Dairy dilemma: Will a $10/kg milk price hinder Fonterra’s plan to sell consumer business?

Fonterra is New Zealand's biggest business. Photo / Supplied

Fonterra’s farm gate milk price is likely to hit $10 a kg of milk solids - a boon for dairy farmers - but a potential hitch in the co-op’s plans to sell the consumer arm of the business.

The country’s largest business revealed in May last year it was looking at full or partial divestment options for some or all of its global consumer business, including well-known brands such as Anchor, and its integrated businesses Fonterra Oceania and Fonterra Sri Lanka.

On May 29, 2024 the co-operative forecast a farmgate milk price midpoint of $7.80 per kg of milk solids. But by December last year, it had been revised up on multiple occasions and is now forecast to be $10 per kg of milk solids.

A high milk price has in the past tended to act against Fonterra’s consumer division, with milk being its highest input cost.

“There is a scenario here that consumer’s earnings will be under pressure more than they would have been six months ago, with the milk price being where it is, which is frustrating when you are trying to sell a business,” Forsyth Barr senior analyst Matt Montgomerie said.

“But overall, it shouldn’t have a material impact on the process,” he said.

Andrew Murray, the co-op’s chief financial officer, says Fonterra can handle what looks likely to be a record milk price.

The co-op wants to divest its consumer business as well as integrated businesses Fonterra Oceania and Sri Lanka - assets estimated by analysts to be worth around $2.5 to $3.5 billion - in order to focus on its high-performing ingredients and food service businesses.

Asset sales will require approval from its 10,000 or so farmer-shareholders.

Murray, who has spent most of his career in the fast-moving consumer goods (FMCG) market, joined Fonterra in 2023 as commercial director for Fonterra’s global markets business. He was appointed chief financial officer last August.

Fonterra has already sold assets such as Tip Top and Chile’s Soprole to narrow its focus and reduce debt.

The decision to exit the consumer business, which contains big names like Anchor, was what one analyst called Fonterra’s boldest decision yet.

If it came to a sale, Fonterra expects that it would continue to supply the consumer business in much the same way as it did with Tip Top, which it sold in 2019 to Froneri for $380 million.

In an interview with the Herald, Murray said he does not see a “good, solid” milk price standing in the way of any possible sale of Fonterra’s consumer business.

He says the co-op, which issued an update in November, has more clarity now as to what lies ahead.

“It’s a nice spot to be in.

“Everything is proceeding exactly as we expected.

“It’s not a quick process, obviously.

“Our last communication in November was that we had moved into a sale process and that’s the part we are in now.

The future could see an initial public offer (IPO) or an outright sale.

“We are absolutely pursuing a dual track that could involve a trade sale as well.”

Fonterra has previously said the divestments could take 12 to 18 months to complete.

On the milk price, Murray said: “From our perspective as a co-operative, a high milk price is a good thing.

“For consumer and food service, what we need to be able to do is deal with the volatility of the milk price - that means being able to put in place the right measures - be it in pricing or in formulation.

“I think that we have developed quite a strong model in that space now around being able to do that.

“That’s what it means for the consumer business - a higher milk price means that you essentially have a higher input cost - but it’s how you react to that that is important.

“It’s not automatically a bad thing - usually it’s not a matter of all costs going the same way.

“The milk price is a big part of the input cost, but there are many other variables that are at play as well.”

The high milk prices coincide with what analysts expect to be a strong financial performance from the co-op.

“We are in a good space at the moment,” the softly spoken Glaswegian says.

Assuming consumer is sold - and farmers have yet to give their seal of approval - what would Fonterra look like?

Ingredients - mostly milk powder - is the biggest part of Fonterra’s business, offering a good return on capital.

“It’s a good margin business and a sizeable part of our Ebit comes from the ingredients business.”

“Food service, again, is very important, offering a good margin and a good return on capital.”

Murray says the co-op hopes to leverage the success it has with food service in China in other geographies.

Andrew Murray, Fonterra's chief financial officer. Photo / Supplied

“We know that we are in a good spot and it’s about maintaining that momentum - we are really focused on that,” he said.

He said Fonterra’s strategy was not reliant on getting a sale for consumer.

Rather, he said it was a question of whether capital tied up with consumer could be used in a better way.

Assuming a sale goes ahead, what would a post-consumer Fonterra look like?

“In ingredients in particular we have very strong relationships and we are continuing to develop those around being able to push into the higher value, more advanced ingredients - that’s a definite space for us.

“I think also that sometimes we forget that the consumer business - if we divested- is almost guaranteed to become one of our biggest customers because the business will still need a milk supply.”

There was an opportunity to further strengthen its food service using the knowledge already built up in the business-to-business (B2B) space.

Fonterra’s food service business has done well in China, where the take up of dairy products has risen over the years.

Murray says there is still plenty of growth potential for food service over the next five to 10 years as dairy consumption is still relatively low in a lot of South East Asia and the Middle East.

“It is food service, it is ingredients, and that focus on being the best B2B business that we can possibly be - that’s where the opportunity lies, because we have a world class manufacturing footprint.

“Our ability to reliably collect and process milk is not guaranteed everywhere, and we can do that very well.”

Murray says there are still opportunities for geographical expansion in China.

“If you look at China as a whole, there is a lot of doom and gloom, but actually we have not seen much of that.”

China, he said, looked to be a two-speed economy, and the food sector was still going strong.

Feedback from farmers

Feedback from farmers had been positive on the prospects of a $10 milk price, but Murray says it’s not the same as it would have been three or four years ago, thanks to inflation.

Since its inception in 2001, Fonterra has until recently struggled to put together a consistent earnings record.

Last year, Fonterra reported earnings from continuing operations of 70 cents per share - the top of its guidance and only marginally down on 2023’s record earnings outcome of 75 cents.

“We have had reasonably stable earnings for a period now, so we have much greater stability.

“There is strength in our ingredients, food service and consumer businesses and we have maintained margins in those spaces.

“It’s a nice position to be in, and we don’t take it lightly.”

Jamie Gray is an Auckland-based journalist, covering the financial markets, the primary sector and energy. He joined the Herald in 2011.