Rod Oram spoke to Fonterra’s farmers after they challenged directors and management about their big losses in China. He found a sombre and dispirited mood.

From Whangarei down to Invercargill this week Fonterra’s farmer-shareholders went looking for answers from their co-op’s directors. Its mediocre performance, stagnant dividend and share price, large write-down in China, erosion of equity, and their desire to change boardroom culture and leadership were top of their questions.

But judging by reports back to this writer from many of the 13 meetings, all they got was: a presentation playing to positives but failing to address any negatives; bland reassurances all was well with strategy and performance; promises that what wasn’t right (notably its investment in Beingmate, the Chinese infant formula company) would be put right; emphasis on ‘normalized’ profits which ignore write-downs; and assurances of how well farmers have benefitted over recent years from rising milk payouts and dividends.

“The information they came with, and how they presented it, encapsulated everything wrong with Fonterra,” said one senior North Island shareholder. “I didn’t take any pleasure out of that at all.”

Despite Fonterra forecasting it will make its fourth highest milk payout ever this season, people in various meetings described the mood as somber, dispiriting and disillusioning, among other downbeat terms.

There was also widespread anger that the board and management gave no apology for decisions they had made which had resulted in the co-op writing down the value of its investment in Beingmate by two-thirds to $244 m so far. They fear further write-offs on it later.

According to shareholders at two meetings, Brent Goldsack, a new member of the board, told farmers that he had read the due diligence report on Beingmate. Based on his extensive experience with such documents at PwC – he resigned from running its Waikato operation to join the board five months ago – the Beingmate report was “as good as they come,” one shareholder reported.

PwC is Fonterra’s long-standing auditor. It approved an initial $35 m write-off of Beingmate at the year-end results last September, and the latest $408 m write-off just six months later.

Shareholders also noted a paucity of patsy questions and praise for the board and management. “Cringe-worthy” was how one described a short, upbeat video intended for townies about how fabulous Fonterra and its farmers are. “It didn’t sit right with farmers at all. The results speak for themselves,” he added.

Yet, farmers had turned up in higher than usual numbers. Some 350 attended the Hamilton meeting, double the usual number, a Fonterra media person told me as I stood outside talking to shareholders on their way into the meeting, including John Wilson, the chairman.

Of course, there was a new feature this time around, the press person explained. The Shareholders’ Council had requested the serving of a hot buffet lunch or dinner (depending on the meeting time) to encourage more people to come. In the past, they just get free drinks and nibbles.

Fonterra has 10,500 shareholders; perhaps only 15 percent of them went to the roadshow meetings; and the ones I talked with in person, or exchanged emails and calls with, were a tiny cross-section more likely to be unhappy than happy shareholders.

That said, their views fall into three broad categories:

Those who understand well their co-op’s strategy and finances, and who know exactly how their farm businesses are performing. These are the most worried shareholders, and the keenest for changes in strategy and leadership.

Those who say they are small cogs in a big machine. They feel the co-op doesn’t listen to them, and they have no power to influence its direction.

Those who say the co-op persevered in the past to eventually turn round difficult investments in Chile and Australia. They have confidence the current board and senior management will do the same in China.

The first category of shareholders has plenty of evidence and analysis to support their stand. As Bernard Hickey noted in his Newsroom analysis after the co-op’s interim results last week, it has performed poorly over the past seven years with Theo Spierings as chief executive and John Wilson as chairman:

Shareholder equity was $6.5 billion in the 2011 annual report, but had only inched up to $6.6 billion at January 31 this year.

Over the past seven seasons the milk payout averaged $5.90 per kg of milksolids, up 45 cents on the average of the previous seven years. But those are set by international prices of dairy commodities, which were rising, not by the co-op’s performance.

The dividend, the best measure of the co-op’s ability to add value to milk, was unchanged at 30c a share on average over the latest seven years.

The savviest farmers are worried most of all about the co-op’s weakening equity base. They were unimpressed by reassurances in some of the meetings by Wilson and Marc Rivers, the new chief financial officer, that it was “strong”.

Fonterra has only two ways to raise new equity: when milk supply is growing, farmers have to buy more shares to match the volume of milk they send for processing; and retention of profits.

But New Zealand milk production has likely plateaued, and will probably fall as environmental pressures cause farmers to stock fewer cows. Moreover, Fonterra’s share of supply is falling. It is losing some large suppliers, such as Southern Pastures to Westland, and many smaller ones to other processors; and many of those are investing in its traditional territories, as Synlait and Open Country are doing in the Waikato.

Some seasons, such as this one, Fonterra’s milk supply volumes decline because of inclement weather. But the risks are rising of an outright systemic decline in Fonterra’s volumes.

This is a big turnaround from the early 2000s when dairying was booming. Fonterra pulled in some $4-5 billion of new capital in just the five years up to 2012. That was also the year the co-op changed its capital structure, thereby eliminating the risk that redemption of shares by farmers would erode its equity. As a result of this lost discipline, many shareholders worry the board has become less careful with their capital.

For them, Beingmate is the prime example of a large investment made in haste with inadequate due diligence, made worse by a subsequent lack of monitoring and corrective action. In their roadshow meetings, directors and management offered no apology or credible assurances Fonterra could help turn round the deeply troubled company, a number of shareholders said.

The other source of new capital is retained profits. But Fonterra has a track record of minimal retentions and maximum dividend payments to please two parties: those farmer-shareholders who want to maximise their short-term returns; and external investors in the co-op’s NZX-listed Shareholders’ Fund whose main rewards is the dividend.

As a result of these factors, farmers’ equity has fallen from 42 percent of the co-op’s total assets in 2011 to 33 percent this January, which made the subsequent near half-a-billion dollar write-off of Beingmate all the more damaging to the balance sheet.

Meanwhile, Fonterra is using this constrained New Zealand equity base to help it invest in milk pools abroad, notably in China, and in downstream production overseas. To facilitate those, it is resorting to heavy borrowing. Debt and bonds, for example, financed its $756 m investment in Beingmate. At the half year, its gearing was 51 percent, which is above its target. It believes its gearing will fall in the second half of the year, and it will be able to pay a final dividend of 15-25 cents a share.

For those shareholders who believe the co-op urgently needs a change of leadership and strategy, the news that Spierings is leaving and his replacement will be appointed later this year is less than reassuring. They worry that Wilson will remain chairman, the strategy and board culture will remain unchanged, and the next CEO will be picked for skills that seem right for the current strategy.

They are also critical of the board’s lack of development of potential successors to Wilson, to the point the board has never had a deputy chair; and they are critical of its candidate selection process. They say it perpetuates the current culture by making it impossible for non-approved candidates to stand for election.

They also point out the best companies grow their own highly talented, widely experienced, open-to-new-ideas candidates for chief executive. While there are one or two such credible internal candidates, particularly from the ingredients side of the business, they say the existing board is likely to choose an external candidate strong on consumer markets and brands.

If he or she stays for seven or eight years, as Spierings and his predecessor Andrew Ferrier did, the co-op will have been run for more than 20 years by people from overseas who have had to learn about the co-op and its culture, New Zealand and its farmers, and in the case of Ferrier and potentially the next chief executive, about the dairy industry itself.

While all these are complex and massive issues for the co-op to get to grips with, some farmer-shareholders know how to cut to the heart of matters. Such as two old fellas at urinals adjacent to mine at the Hamilton meeting on Tuesday evening:

Farmer A: “See the share price today? Down again.”

Farmer B: “The Chinese saw us coming”

Farmer A: “Nobody put their hand up.”

Farmer B: “To err is human, they say.”

Farmer A: “To lose millions is bloody incompetence.”

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