Fonterra, farmers and that fat profit

fonterraprofit

Fonterra rocked its Australian farmers last May with a price drop following Murray Goulburn’s own shock price announcement. I think it was fair to say nobody was surprised there was a drop – Fonterra had been signalling one for months – but the savagery of its execution left many farmers aghast and distraught.

Salt was added to the wound three weeks later when Fonterra chief executive Theo Spierings reportedly said:

“What we are doing is drive (sic) every cent of money which we can out of Australia back to New Zealand shareholders in this extremely low milk price environment,” he said.

“That is what we are doing everyday. And Australian business this year will be at a plus.”

Yesterday, the wound was opened afresh with Fonterra’s annual results headlined by a profit of $834 million after tax, including a healthy profit from the Australian division. With all this in mind, Milk Maid Marian asked Fonterra’s GM Australian Milk Supply, Matt Watt, some rather blunt questions. To his enormous credit, Matt had the following answers for us in less than 24 hours.

MMM: Fonterra Australia is very good at assessing farmer sentiment with its regular forums and Mood Meter surveys. How did the pricing changes announced in May affect the sentiment of farmers supplying Fonterra Australia?

MW: On the back of the shock and challenge that the price revision in May had to our farmers, we have seen a significant drop in farmer sentiment measures – that’s absolutely reflective of the discussions I’ve had over the phone and in person with our farmers and as has been fed back via our field team, BSC board and supplier forum.

MMM: How has sentiment changed since?
MW: Since opening price, we have seen a slight increase in sentiment. Importantly, the aspect that does rate positively is our field team interaction and support – we are proud of the work that the team does and, despite the surrounding circumstances, they continue to find ways to help our farmers through this period.

MMM: How much money did Fonterra Australia save by slashing the milk price in May and June?
MW: The milk price revision in May reduced our losses by around $40M which, on its own, enabled the Australian Ingredients business to get to around a break even position.

MMM: Given the reshaping of the Australian business was already well underway, why was it considered necessary to make the radical price cut?
MW: There has been significant effort and investment in the turnaround – we’ve divested loss-making businesses and non-core assets, such as our yoghurt and dairy desserts business, our Bega shares and our stake in Dairy Technical Services.

We reduced our working capital and our headcount, and undertook a program to drive efficiency throughout our business. However, the simple truth is, we were paying a milk price that was not being returned by the market, and that was impacting our profitability.

Our results today show improvement for the Australian business, which has contributed to the strong result for the Co-op, however, our turnaround is not complete and we need to continue to invest – our new, more efficient warehouse investment and further expansion of cheese capacity at Wynyard are examples of investments that have been made recently. Without a profitable business we compromise our ability to invest, risk devaluing the business, and risk our ability to provide sustainable returns right back to the farm gate.

MMM: What, if anything, do you regret about the decisions made in May?
MW: Whilst I can’t personally feel the impact on every single farm and the business and family circumstances, I am acutely aware of the massive impact that this decision had. In hindsight I often reflect as to how we could have more overtly communicated the disconnect between the Australian farm gate price and returns available in the market.

Having said that, the attempts that we did make about Australia not being immune to global challenges and that the milk price did not reflect what was being earned in the market had a discernible, negative impact on our supplier sentiment. We were accused of talking down the market.

MMM: How does Fonterra justify such harsh cuts while making a profit?
MW: While the milk price revision was regrettable, it is important that both our farmers and Fonterra have a model that ensures sustainable profitability.

The reality is that Australian milk price last year was not reflective of the global dairy commodity prices and around the world, all dairy farmers have experienced low farmgatge milk price. Our business is owned by farmers, and they have $1 billion of equity invested here. Last year these farmers received $3.90 per kgMS (NZD) in milk price plus a 40c per kgMS dividend on the back of the profit result. This takes them to $4.30 per kgMS (NZD) vs a final farm gate milk price of $5.13 (AUD) here in Australia.

