Fonterra's proposed restructure still requires government approval. Photo / File
The capital restructure of Fonterra, New Zealand's biggest business, will cause its farmers a short-term loss of $4 billion, strengthen the dairy company's market dominance and push up the price of milk at the grocery chiller, claims a new report.
It will also probably fuel land prices, says the Castalia report commissioned by Fonterra export rival and the country's second-biggest dairy processor Open Country.
Open Country hired Castalia, a global strategic advisory firm, to examine the impact of the proposed restructure on Fonterra's share price and on competition between dairy processors for milk supply.
In summary, the report said the proposal would likely collapse the price of Fonterra shares and shift significant wealth from current farmers to Fonterra itself.
"This has detrimental effects for competition in the milk processor market, compounding anti-competitive changes in 2020 to the Dairy Industry Restructuring Act 2001. The proposal is likely to lead to higher milk prices, including for domestic milk consumers."
Fonterra said it had not seen the Castalia report and was not prepared to comment in detail without reading it.
However, the report's main points, referred to by the Herald, "are not consistent with our expert advice, which has the benefit of utilising our internal data, not assumptions".
"It's important to keep in mind that Fonterra is a co-operative. We are an extension of our 10,000 farming families and a strong and sustainable co-operative of scale is good for farmers and for New Zealand communities. Because we're owned by Kiwi families, our profits go to New Zealanders."
The proposed restructure, approved by Fonterra's 10,000 farmer-owners but still needing the Government's tick because Fonterra is regulated, will make it easier, and cheaper, for farmers to join the co-operative and supply it with milk.
Fonterra, created in 2001 from an industry mega-merger under specially-written legislation, today collects around 80 per cent of the country's raw milk (it started off with 96 per cent.) But with national milk production forecast to remain flat or fall, the big co-operative is seeking to ensure its future viability and to keep its tanks full.
After the restructure, a farmer will only have to buy one-third of the shares required now to supply milk.
"Hence the focus of the restructure is to enable Fonterra to gain market share even if it reduces access to new capital," said the report.
"The restructure has already substantially reduced the market price of Fonterra shares and we estimate a further 40 per cent drop is likely.
"It will cause a massive imbalance between sellers and buyers in the market. Instead of around 13 per cent of shares in the 'free float' available to be traded as pure investments, around 71 per cent will now be traded purely for investment purposes, rather than in order to 'share up'."
The restructure shifts wealth from current farmers to Fonterra in the short term, said the report.
"We estimate the Fonterra share price will fall to settle at a price that reflects the discounted cash flow value of Fonterra's announced dividends. This implies a fall from the May 2021 share price of $4.60 (before the restructure announcement) to around $2.
"For the average dairy farm producing 176,000kg milk solids per year, this is a loss of around $360,000. Multiplied over all Fonterra shareholders, it is a loss of $4.1 billion.
"In exchange for suffering this short-term balance sheet hit, farmers are providing Fonterra with the ability to attract new farmers more easily and increase milk supply. More efficient utilisation of capacity should reduce processing costs and enable Fonterra to pay a higher milk price. This should feed back into farmers' wealth in the form of higher dairy farm prices."
The report claims the restructure removes "the last vestige" of anti-competition protection afforded by the 2012 amendment to the Dairy Industry Restructuring Act (Dira), under which Fonterra operates.
This amendment introduced Fonterra's present capital structure, Trading Among Farmers (Taf) and the Fonterra Shareholders Market. It also introduced the Fonterra Shareholders Fund (FSF), a listed vehicle for dividend-carrying, non-voting units in farmer-owned shares, available to the public.
The report said FSF exposed Fonterra to public capital market discipline.
"Both aspects were intended to influence Fonterra to not divert revenues towards inflating the milk price at the expense of paying a fair dividend. While these were weak constraints on Fonterra's behaviour (it has still diverted income towards the milk price), Fonterra has always argued they were effective.
"The restructure now removes this last constraint. Fonterra now can use the milk price setting regime to discourage competition."
The restructure would probably feed into higher milk prices and higher, non-taxable, farm value gains, the report claimed. Fonterra is seen as New Zealand's raw milk market price setter.
"Since farmers are taking a balance sheet hit, we expect additional pressure to fall on the
Fonterra board, and the milk price panel, to ensure the farmgate milk price is biased upwards. With the shares losing their financial investment value overall, it is unlikely shareholders will seek to exercise influence to achieve higher dividends. Instead, the focus will shift primarily to ensuring a higher milk price."
Fonterra in response said: "...The capital restructure does not of itself affect Fonterra's farmgate milk price-setting process, which is set in accordance with an administrative and public methodology and subject to Commerce Commission oversight. In addition, the 2020 amendments to Dira allowed for a ministerial nominee to be on the Fonterra Milk Price Panel, which increases its independence. Professor Hamish Gow has filled that position."
"Lower capital cost of entry to Fonterra should stimulate demand for farms, adding to the
higher milk price being capitalised into farmland values. These gains in land value are untaxed when realised on farm sale, unlike dividends on the shares."
Competition in the processing market would be affected because Fonterra would reduce the cost of entry and channel all benefits of additional milk supply into the milk price, the report claimed.
"Fonterra will be able to increase its dominant position in the market and attract additional supply from other processors."
This would have negative consequences for sector efficiency, productivity, and innovation.
Household milk product prices would rise, the report predicted.
"In recent media statements, the Minister for Primary Industries is focused on domestic dairy product prices and has said there is an opportunity to address these in the context of changes to Dira required by the restructure. Domestic milk prices will rise as a result of the restructure. Any policy change that attempts to de-link domestic milk product prices from the farmgate milk price will be unworkable and will fail."
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