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Oram: Time for Fonterra to get serious

For its new strategy to work, Fonterra will have to get really serious about making dairy farming deeply sustainable as well as focusing on how to get a premium for high-quality New Zealand milk products, writes Rod Oram.

Amid Fonterra’s plodding interim results this week which suggested a tougher second half, two comments by the co-op stood out. One offered hope; the other more losses.

On the bright side, John Monaghan, the chairman, said the co-op’s strategy would focus on the sustainability, quality and premium-earning potential of its New Zealand farmer-shareholder’s milk.

This is more radical than it seems. Gone is the strategy of recent years of chasing volume growth at home through high intensity farming and conversions of sheep farms, and through ill-advised, large investments in milk supply overseas.

But for this home-based strategy to work, Fonterra will have to get really serious about making dairy farming deeply sustainable, particularly by sharply reducing the damage it does to the climate; about identifying the qualities of New Zealand milk; and about earning a substantial premium for it.

Only then will it shift from being in large part a producer of basic commodities to being entirely a maker of high value, specialised dairy products. If it achieves all of that in the next 10 years, then it and its farmer-shareholders have a future, and a profitable one to boot.

The Beingmate debacle

On the dark side, Marc Rivers, the co-op’s chief financial officer, conceded that the $755 million stake Fonterra took in Beingmate, a Chinese infant formula company, in March 2015 is now simply a “financial investment” of uncertain value.

None of the strategic rationales for taking the 18.8 percent stake are operative. Mind you, only one of the five was activated fully: Fonterra’s sale of a 51 per cent stake in its Darnum plant in Australia to Beingmate. Another was activated very badly: Beingmate’s distribution of Fonterra’s Anmum brand of infant formula in China.

Even worse, there is barely any commercial activity between the two companies. The only one will be the resumption in this half-year of some milk powder shipments from Darnum to Beingmate. But Fonterra won’t even get any money for those. Beingmate is taking goods not cash in return for selling back to Fonterra the 51 percent stake in the plant it bought from the co-op just a few years ago.

Fonterra won’t be drawn on the prospects for Beingmate or the value of its stake in it. But the signs are ominous. Beingmate is a shadow of its former self, with no signs of a strategy to rebuild itself. Last year its sales were 2.47 billion yuan (NZ$550m), barely one-third of the level they were when Fonterra first expressed its interest in the company, and half the level when it bought its stake.

Beingmate’s profits are equally minuscule at 41m yuan last year, versus 72m yuan in 2013 and 103m yuan in 2015 when Fonterra invested in it. Some form of China Inc. attempt to stabilise and rebuild Beingmate is underway. But Fonterra and its shareholders shouldn’t be fooled by the recent rise in Beingmate’s share price on thin volume. The price has always been detached from the reality of the company. For example, it shot up while Fonterra was buying its stake, even though Beingmate was in decline at the time.

Beingmate sees no role for Fonterra in its attempted revival. Instead, it has turned to Bubs, a small, fast-growing Australian producer of organic and goat milk infant formulas for its next big thing. Two weeks ago, the two companies announced a joint venture to take Bubs products into 30,000 bricks and mortar Beingmate stores in China. Substitute Fonterra for Bubs and it could have been the same announcement the co-op made in 2015.

In due course, Fonterra, with no cards left to play, will have to negotiate an exit price. With that grim prospect in mind, farmer-shareholders should prepare for a further write-off of their investment in Beingmate.

How to earn a social licence and a positive brand story

Back to the bright side of maximising the profitability and sustainability of dairy farming in New Zealand. Over recent years, Fonterra and its suppliers have made some useful progress on environmental issues, such as fencing to keep cattle out of waterways, and riparian plantings to help reduce pollution from paddocks leaching into waterways.

Over the past two years, Fonterra has also put a lot of effort into understanding and measuring the benefits of New Zealand milk and farming practices. Wisely, it wants to ensure it can back up every claim it makes. But so far it has been timid about the messages and obsessed about the data. Thus, its New Zealand provenance story is pale and ineffective. Ireland, for example, is doing a far better job with its Origin Green programme.

On this, Fonterra’s performance to date is sub-optimal, Miles Hurrell, Fonterra’s CEO, conceded at the interim results media briefing.

But the co-op has vastly more to do than hone its messages and declutter its data. It, along with the rest of the dairy sector, has to understand that they have to find ways to reduce their sector’s considerable contribution to climate change.

All the ways of doing so will have substantial co-benefits such as healthier cows, soils and waterways. Thus, the sector will earn a very strong social licence to operate here and a powerful provenance and brand story to sell overseas. Armed with those, they will produce fewer products by volume but earn much more money than they do currently.

Big on talk, big on emissions

Fonterra, though, is not taking climate change seriously, even though its suppliers are by far the largest source of greenhouse gases in the country. When it speaks of its action on climate, it talks up big its modest efforts on energy efficiency and tentative plans to introduce a few trials of renewable energy to substitute for the coal and gas it uses to dry its milk.

On its current plans, it reserves the right to still be building new coal fired plants in 2030. Those could have a life of up to 30 years. Fonterra is delusional if it believes it could still be burning coal in 2060.

But worse, all of those emissions from its manufacturing, transport and distribution only account for 10 percent of its overall emissions.

The other 90 percent are on farm from animals and artificial fertiliser. On those, Fonterra is only pledging to keep its methane levels unchanged by 2030. If its farmers achieve any reduction in methane per litre of a milk a cow produces, it will put the gains to higher milk volumes.

But worldwide, we have to reduce methane emissions by 35 percent by 2050 if we are to stand any chance of keeping the rise in global temperatures to 1.5c, the UN's IPCC reported last October.

Fonterra argues that at best farmers have only a few very minor tools to start reducing methane, as it laid out in its submission on the Zero Carbon Bill.

But that is absolutely not the case, as our Parliamentary Commissioner for the Environment, our Productivity Commission and many of our agricultural scientists, not to mention scientists and authorities overseas, have catalogued.

While many of those pathways to methane reduction are fledgling, the best way to fast-forward them is for Fonterra and the rest of the agricultural sector to commit to sizeable reductions in methane. They would then be rewarded by government backing for the science investment to make it happen so they can still produce large volumes of products from ruminant animals, but in climate-friendly ways.

Despite that welcome future, Fonterra and many other farming organisations are still dragging their feet. They are using a distinctly minority view on methane as a rationale for no action. For more on this topic, see this column I wrote last October.

If Fonterra and other New Zealand dairy companies continue to shun leadership on these issues, they are running a very real risk that Chinese investors in NZ dairying will displace them, thereby gaining the kudos and benefits.

This is starting to happen. For example, Synlait Milk, which is 39 percent owned by Bright Dairy, which in turn is owned by the Shanghai municipal government, rewards suppliers with a premium for their milk if they meet demanding environmental standards.

This week the Westland co-op announced it was selling up to Yili, China and Asia’s largest dairy company. If the sale eventuates, it will take Yili’s investment in NZ to well over $1b in just six years. For that sum it has bought and expanded New Zealand processing assets and secured a strong base of Kiwi farmers and gained the benefit of exporting New Zealand branded milk.

It’s worth reflecting that over the same period Fonterra has spent well over $1b in China on its stake in Beingmate and its investment in its own farms there. But it has got remarkably little to show for those investments. Worse the write-offs of farmer-shareholder capital are not over yet.

With the Chinese teaching Fonterra some painful and expensive lessons about the dairy business in China, it would be ironic if Chinese investors took leadership here on sustainability and climate change.

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