Curious Case of Fonterra Shareholders’ Market

Summary

• Softening global dairy demand due to COVID-19 is mainly impacting price of this season’s farmgate milk.
• Trading Among Farmers (TAF) and Fonterra Shareholders’ Market (FSM) is centred around retaining shareholder farmers’ control in the co-op.
• Fonterra Shareholders’ Fund (FSF), which provides entry to outside investors via investing in units listed on main NZX board, is focussed at providing liquidity and foster co-op to expand in other markets.
• While Fonterra is committed to continue to draw on Co-op’s proven strengths, the impact of global turmoil on consumer purchasing power is to be closely monitored.

Recent upheavals brought by Covid-19 pandemic has no doubt grappled the market position and sustainability of several businesses. While companies were battered by economic implications, few carved out their way to emerge strongly. Significantly, the nature of industry and strategies adopted by companies played a significant role in the transition process.

In this context, global dairy nutrition player Fonterra Co-operative Group Limited (NZX: FCG) deserves closer attention, witnessing continued improvement in its business performance with steady cashflow and continually reducing debt.

Compared to the previous corresponding period, the normalised Earnings Before Interest and Tax (EBIT) for the Cooperative group saw an increase of $301 million to $815 million for the nine months ending 30 April 2020.

Fonterra CEO Miles Hurrell indicated that owing to volatility in the market, outlook for global dairy market remains uncertain. Mr Hurrell further stated that despite the challenges brought forth by Covid-19 scenario, Fonterra’s all three businesses had performed well.

Keeping in mind the uncertainty, the opening 2020/21 forecast Farmgate Milk Price range has been set at $5.40 - $6.90 per kgMS.

Glimpse at the Fonterra’s Shareholders Market

Constituted as a part of “Trading Among Farmers” (TAF), Fonterra Shareholders’ Market (FSM) is a private market which limits cooperative’s share trading to only its Farmers, Fonterra and the appointed market makers. Using FSM, the farmer shareholders are able to buy and sell shares to other farmer shareholders, helping them to raise capital without outside capital into the cooperative.

However, as operating in the same industry and market, farmer shareholders’ buying and selling pattern may follow identical direction and momentum, which can create massive volatility for the Forterra shares.

It would mean that during low production of milk, shareholders would want to decrease their share ownership, while they would be looking to purchase the shares during high output to maintain their supply with the shares holding. It would create massive movement in a single direction creating peaks and troughs.

Fonterra Shareholder’s Fund (ASX:FSF) solves the excess volatility concerns and additional capital requirements for the co-op. The farmer shareholders can sell their economic rights of some portion of shares (Wet Shares) to the fund, provided they retain certain number of shares in alignment to their milk supply. Although economic rights of farmers are transferred in the process, they still hold the voting rights.

FSF allows entry of outsiders into the capital structure of dairy. While outside investors are not allowed to hold Fonterra shares, they get the opportunity to invest in units of the Fonterra Shareholder’s Fund (FSF). The investment in FSF units provides outsiders with the economic rights associated with the shares, and these FSF units are listed on NZX mainboard.

The primary focus of TAF is to reduce the redemption risk, allowing the co-op to strengthen its balance sheet. It also ensures largescale farmer control and ownership in the cooperative.

TAF, apart from providing price discovery to the units traded, also delivers its farmer shareholders a deep and liquid market. The introduction of Fonterra’s Shareholder’s Fund (FSF) seems to generate many benefits for shareholders and the company as it enhances the durability of co-op’s capital structure.

Moreover, if farmers want to reclaim their economic rights, they can do so by purchasing the fund units.

The capital structure preserves original integrity of the company while providing scope for future expansion which the New Zealand’s dairy market is mainly witnessing overseas.

Criticism of the Fonterra’s Trading System

Fonterra trading system seems to garner criticism now and then. Shareholder farmers, looking to increase milk supply to the co-op needs, are required to buy shares in its private market. However, during tough times when the milk supply gets slow, the farmer shareholders might face substantial difficulty in selling their shares in the FSM.

Moreover, while FSF allows certain liquidity, farmers are required to maintain a certain number of shares in accordance with their milk supply.

ALSO READ: Dairy Stocks on the Whip: Fonterra’s NZ Production Dips With Drought

Many have criticised co-op for its extensive focus on global expansion over dividends to the shareholders, while shareholders remain apprehensive about the next dividend payment.

Meanwhile, despite the profit made in the nine months till 30 April 2020, Fonterra narrowed this season’s farmgate milk price range between $7.10 and $7.30 per kilogram of milk solid (kgMS), with a mid-point of $7.20 per kgMS. Chairman John Monaghan indicated that “softening demand” due to pandemic impact has been the primary cause for the price drop.

(Please note all currency in NZD, unless otherwise specified)