“Or are our values and risk appetite more aligned to producing high-value base products to sell to multinationals who already have strong consumer brands,” Courtman wrote in his Kellogg report.
“Neither option is right or wrong but doing one option poorly due to a lack of capital or misaligned strategy is not a good option for the business.”
Fonterra’s board and senior management need to be brave enough to bring a split co-operative model forward for a good, robust discussion.
Courtman is an equity partner and contract milker for a 640-cow herd at Te Kauwhata, Waikato, now in his second season on that farm after seven years working for the Townshend family dairy interests.
His report title is Trading Among Farmers – Why we need it, how well is it working and where to in the future?
He said the aging demographic of Fonterra farmers and much higher land values are barriers to farm ownership for younger farmers.
“Older farmers are likely to be more risk-averse whereas younger suppliers are more likely to be open to innovative ideas and taking risks or exploring new opportunities.
“How does Fonterra and its older shareholder base not hamstring future growth opportunities for the younger generation?”
Options include increasing the number of dry shares on offer, allowing retiring farmers to hold on to dry shares, more joint ventures, more retentions or breaking the co-op into two parts.
Courtman went back 11 years to the first capital structure review, followed by the two-company proposal that did not find favour with farmers.
The market-value share price and milk price model took shape and in 2012 farmers approved the TAF structure.
“It deals very well with redemption risk and maintains 100% farmer ownership and control.”
Inherent flexibilities include year-round supply share trading, the three-year rolling average share standard to reduce climatic seasonal differences and a six-year sharing up option for new suppliers.
He reminded farmers of the $740 million capital redemption by shareholders after the 2007-08 drought when total milk production dropped by 54m kilograms.
The debt-to-debt-plus-equity ratio peaked at 57.6%.
But that was when Fonterra had a New Zealand milk market share of 94%, which has now fallen to 82%.
Five of the past 11 seasons, including four of the last six, have seen milk collection falls.
Fonterra has maintained annual capital expenditure in excess of $1 billion through the recent period of essentially flat milk supply of about 1500m kg each season.
Fonterra farsightedly introduced TAF before the market share decline, Courtman said.
“Regardless if you agree with TAF, the worst outcome would have been doing nothing.
“Sir Henry van der Heyden (the former chairman) believes one of the best ways to judge the success of TAF is the fact that no-one really talks about it now.”
TAF did little to provide more capital but the permanence of capital in the balance sheet let the co-operative invest in value-add processing with more confidence.
It bought the co-op more time to discuss the future needs for capital structure, Courtman said.
Fat stream processing capacity enabled Fonterra to pay suppliers 130% for fat in milk compared with protein, a complete turnaround from the market situation three seasons before.
However, Open Country Dairy pays more for protein than fat because it has not invested in the necessary product processing stream.
The two-company model for Fonterra would offer farmers a choice over whether to invest in capital-intensive, higher-risk value-adding.
Farmers would continue to have security over milk processing assets, business performance would be clearer and added value inside the farm gate, such as organic or A2, would be priced transparently.
Separate boards of directors would have more appropriately matched skill sets, he said.
