons behind the losses.

A number of board directors at Beingmate, including the two board members nominated by Fonterra, have also expressed reservations relating to the financial management and reporting practices at Beingmate.

Allegations of insider trading and product tampering have dogged Beingmate throughout 2017. Share trading in Beingmate was halted on the Shenzhen stock exchange for an indefinite period last July after the company announced plans to begin an asset sale programme to shore up losses.

The Chinese infant formula maker blamed its poor financial performance on recent regulatory changes made by Chinese authorities which limits the number of brands a company can manufacture.

For farmer shareholders in Fonterra, the abject performance of Beingmate since 2015 has been a hard pill to swallow. The original thinking behind the investment was to gain a stake in the largest infant formula company in China.

At the time, Beingmate was the largest player in China, holding a 10% share of the country’s €30bn infant formula market. However, Beingmate rapidly lost market share over recent years. It had just 2.5% share of the market last year.

China strategy

On top of this, other aspects of Fonterra’s strategy in China have not performed. Since 2005, Fonterra has been building large-scale dairy farms in China, which now comprises almost 35,000 cows on 10 different farms. These farms produced a cumulative 335m litres of milk last year.

However, the original aim of the strategy was to produce 1bn litres of milk in China by 2018. While the investment made a profit of €600,000 last year, Fonterra’s China farms racked up losses in excess of €60m in 2015 and 2016 as the co-op struggled to gain a handle on production costs in China.

A growing frustration among Fonterra’s farmer shareholders has been bubbling under the surface in recent years. When the Irish Farmers Journal visited New Zealand last month, anger among Fonterra suppliers over the China strategy was discernible, with one farmer adamant that either Theo Spierings or John Wilson, chairman of Fonterra, “had to go” for presiding over the Beingmate investment.

The frustration around Fonterra’s strategy in China, which is a critical market for the co-op, accounting for 20% of sales, came to a bizarre head this year after Fonterra obtained a high court injunction against Leonie Guiney, a former board member of the co-op.

The injunction restrains Guiney from disseminating information to the media as it would breach her duties of confidentiality to Fonterra. Guiney has been a vocal critic of Fonterra’s investment in Beingmate and is understood to have been dissatisfied with the governance of the Chinese company.

To add to its China woes, Fonterra was recently ordered to pay €107m in damages to Danone, following a product recall in 2013 linked to a false botulism scare. The payment of these damages, coupled with the Beingmate impairment charge, has left many farmers questioning whether Fonterra will be able to pay out a dividend this year to farmers.

The co-op has said it will pay out a dividend of 25c to 35c per share to its farmer members at the end of this season, depending on how the remainder of the financial year plays out.

Milk supply

Perhaps the most obvious sign of farmer dissatisfaction with Fonterra is the co-op’s falling share of the milk pool in New Zealand. When Fonterra was first created, it collected and processed 96% of all the milk in New Zealand.

However, the co-op is now losing more than 1% market share per year of New Zealand milk collections. For the 2016/2017 milking season, Fonterra accounted for just 82% of the New Zealand milk pool.

Dairy farmers on the South Island in particular, who tend to have larger-scale farms, have switched to smaller dairy companies such as Synlait, Open Country or Westland.

Many farmers feel Fonterra has lost touch with its co-operative roots and become too corporate in recent years. In 2016, when milk prices were on the floor, Fonterra moved to a new purpose-built head office in downtown Auckland, which is one of the most impressive buildings in the city. Many farmers accused the co-op of being disconnected with its shareholder owners.

In 2017, it emerged that Theo Spierings was paid almost €5m in salary, pension and performance-related bonuses, which was a more than 50% increase on the previous year. This made Spierings the highest paid CEO in New Zealand, although it is important to note that Fonterra is by far the largest company in the country.

Despite its current challenges, it must be acknowledged that the Fonterra story has been hugely successful for New Zealand dairy farmers. New Zealand milk prices have been much stronger over the last decade compared to where they were prior to the formation of Fonterra. The co-ops scale has also given it an unrivalled reach in global dairy markets. However, there are lessons for the Irish dairy industry from Fonterra’s recent problems. The poor performance of the Beingmate investment shows that partnering with a large Chinese company does not guarantee profits in the world’s largest market. Ultimately, it shows that farmers and boards must always be confident to challenge company management on future direction and strategy. In that way it reduces the risk of failures that end up costing farmers.

– Eoin Lowry