Theo Spierings gets a hefty pay rise, but how is Fonterra performing?

by Jonathan Underhill / 03 October, 2017

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Theo Spierings: $8.32 million man. Photo/Getty Images

Milk processor Fonterra gets a pass mark for progress. 

Fonterra chairman John Wilson took a moment during the dairy co-operative’s annual results briefing this week to comment on CEO Theo Spierings’ pay, observing that it was likely to provoke comment and that “yes, they are big numbers”.

Spierings’ $8.32 million package, including a superannuation contribution, amounts to a pay rise of almost 80%. The biggest element was his long-term incentive payments, which in 2016 and 2017 were dubbed a “velocity leadership incentive” aimed at rewarding him for speeding up Fonterra’s business transformation. The VLI, which actually related to the 2016 year, was about $3.1 million, more than his $2.5 million base pay.

The raise for the country’s highest-paid executive came in a year when Fonterra’s profit margins fell and it recognised $76 million of losses from its investment in Beingmate Baby & Child Food, the unprofitable Chinese infant formula producer and distributor that sells Fonterra’s Anmum formula in China.

Fonterra’s gross margin fell to 17% in the year ended July 31 from 21.1% a year earlier. Normalised earnings before interest and tax dropped 15% to $1.2 billion. Yet Wilson called it “an outstanding result” and Fonterra’s shareholders apparently agree.

“The past three years, it has been really difficult to be a dairy farmer and a processor of milk and get value out of it,” says Chris Lewis, a dairy farmer from Pukeatua, south of Hamilton, and Federated Farmers’ national dairy chair. “This is a solid result. If we could get more of this and stability of prices, then farmers will be happy.”

He says armchair critics of Fonterra tend to have a short-term outlook, whereas farmers take a long-term view. “If you’re in for a quick buck, you’re going to get burnt.”

Fonterra’s milk suppliers climbed out of a two-year hole in 2017. Weak prices for dairy products in the face of a global supply-demand imbalance meant the farm-gate return tumbled 48% to $4.40 a kilogram of milk solids in 2014-15 and sank to $3.90/kgMS the following year, well below break-even for the average farmer. It recovered to $6.12/kgMS in 2016-17 and Fonterra has affirmed its 2017-18 forecast of $6.75/kgMS.

Fonterra’s milk payout is set from a reference group of commodities and is a double-edged sword for a business that uses milk as a raw material. What Fonterra calls “stream returns” turned negative to the tune of $40 million in the latest year, a decline of $180 million compared with 2015-16.

John Wilson: “big numbers”. Photo/Trefor Ward

On being mates

The infant formula partnership with Beingmate, announced in 2014, was its first significant tie-up in China since the disastrous San Lu venture that failed amid a tainted-milk scandal in 2008. It was trumpeted at the time as “a game changer”, giving Beingmate an exclusive licence to sell Anmum in China through 80,000 outlets. Since then, Beingmate has posted losses and its shares have tumbled.

The joint venture acquired Fonterra’s Darnum infant formula plant in Australia that had been left with excess capacity when the 2013 whey protein concentrate contamination scare prompted Danone to walk away. Fonterra needed a Chinese partner to operate in China.

Fonterra paid 18 yuan a share for 18.8% of Beingmate. This week the shares were below 10 yuan – a 45% decline. It took an impairment loss of $35 million on its stake, reducing the carrying value to $617 million, which it said reflected Beingmate’s share-price slide and recent losses.

But the new valuation still exceeds the value of Fonterra’s holding, which is about $400 million based on Beingmate’s recent stock price and exchange rate. That’s because Fonterra regards Beingmate as a strategic investment worthy of a 20% premium.

Spierings says Beingmate’s direct distribution actually amounts to 40,000 outlets, not 80,000, after its partner right-sized its model. It sold a relatively modest 2000 tonnes of products.

The co-operative says the venture’s significance will become clear next year. From 2018, only registered infant formula will be allowed to be sold in China, resulting in the thousands of brands in the market reducing to hundreds, including, at last count, 15 recipes owned by Beingmate and Fonterra.

“Questions remain over Beingmate and to what extent its performance will lift in 2018/19,” says Con Williams, rural economist at ANZ Bank. Lewis says it is too soon to pass judgment.

But there were other reasons for optimism. Fonterra disclosed normalised earnings before interest and tax (Ebit) of $1 million for China Farms, its dairy-farm operation in China, compared with an Ebit loss of $59 million a year earlier.

Fonterra’s Chinese farms comprise two hubs: Yutian, with 19,200 milking cows; and Ying, with 15,700.

The farms aren’t out of the woods – Fonterra’s gross margin from ingredients included “a $38 million loss representing the difference between the domestic milk price and the internal raw milk price paid to China Farms”.

Theo Spierings. Photo/Getty Images

Looking up in oz

Fonterra’s fortunes have also improved in Australia, where unprofitable rival Murray Goulburn, which the company has made a bid to buy, has been unable to match Fonterra on milk payments and defections have added 500 million litres of milk to the Kiwi co-op’s pool in recent months.

Australia, a long-term problem-child for Fonterra, with too little milk and too much processing capacity, returned normalised Ebit for ingredients of $62 million.

“After a multi-year transformation, the ingredients, consumer and food-service businesses are performing well, generating sustainable profits while paying a competitive milk price to our supplying farmers,” the co-operative says.

Fonterra also had an answer for critics who complain that it hasn’t done enough to move up the value chain from bulk commodities to high-value products. It processed 473 million LME (liquid milk equivalents) into what it calls advanced ingredients, such as whey protein isolate, medical-grade lactose and extra-stretch cheese, in the latest year, a gain of 9% that lifted advanced ingredients to 19% of total sales.

Lewis says he wants to see Fonterra “delivering on its strategies more than what we’ve seen in the past two years” and ensuring “the value proposition to supplier-shareholders is No 1 in New Zealand”.

“Broadly speaking,” he says, “it’s on the right track. There are always going to be challenges along the way.”

This article was first published in the October 7, 2017 issue of the New Zealand Listener.

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