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The day the Fonterra dream finally died

Fonterra's value has almost halved since its overseas expansion strategy imploded in early 2018. Now its new leaders have found yet more losses and look set to dismantle what remains of what many hoped would become a national champion. Bernard Hickey looks through the rubble.

The dream is over, except for the final garage sale and the divvying up of the proceeds.

The last Labour-led Government drove through the Dairy Industry Restructuring Act (DIRA) in 2001 in concert with the almost all of New Zealand's 12,500 dairy farmers in the hopes of creating a national champion with the global scale and ambition to match or beat the likes of Danone, Arla or even Nestle.

The idea was to create an internationally connected powerhouse that would deliver super-sized returns for New Zealand's white gold and make both the nation's 12,000 farmers and the communities around them much richer. The dream was to create a value-adding machine that broke the tyranny and volatility of being a commodity-producing price taker dependent on the whims of currencies, markets and the weather.

Back then, dreamers talked of Fonterra becoming the Nokia of the south. How things have changed. For both Finland and New Zealand. There was still hope as recently as the beginning of 2018 when Fonterra appeared to be recovering from years of low payouts and a damaging botulism scare.

But no more.

This week's news of another $840 million of asset write-downs caps a truly awful 2018/19 season for Fonterra farmers and has set the co-operative on the path to a break-up and a return to the main dairy company being a simple milk collection, drying, bagging and shipping company of milk powder for others to make the real profits from consumer brands and complex food and other products. The carving off of Fonterra's value-added consumer brands and food service businesses, which currently use about half of its capital (debt plus equity) of around $12 billion, now looks most likely. Fonterra said it was actively reviewing its capital structure along with its strategy, and faced years of dividend-free debt repayment without major changes.

"Capital structure is a discussion that the board have kicked off as well," CEO Miles Hurrell told reporters yesterday. He said the board remained committed to being a co-operative, but the scale and focus of its activities were all on the table.

CFO Marc Rivers admitted Fonterra had fallen behind on its plan to repay $800 million of debt by July 31 and had not reached its targeted debt to debt plus equity leverage range of 40-45 percent. They did not detail the current debt position, but rejected suggestions Fonterra was in breach of its debt covenants. Fonterra had $7.1 billion of debt at January 31 and its leverage was at 52.5 percent.

Fonterra's management, board and shareholders now face an intense debate ahead of its final results and strategy announcement in September about whether the co-operate will sell off the value-add assets and return the proceeds of over $5 billion to farmers to repay dairy debt owed to banks such as ANZ, Rabobank, Westpac, ASB and BNZ of $42 billion. Some of the proceeds may have to be used to repay Fonterra's own debt first.

The Reserve Bank warned again in May that dairy sector debt was too high, with around 35 percent of the debt (around $15 billion) on farms with more than $35 of debt per kilogram of milk solids. On average, these farms need a cash payout of $6.20/kg just to break even. The removal of the dividend this year, and potentially next year, would leave many of the most indebted, large, recently-converted mega-dairy farms making losses with the current forecast milk-only payout of $6.30/kg.

Farmers meet for Fonterra's annual meeting in November. It is set to be an historic one with the potential to formally end Fonterra's grand ambitions. It will bookend an awful year for Fonterra's shareholder-farmers, which now number 10,500.

An annus horribilis in 2018/19

The market value of their co-operative has fallen $4.8 billion since the shock resignation of CEO Theo Speirings in March 2018 and their expected cash payouts from milk and dividends have fallen $1.1 billion. They once hoped for as much $7.10/kg, including a dividend of around 20 cents a share. Now they're looking at payout of around $6.30/kg with no dividend and their share price has dropped from $6.68 to $3.57, including a 5.0 percent fall on Monday after the latest shock announcement.

New CEO Miles Hurrell and CFO Marc Rivers held a hastily arranged mid-morning telephone conference with journalists to warn that the final results would show a net loss in a range of $590-675 million or 37-42 cents per share. Early last year Fonterra was forecasting earnings of 25-35 cents per share, and that was after Fonterra reported its first ever net loss of $196 million for the 2017/18 year because of $638 million of writedowns on assets in Australia and China. Back then, some hoped the scale of the losses overseas had been fully accounted for.

But the latest news was much, much worse than expected.

Hurrell said "it has become clear that Fonterra needs to reduce the carrying value of several of its assets and take account of other one-off accounting adjustments, which total approximately $820-860 million."

“Since September 2018 we’ve been re-evaluating all investments, major assets and partnerships to ensure they still meet the Co-operative’s needs. We are leaving no stone unturned in the work to turn our performance around. We have taken a hard look at our end-to-end business, including selling and reviewing the future of a number of assets that are no longer core to our strategy," he said.

"The review process has also identified a small number of assets that we believe are overvalued, based on the outlook for their expected future returns."

There were more losses in China, which has been the main source of concern for years, and most concerningly, there were big losses in Fonterra's home market because of the botched launch of a new national distribution centre and hotter competition on local supermarket shelves from new brands of milk, yoghurt and cheese.

“In our New Zealand consumer business, the compounding effect of operational challenges, along with a slower than planned recovery in our market share, has resulted in us reassessing its future earnings," he said.

"We are now rebuilding this business and, as part of this, have sold Tip Top which allows the team to focus on its core business. The combined impact is a write-down of approximately $200 million."

Problems in New Zealand too

Hurrell confirmed in the news conference that the New Zealand writedown was actually $300 million, given the Tip Top sale for $380 million yielded a profit of $100 million.

He detailed a write-down of Fonterra's DPA Brazil assets of about $200 million. Fonterra is reviewing this joint venture with Nestle. Fonterra wrote down the value of its Venezuelan assets by $135 million and reduced the value of its farms in China by $200 million. It increased its Australian write-down from $50 million to $70 million.

Rivers talked down the prospect of a quick return to dividends or hitting the debt reduction target.

“The key position we’d need to get ourselves into is to be able to continue to perform on that underlying business. As that performs, that puts us in a position to be able to pay a proper dividend, but we need to earn it first," he said.

"This is going to take a couple of seasons to get the balance sheet to a level it needs to be at but we're actually on a good path," he said when pressed about future dividends.

A2 Milk shares closed yesterday at $16.04 and the company was worth $11.8 billion, more than twice Fonterra's value.

Asked if Fonterra would now need to reduce debt by more than $800 million, Rivers only said more work needed to be done.

“The key for that, when we talk about the strategy in September, is we need to get the balance sheet into a strong position to be resilient to give us optionality. This will take time for us to do this in a proper diligent way.”

Meanwhile, Fonterra farmers have watched Fonterra's market value crater from over $10.7 billion in early 2018, when it was worth almost twice as much as A2 Milk.

Fonterra's shares closed on Monday at $3.57, down 5.0 percent on the day, and its market value was $5.7 billion. A2 Milk shares closed yesterday at $16.04 and the company was worth $11.8 billion, more than twice Fonterra's value.