MMM: Where have the 200 million extra litres come from?
MW: The new milk has largely come from MG farmers moving to supply Fonterra.

MMM: The presentation also says Fonterra Au’s outlook is to continue efforts to fill Darnum and notes that Stanhope will be online in 2017. How many more litres will be needed?
MW: The additional milk that we have brought on goes part way to meeting these needs. However, we continue to expect to see market opportunities continue to emerge, meaning that we will want to continue to grow volume, particularly in Northern Victoria.

MMM: The presentation says Fonterra Australia has gone from “Disconnect between milk price and reality” to “Market connected milk price”, yet Fonterra Australia is still bound by the Bonlac Supply Agreement to match or better the price of Australia’s largest processor. What are Fonterra plans in respect to that agreement?
MW: Our opening price and forecast close of $5.00 per kgMS reflects market conditions, but also is well above MG, the benchmark milk price. We remain committed to meeting our obligations under the BSC agreement, which is why, in 8 out of the last 10 years, we have paid a higher price than the BSC minimum commitment.

Thank you very much to Matt Watt, Fonterra’s GM Australian Milk Supply, for answering Milk Maid Marian’s questions.

The call of the farm speaks to so many

"Trough activated, Captain!"

“Trough activated, Captain!”

Alex was excited as he pulled on his boots this morning. He had full custodianship of the big Dolphin torch and lit our way through the paddock to open the gates in time for the cows.

With the gates open and the track diverted, Alex checked the operation of the trough, just as the sun’s glow lit the sky.

The Little Man is growing up with the call of the farm in his blood, something that makes him unusual for Australian kids these days, something that’s a real privilege.

He doesn’t realise it yet and I suspect many of the Year 8 students I met today don’t, either. Two DEPI experts and I were part of a panel drawn together to help inspire a new generation to follow their passions and keep learning all the way through life. A lofty aim that’s somewhat daunting, for it took two tragedies to find my way here.

During the questions that followed, one boy illuminated the elephant in the room: “Is it better to get a job you really like even if it pays badly or should you go for one that pays really well?”

For me the answer is clear. While Lynne Strong is undoubtedly correct when she writes that an adequate financial reward is key to seeing more young people return to agriculture, it’s not the only thing. Profits support a passion but rarely do they invoke one.

WinterValleyLoRes

How you are a pawn in the profit of permeate

I have a rule never to blog while I’m angry, so there’s been a distinct lack of activity on Milk Maid Marian over the last week. In the end, I’ve decided to simply lay out the facts:

– Permeate is a natural part of milk, not a waste product of the cheese making process. In fact, if you sit unhomogenised milk still long enough, the permeate settles out all by itself very clearly. In other words, there is no such thing as pure milk without permeate.

– Permeate is the milk’s sugar, minerals and vitamins.

– The composition of milk (fat and protein especially) straight from the cow fluctuates wildly over the course of a year but consumers want milk that is the same all year round. Consumers also want to be able to choose skim and full cream milks.

– We call ironing out the bumps and providing the specific fat and protein content of the milk “standardisation”.

– The very small producers do not have the technology to separate all the different parts of milk to make lots of different products (like powder, casein, whey, etc). Generally, all they can do is separate the cream from the milk, which is how they standardise it.

– The larger milk companies cannot limit themselves to the tiny niches of these smaller companies, so make food ingredients as well (like the stuff that goes in sports drinks, pizza crusts, etc). This means that the milk is broken into its constituents (which include permeate) with a filter then re-mixed to standardise milk. This is what the term “modified milk” on cartons means – still 100% pure milk.

– Consumer group Choice has done lots of work on permeate and their tests confirm no taste or nutritional difference between milk that has permeate remixed and that without.

– Permeate is nothing new – been part of milk processing for years and years.

– Small and specialty milk processors need to find a point of difference in order to make milk sales viable because their cost of production is much higher.

Draw your own conclusions!

