Fonterra's capital restructure still needs Government tick. Photo / File
Fonterra has challenged a report strongly criticising its capital restructure proposal, published by its largest competitor for New Zealand milk.
Open Country Dairy commissioned the report by consultancy Castalia, which claimed the capital reform - yet to receive Government approval - will cause its farmers a short-term loss of $4 billion, strengthen Fonterra's market dominance and push up the price of milk at the grocery chiller.
Fonterra in a statement to the NZX, on which it has listed units, said it disagreed with the report and a number of its conclusions, "including the assertion that protection for a fair milk price will be eroded and that the restructure will cause Fonterra's milk price to increase".
New Zealand's biggest business also challenged Castalia's estimates on Fonterra's future share price.
"Fonterra also notes that Castalia estimates Fonterra's future share price on the basis of possible dividends up to 2020 but appears to assume that Fonterra has zero value at the end of 2030. Fonterra considers this to be a misleading approach to valuing its shares."
Fonterra said the report contained no perspectives not previously considered by the farmer-owned co-operative and discussed with its shareholders, who voted 85 per cent in support of the restructure proposal in December.
Jarden head of institutional research Arie Dekker also questioned aspects of the Castalia report, revealed by the Herald on Friday.
In a research note, Dekker said independent processor concern highlighted the significance of the changes planned for Fonterra's capital structure.
He noted Castalia's estimate, as reported by the Herald, that Fonterra's share price would fall to settle at a price that reflected the discounted cashflow of Fonterra's announced dividends.
The report said this implied a fall from the May 2021 share price of $4.60, before the restructure announcement, to around $2.
Dekker: "We question the $2 reference point with FSF [Fonterra Shareholders' Fund]
highlighting the same concern.
"FSF is currently generating 30c per share of EPS supporting a 20cps dividend.
"It hopes to increase earnings and dividends over the next 10 years with meaningful investment to support that. Even in the absence of meaningful dividend growth, discounting dividends currently supported by FSF's earnings results in a share value well above the suggested $2, with FSF's dividend stream to extend beyond any timeframe they have signalled dividends for.
"In addition we note FSF plans to return $1 billion of capital to shareholders – roughly $0.60/share.
"Also, the proposed capital structure plans do not change the way in which the milk price is set. The level of independence in the setting of the milk price has long been an area of debate in the industry. The level of independent oversight was reviewed recently with a ministerial appointee added to the milk price panel.
"Despite the questions, we remain of the view that the robustness of the milk price has been supported over the past two decades by the increase in independent processing capacity put in place in New Zealand. Capacity would not likely have been put in on an ongoing basis if FSF had been consistently overpaying the milk price."
Dekker said it was also worth noting that under the proposed restructure, significantly more shares would be held for investment purposes and "this should add an interesting additional dynamic on scrutiny of the milk price".
In summary, the Castalia report said the restructure proposal would likely collapse the price of Fonterra shares and shift significant wealth from farmers to Fonterra.
"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," it said.
When forwarded Castalia's main claims by the Herald, Fonterra chairman Peter McBride responded the company had not seen the report and was not prepared to comment in detail without reading it.
However he said the main points "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," McBride said.
Exporter Open Country, which commissioned the report, is owned by New Zealand's Talley's Group.
Fonterra's capital restructure proposal still needs a tick from the Government, because the dairy industry is regulated.
With national milk production flattening and expected to fall over the next decade, Fonterra is seeking to protect its future milk supply by giving farmers greater flexibility and ease of sharing up - or buying shares - to supply.
As Dekker said, this is despite the proposed changes coming at the expense of farmer investment with the share price falling since the proposal was announced in May last year.
"FSF has positioned the changes as important for its ability to successfully compete for a finite New Zealand milk pool with ongoing loss of market share to independents, putting it at risk of stranded capital in this new environment for milk supply.
"Enabling farmers the ability to reduce the amount of capital invested at an individual level - one share for each 3kg milk solids supplied, down from 1:1 - should help in attracting and retaining supply over time.
"The reality is that with shares on issue remaining unchanged [provision for a small buyback facility to accommodate initial liquidity if required] farmers will still collectively continue to own the same number of shares, outside of buying demand coming from a new group of associate shareholders [such as supplying farmer-owners, share milkers, contract milkers, lessors].
Dekker said with exchangeability between the Fonterra farmer-only trading market into the FSF market stopped, that new group should provide additional buying demand on what could be a significant pool of surplus supplying farmer shares over time.
Removing the influence of demand from outside investors - through the FSF - on the share price should also help take some of the pressure off the capital cost for farmers in supply Fonterra, he said.
"It is important to note that post changes, a much greater proportion of shares will be held for investment purposes over supply purposes than has been the case."
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