Focus on supporting farmers required. Photo by Gerard
With the first anniversary of Trading Among Farmers (TAF)
approaching, Craigs Investment Partners broker Greg Easton
believes investors are well served taking a cautious approach
While TAF was working well and the strategy compelling,
Fonterra was a turnaround story with earnings momentum
elusive, despite sustained growth investment.
Volatility and elevated world dairy prices were conspiring
against Fonterra and a lack of visibility in underlying
earnings made forecasting difficult, he said.
''We also see further evolution in how Fonterra manages its
relationship with farmers and the requirement for them to
support a higher risk strategy in its early phases of
The TAF mechanism was bedded down and working well. However,
the benefits associated with Fonterra's strategy looked set
to remain elusive until at least the 2015 financial year, Mr
Earnings were expected to be ''challenged'' by ongoing high
prices in 2014.
The volatility inherent in Fonterra's earnings, evident in
the 2013 result, was not surprising due to the potential for
mismatches between its key input costs and Fonterra's
different production mix, he said.
''We believe Fonterra's strategy remains clear and compelling
although the focus on shifting Fonterra's business
composition further away from its area of genuine competitive
advantage of New Zealand milk processing clearly has risks.''
Given the size of the NZ Milk Products business, Fonterra
needed to implement with ''velocity'' if the strategy was to
have a meaningful impact, Mr Easton said.
In the absence of improved operating performance, and
depending on factors such as merger and acquisition activity,
that would probably require further capital for growth, given
farmers were clearly committed to retaining a strong balance
Farmers remained the core providers of capital to the
co-operative given constraints around levels of outside
investment and no desire evident to spin businesses off, he
Coming up to the one-year anniversary, there were no issues
with the mechanics of TAF, although the use of the market
mechanism to set the price had seen a significant increase in
the costs to ''share up'' from $4.52 pre-TAF to between $7 to
$8 for much of Fonterra's first year under TAF.
''While this is clearly pleasing for farmers, particularly
those with mature farms or considering exit, it creates a
different dynamic for those growing or entering the co-op.''
Fonterra had made some early moves following TAF, including a
bonus issue and growth contracts, to alleviate pressure on
farmers facing a sudden increase in the cost of buying
shares. But without a change to the share standard, Mr Easton
expected Fonterra to focus over the next 12 months on
additional ways it could support farmer growth and ensure its
farmer base remained engaged and supportive of the growth
The co-op also needed to ensure its farmer base was better
informed about the benefits of share ownership over and above
milk supply rights. With the milk price high, Fonterra had
time to address those issues.
It remained difficult to gauge Fonterra's base earnings, due
to volatility and a lack of visibility on core earnings, he
said. Fonterra's reporting needed to better align with
strategy to provide a basis on which Fonterra could set
objectives and guidance for outside and farmer investors, Mr
That would enable more informed decisions about value and
provide a basis for measuring performance against the
With a new chief financial officer on board, Craigs expected
improvements in that area.