Should farmers be embarrassed to talk about money?

A very thought-provoking piece by Terry Etherton deserves some discussion in dairy circles, I think.

Is it considered a little shabby for dairy farmers to be concerned with profit? Certainly, animal activists are quick to label farmers as greedy at the expense of their animals and the environment. Their web sites and advertisements paint “profit” and “money” as very dirty words indeed.

In contrast, Terry Etherton makes the point very well that:

“My perspective is that sustainable should first be viewed through the ‘lens’ of economic sustainability. Farms are businesses. If they don’t make money they close…pretty simple.”

“However, sustainable gets used in a myriad of confusing ways. For example, some in society talk about sustainable in the context of this being the ‘best’ food production practice to embrace. I am sure many readers have seen the marketing message: organic food production is more sustainable than other agricultural production practices and, therefore, better.”

Mr Etherton is right and Australian dairy farms are even more precariously balanced than their US counterparts, receiving no taxpayer-funded subsidies at all. We do have to be keenly focussed on the almighty dollar to survive. On the other hand, that doesn’t mean we cut corners when it comes to animal wellbeing.

A dairy farmer with a dislike of animals would soon quit. We work with them all day, 365 days of the year. They’d also quite likely get “sacked by the bank” because being mean is not profitable. Our livestock, our land and our people are our greatest assets – generations of farmers and cows know that.

So, how do we respond when we are labelled as “greedy farmers who exploit animals”? The US experience is that it’s best to say little about the link between profitability and animal welfare, preferring instead to focus on the values that we as farmers hold.

I agree because it’s true that values are much more powerful than profit. When the chips are down during drought, fire or pestilence (so to speak), it is the farm family that goes without, not the cows.

Why do farmers accept low milk prices?

During the recent publicity surrounding the milk price wars, I noticed a lot of comments following newspaper stories asking why dairy farmers continued to supply milk if it wasn’t financially rewarding. Simple question, complex answer.

Then yesterday, I went to a dairy farmer forum where respected farm consultant John Mulvany said, “A milk price of $5.00 to $5.50 per kilogram of milk solids is required for the foundation business of the industry (owner-operator farms) to receive an adequate return on the assets plus capital growth. This assumes ‘best practice’ management in the top 25 per cent.”

Also, that: “A large corporate investor will require a milk price of $5.50 to $6.00 per kilogram of milk solids to generate a return to shareholders in addition to growth.”

Then he presented a table that showed milk prices had only reached $5.00 per kilogram of milk solids twice since 1994/95.

If we accept John’s numbers, they raise two really important questions: why do dairy farmers keep going and why should family-run farms accept lower profits than corporate investors would? John’s always said that dairy farmers are optimistic by nature and I guess that’s part of the answer. But, if you can make a better return on the share market without working seven days per week, why wouldn’t you?

Every farmer will have a different answer to this question but I think it’s because we’re pretty much locked in, whether that’s emotionally or financially or a bit of both.

The financial ties that bind us are debt and the cost of exiting (and re-entering) milk production. Unlike broadacre farmers, we cannot readily shift our production focus in line with commodity price movements. We have a herd of cows that cannot be replaced overnight or “redeployed” and costly infrastructure that must be used to service debt. Nor can we readily wind back production. Cows must be well fed, no matter what, and that costs a lot of money. So when milk prices fall below profitable levels, we don’t withdraw supply immediately – instead, we draw on the buffer that equity in our land provides. Sadly, that’s just not good enough for many farmers and we are seeing a slow but constant attrition in farm and cow numbers as the decades roll on.

The emotional ties are harder to explain. After my father died, my accountant’s advice was to sell and invest the money elsewhere. “You’ve got other skills. Why work so hard when you could buy a nice little property out of town and be comfortable?” he reasoned. Sound advice but I wanted desperately to farm because, as corny as it sounds, I love the land, the animals, the life skills it will teach my children and the wind in my face. Something no corporate investor would value.