Theo Spierings says he’ll fight to keep Fonterra’s 87% share of NZ milk in face of increased rivalry

Fonterra Cooperative Group chief executive Theo Spierings said he’s determined not to allow the dairy cooperative to fall below its current 87 percent share of the New Zealand milk pool, despite increased competition for supply.

Spierings fronted up to the media this morning after widespread criticism of the dairy cooperative’s management performance following a weak half-year financial result, lower forecast dairy payout, and anecdotal reports many of its 10,500 suppliers were seeking to leave and supply independents.

He said a major review underway of the business would lead to hundreds of its 1,500 head office and support function staff being laid off because it wanted to redirect more staff into sales and in market roles to help drive up returns. Fonterra currently employs 11,500 staff in New Zealand and 18,000 worldwide.

Spierings wouldn’t confirm the number of layoffs until a final review is completed and approved by the board, due Aug. 1. The review was started in December when it became clear the global dairy market wasn’t going to recover as quickly as hoped and Spierings said “everything was in scope” to grab as much cash out of the business as possible.

“We’re looking at the quality of the top line and what goods are sold and the gross margin levels and operating expenses. We’re looking at what more we can do to create value,” he said.

The company has slashed its farmgate milk price to $4.40 per kilogram of milk solids for the 2014/15 season and has an opening forecast of $5.25/kgMS for next season while Dairy NZ has forecast farmers need $5.70/kgMS to break even. Spierings says on-going volatility in the market means there could be a $1.50/kgMS swing either way to the 2015/16 forecast but he’s confident demand will come back in the market at some point, given global milk inventories are relatively low.

The review includes external input from McKinsey & Co providing global benchmarking on how Fonterra was performing against its peers although earlier this week the company refused to confirm the business management consultancy was even involved in the review.  

Spierings defended the $22 billion-annual-turnover cooperative’s underlying performance despite a disappointing half-year result that showed declining profit and revenue.

“Our return on capital has been 10-to-11 percent with what we’re doing with the team. We want to move to a 13 percent return on capital which would be a very strong business,” Spierings said.

Fonterra has been accused of having bloated head office management, with 17 staff earning over $1 million a year while more than a third of farmers are likely to face negative cash flow this year. However, Spierings said that figure had been reduced from 29 earning over $1 million five years ago and operating expenses had not increased “by $1” in the last few years.

When Fonterra was set up in 2001 it was owned by 11,000 dairy farmers and supplied 96 percent of the country’s milk. With the rapid expansion of smaller export-orientated dairy firms, Fonterra’s market share has declined to 87 percent of the growing milk pool and it is expanding at a slower pace than its smaller competitors.

There has been anecdotal talk of some of Fonterra’s 10,500 suppliers voting with their feet to join other dairy processors offering payouts above its payout rate or not requiring suppliers to pay for shares based on production levels that they will struggle to afford.

Spierings said while some have indicated they will leave the cooperative in the following season, most of those are in regions where other processors have built plants. He says the MyMilk brand, where farmers can join as suppliers without having to buy shares immediately, has won at least 20 suppliers back for the next season and overall supplier numbers have stayed stable.

A recent Dairy NZ report indicated farmer returns have not increased despite their production growing. Spierings said the review was aimed at driving more value back to farmers and volume growth was an important part of its global strategy.

“We have to drive the top line and that is volume and value. If we just focus on value-add we will lose a ticket to the game,” he said.

KPMG global head of agribusiness Ian Proudfoot said the biggest problem facing the dairy industry was the cooperative structure, where farmers were focused on getting the maximum cash payout rather than the investment required to drive the value-add rather side of the business.

Spierings said the current structure was working in a tough environment but long-term there were questions over where the money required for value-add investment would come from.

“I agree we need to look at how we will fund the strategy and growth strategy around the world. That’s the question on the table and we don’t want to have to go back to the whole structure of Fonterra again.”

Units of the Fonterra Shareholders’ Fund, which are entitled to Fonterra’s dividend payments, rose 0.4 percent to $4.72 on the NZX and have fallen 22 percent this year.

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