Tuesday, May 29, 2012

Trading Among Farmers

I've decided that I am not a fan of Trading Among Farmers.

To summarise; Fonterra is a Co-operative. So all the farmers who supply Fonterra are also shareholders.  Currently if you want to supply Fonterra with milk you have to buy 1 share for every kilogram of milksolids produced, the current share price is $4.52.  So if you are an average farmer in Canterbury, the statistics say you will have about 700 cows and they will produce about 380 kgms/year, that's  266,000kgms * $4.52= $1,202,320 worth of Fonterra shares.

If the farmer does well and his cows produce 400kgms/cow then they will need to pay an extra $63,280 to buy the extra 14,000 shares.
It goes the other way too.  If the farmer has a bad year and his cows produce 360kgms/cow then Fonterra has to pay the farmer $63,280. 
That is what is referred to as Fonterra's redemption risk.  It is difficult for Fonterra to budget what these amounts will be.  As a result they have to either set aside capital to fund the balance of these payments or have funding arranged to do so.  The amounts become greater when you consider what happens when a farmer decides to stop supplying Fonterra and instead supplies Synlait or Open Country Dairies. Fonterra then have to stump up the full $1,202,320 to the dairy farmer.

Under this arrangement Fonterra say it is difficult for them to budget the amount of capital that they have to pay to farmers.  Their argument is that there is a risk that Fonterra has to find lots of cash to pay back to farmers if they leave Fonterra or reduce production. This affects their balance sheet by essentially reducing the share capital that Fonterra has. Their balance sheet is important because it effects how much they can borrow and at what price they borrow at because their balance sheet affects their credit rating.

That's what Fonterra mean by "Redemption risk". But I don't think that redemption risk is much of an issue for Fonterra, and this bloke Robert Morris agrees with me.
He said Fonterra's reason for TAF - to end "capital washing in and out" of the company when farmers wanted to exit in hard times - was misleading. The only year this had happened was in 2008 after a widespread drought
Theo Spierings has said that TAF is not about raising capital but more about protecting their capital. 
But I don't think that their capital is really at that much risk. Its certainly not at such risk that they need to implement something as fundamental as TAF. Having said that Theo is quite a bit closer to the action than I am.

But that's not really why I'm against TAF.

I just think the whole thing is a series of compromises between the 3 parties. The Fonterra suppliers/farmers, Fonterra the corporate and Outside investors. TAF is trying to please everybody within a Co-op structure.

The farmers want:

  • Total control
  • High milk price
Fonterra want:
  • Stable share capital/equity position
  • $$ to grow the business
Outside investors want:
  • $$/dividends
  • Security of investment

I think Fonterra and the farmers can work out their needs together, so there is no problem there. But the outside investors are a different story.

The farmers are so keen to protect their total control on the business, that they make it unattractive for a non farmer investor to invest in. 

This is what it looks like to an investor:
The farmers want me to invest in a business where I will have no control over my investment, I have no control over who manages the company or how decisions are made. Not only do I have no control but my business partners, who have all the control have an opposing motive to my self.  They (the farmers) want a high milk price (payout) because that is how they make their money, but I want a low milk price because that will make my dividend higher. 
But that's not all, Fonterra has a really crappy history of paying a good dividend.

So that's a big fat "No thanks" from me.
Farmers seem to think that townies are falling over them selves to invest in the dairy industry. But recent events cause me to think other wise.

In 2009 Synlait attempted to raise the capital for their expansion via an Initial Public Offering on the NZX. It was unsuccessful.
Synlait Milk's plans for a $150 million float on the NZX by Christmas have been deferred due to lack of support
Just a few weeks ago Pastoral Dairy Investments which was set up by My Farm's Andrew Watters and Co canned their public investment offering, due to low than expected demand.
Pastoral Dairy Investments' plans to float and become a new player in the dairy sector have been withdrawn with the company saying there is not enough investor interest to get funds to buy farms.
I wouldn't take it for granted that the public actually want to invest with Fonterra and their farmers. Because at the end of the day Fonterra and dairy farms don't actually make that good a return on investment. But that a discussion for another day.

I fear that TAF is just one big compromise by committee. Decisions made by committees or various different groups end up being being a series of little compromises that add up to a strategy that is more about not losing rather than winning.

I don't think Steve Jobs would have run Apple by committee, then again Steve wouldn't have run  a Co-op.

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