Fonterra offers a flimsy excuse for its failures
A temporary share trading halt by Fonterra has been followed by an announcement that farmers will be unlikely to get a final dividend payout. Reality is finally biting for the company thanks to fundamental flaws in culture and strategy, says Rod Oram.
Fonterra says its decision to cut its milk payout and to pay no final dividend for its financial year just ended is a matter of simple prudence. The past season didn’t run out quite as well as it forecast so it has acted to protect its balance sheet, it says.
That irresponsibly skimpy explanation, though, fails to deal with the fundamental reasons for the co-op’s long-running under-performance which have finally come home to roost with this unprecedented financial setback. Its farmer-shareholders deserve far greater rigour and transparency from their board and management.
The heart of the co-op’s malaise is its deficient and badly executed strategy. This is why its return to shareholders has been lower than those of its pure commodity competitors such as Open Country and its value-add competitors such as Synlait and Tatua.
Thanks to this strategy, rising milk prices cause the erosion of profits downstream in its value-add businesses. But it’s those profits that fund the dividend and bolster capital, if the co-op retains some of those earnings. The likes of Nestlé and Danone do not suffer that weakness because of the power of their downstream businesses and their ability to raise external capital.
Management and the board have clearly made poor decisions on the investments and then in the monitoring and managing of them thereafter.
“Our forecast performance right across the business is simply not where we expected it to be,” John Monaghan, Fonterra’s new chairman, said in his message to farmer-shareholders.
He offered no explanation of unexpected market changes largely beyond the co-op’s control. Nor could he. The truth is the failings were internal. It didn’t see the profit weakness coming, or worse if it did, it still took a punt offering shareholders too optimistic a view, including a forecast of a healthy dividend for the financial year just ended.
There are two root causes of these failures of performance and governance. First, it has made some very large and ill-advised investments seeking to develop its value-add strategy. The biggest was investing $756 million in Chinese infant formula company Beingmate, but there are also serious questions over its investment in farming in China. On those and others, management and the board have clearly made poor decisions on the investments and then in the monitoring and managing of them thereafter.
Second, its management and operation disciplines have had some serious lapses, which have led to great disasters, particularly the false botulism scare with whey protein concentrate. That should never have happened; worse Fonterra badly botched the recall. It lost Danone as a very major customer for infant formula, and Danone sued it for $1 billion of damages.
The damage from these dynamics was starting to pile up in the co-op’s fiscal 2017 results when it took its first write down on Beingmate of $76 m. But Beingmate's problems were deeper than that write down suggested and Fonterra was still waiting to hear how much it would have to pay Danone. It should have assessed those risks more rigourously. Instead, it hoped for the best and paid out a very high dividend. If the board had been disciplined and prudent, it would have paid out little or no dividend, retained earnings and begun dealing with its strategic deficiencies in general and its deep problems with Beingmate in particular while it waited to hear what the Danone bill would be.
It was even more imprudent and pushed its luck even further with its interim results this March. By then it had paid Danone $183m and written down Beingmate by a further $405m. Yet it paid an interim dividend of 10 cents and forecast a final dividend of 15-20 cents.
But with Fonterra’s latest grim news, reality is finally biting. Fonterra has nixed its final dividend and clawed back some of the milk payout it promised. To do so it had to break the rules in its milk price manual, and excuse itself by saying its constitution allows it to do so.
These aren’t the result of some minor miss of revenue and profit targets and dividend promises, as Fonterra’s current board would have you believe. Nor will they be fixed by continuity of board culture and corporate strategy, which is precisely what Monaghan promised in his first communication with farmer-shareholders on assuming the chair.
Fonterra will only recover from this, and go on to fulfil its great potential, if it achieves a fundamental change in culture and strategy.
Thus, the upcoming board elections have become even more important. Farmer-shareholders can use it to the trigger transformative change they need and deserve.
Over the past 10 months, Newsroom has delved deeply into these problems besetting Fonterra, shedding light on its failure of strategy and culture, and its investment in China. These are the main articles we have published:
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