Fonterra's chief financial officer Lukas Paravicini responds to Keith Woodford's column last week which stated Fonterra needs more capital:
Professor Keith Woodford opens his article published on March 9 (Fonterra needs more capital) by saying that Fonterra had "retained" 70 cents per kg milksolids from the milk price calculated under its Milk Price Manual. He states that, as a result, the co-operative will add about $1 billion to its bank account at the expense of various stakeholders, including sharemilkers.
However, Fonterra will not be making a retention of this nature. In material released in December, Fonterra explained that its farmgate milk price for all milk collected is based on whole milk powder and skim milk powder streams, which have driven most industry investment in the last decade or more.
Despite that, only about 70 per cent of Fonterra's total milk is manufactured into those streams. The remaining 30 per cent is converted to cheese and casein streams using capacity that Fonterra inherited.
As we outlined in material we released in December, these streams are generating much lower returns this season as demand resulted in a much-bigger-than-usual gap between whole milk powder returns and those from cheese and casein.
As a consequence, the money simply isn't there from this 30 per cent of milk to pay farmers as a milk price or dividend, or to retain in a bank account or add to a share price.
However, Professor Woodford is correct when he notes that Fonterra would be unprofitable if it paid a milk price determined under its Milk Price Manual. That is certainly the case this season, and was acknowledged by Fonterra's CEO, who said in December that "Fonterra would not pay the milk price out of borrowings - particularly in a year when we are forecasting a record payout for our farmers".
To take such a step would not strengthen the co-operative.
Prior to this year, Fonterra has paid a milk price identical to that derived under the manual since it first came into effect in the 2008-2009 season. That's five uninterrupted years.
Fonterra's constitution, and the statutory provisions that apply to the co-operative, leave discretion to Fonterra's board to depart from the milk price under its manual, with clear disclosure of the reasons for doing so.
This flexibility within clear benchmarks ensures the relevancy and success of Trading Among Farmers, and the longevity of the co-operative in the face of volatility in real-world markets.
We will provide an update to the market when we announce our interim results on March 26.
In reply, Woodford says: The key point remains that the rules are only being followed when they give a result acceptable to Fonterra. That raises a consequent crucial question: what will Fonterra do in a year when the milk price as calculated by the Milk Price Manual is so low that some farmers are unprofitable, but Fonterra is making large profits from particular products that are not part of the milk price calculation? Will Fonterra in those years pay out more money to farmers than is calculated by the Milk Price Manual? It would seem only fair that it does so.
- Sunday Star Times