Last week New Zealand dairy co-operative Fonterra confirmed it made a loss of almost €350m for its 2019 financial year. The loss was mainly driven by investment write-downs to the tune of €475m across its global operations, with troubled businesses in China, Australia, Venezuela, Brazil and New Zealand.

With these losses adding to a NZ$6bn (€3.4bn) debt mountain, for the first time in its history it will not pay an annual dividend to its farmers.

This is a blow to Fonterra’s farmer suppliers and the NZ rural economy.

About a third of farmers are struggling to repay bank debts built up during a decade-long expansion, according to central bank data.

A dividend of 10c to 15c per share would have seen the co-op pay out up to €140m to its farmer shareholders, equivalent to around €10,000 to the average milk supplier.

Shares in the company have halved in the past 18 months to NZ$3.56. It is also a concern for the wider economy, given that Fonterra dairy products, including milk powder and cheese, make up a quarter of NZ exports.

Farmer shareholders are now focused on how the co-op, once the golden child envied by dairy farmers world over, can recover.

When it was formed in 2001 through the merger of two co-ops and the dairy export council, its vision was to become the world’s largest dairy exporter, while at the same time representing the interests of NZ dairy farmers.

Today it is responsible for nearly 30% of the global dairy exports

Eighteen years later, Fonterra and its 10,000 farmer shareholders had grown into a global giant, processing milk in New Zealand, Australia, China and Latin America. Former CEO Theo Spierings and former chair John Wilson had the ambition to transform Fonterra from a New Zealand commodity milk processor into an international dairy powerhouse. Today it is responsible for nearly 30% of the global dairy exports.

But it lost sight of what its purpose was as it tried to do more glamorous things, which it didn’t do very well. It spent more than NZ$2bn (€1.1bn) on poorly performing, overpriced foreign ventures. It was shaken by food scandals and more agile competitors that captured profitable new markets.

It invested NZ$1bn (€o.6bn) in Chinese dairy farms, NZ$750m (€428m) in infant formula maker Beingmate, to take on the likes of Danone or Nestlé along with hundreds of millions in South American and Australian dairy businesses, all of which have underperformed and are loss-making.

So now, with a new CEO in place, Fonterra has unveiled a new strategy to try reverse the losses

It is a fall from grace that has called the company’s strategy and structure into question. So now, with a new CEO in place, Fonterra has unveiled a new strategy to try reverse the losses.

It goes back to basics and focuses on the co-op’s core strength: its milk processing and ingredients business in New Zealand. It is about chasing value rather than volume, something it has been hit and miss about doing in past years.

CEO Miles Hurrell said: “It’s a strategy which recognises we are a New Zealand co-op ... we will complement our farmer owners’ milk with milk components sourced offshore when required. We will start rationalising our offshore milk pools over time.”

Back to basics

So the volume-based, dairy-only approach pursued under the former chief executive is gone and the strategy will now focus on using NZ milk to meet market needs. This will see Fonterra offload its offshore milk pools over time. In China it has 35,000 cows across three farming hubs. These have seen weak performance and gobbled up almost $1bn (€0.6bn) without returning any profit.

Hurrell believes the new strategy is the right one, but it will require hard choices.

He said the co-op’sstrategy will be built from the belief that NZ farmers’ milk is the best in the world. The co-op will focus on dairy ingredients: paediatrics, medical and ageing, sports and active, and core dairy.

Asset sales of nearly NZ$1bn (€0.6bn) are expected to help reduce the debt mountain

It also plans to create new opportunities in new ways for foodservice, building on foodservice success in China and developing new markets, particularly in Asia Pacific. Some have also criticised the co-op structure, which seeks to balance farmer shareholder demands (milk price) with the commercial need for cheap raw material to maximise margins to meet covenants with banks on its debt.

Asset sales of nearly NZ$1bn (€0.6bn) are expected to help reduce the debt mountain. Farmers carrying huge debts from a decade-long expansion look unlikely to be in a position to stump up more cash. Given the high debt levels, and being constrained to fund any new ventures or upgrade facilities, farmers may also have to accept the company retaining more of its profits, with reduced or no dividend or weaker milk prices.

This puts its milk pool at risk. Farmers have been switching to rivals such as A2 Milk Company, which has seen the co-op’s market share fall from 95% in 2001 to about 80% last year. No turnarounds are ever easy – they involve pain and take time. But will farmers give it the time, especially given their own debt and profitability concerns?

What’s going to be different?

  • Focus back on NZ.
  • Get balance sheet in order.
  • Offload overseas milk pools over time.
  • Focus on adding value to New Zealand’s milk pool.
  • In five years it wants

  • Gross margins of 15.6% - 15% in 2019.
  • Capital expenditure no more than NZ$500m to NZ$600m in 2019.
  • Profits (EBIT) of NZ$1.1bn to NZ$819m in 2019.
  • Debt less than 3.5 times earnings to 4.3 times in 2019.
  • Return on capital of 10%- 5.8% today.
  • Earnings per share of 50c to 17c today.