Fonterra's proposed capital and share restructure will tilt competition for raw milk and enable it to gain market share even with reduced access to new capital, consultancy Castalia argues.
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Consultants Castalia say Fonterra’s capital and share restructure could lead to a farmers-only share market overwhelmed with dry shares trading at discounted prices.

In a report on the implications of restructuring commissioned by the largest competitor, Open County Dairy, the consultancy warns of higher consumer prices for dairy products.

It also predicts a farmers-only share market overwhelmed with dry shares trading at discounted prices.

After building more processing capacity in the mid-2010s, Fonterra has at least 5% over-capacity and gaining or at least maintaining market share will be critical to reducing the cost of sales, Castalia said.

“If our co-op’s milk supply declines, we are likely to see fixed costs being spread over fewer milk solids, which would reduce the milk price,” Fonterra has said.

The restructure will make it much easier to attract new supplying farms as the cost of entry will be cut by two-thirds.

But two out of every three existing shares will be made “dry” and only “wet” shares will have voting power.

Castalia predicts this will cause a massive imbalance between buyers and sellers, when the wet/dry ratio is turned on its head.

“There will be almost four times as many sellers which other parties must buy to meet the share standard.”

Therefore Castalia forecasts a further 40% fall in share values to under $2 and a total loss to farmers of $4 billion of share capital since the restructuring was first announced in May 2021.

“In exchange for suffering this short-term balance sheet hit, farmers are providing Fonterra with the ability to attract new farmers more easily and increase milk supply.

“More efficient utilisation of capacity should reduce processing costs and enable Fonterra to pay a higher milk price.

“This should feed back into farmers’ wealth in the form of higher dairy farm prices.”

Most controversially, Castalia alleges that Fonterra has had and will continue to have in the future a bias towards high milk prices, which Open Country has repeatedly claimed.

“There is a long-standing issue with the milk price monitoring regime, which permits Fonterra to engage and act in ways that tend to result in a non-transparent and inefficient milk price.

“By manipulating the milk price away from a fair level, Fonterra harms its rivals. This has negative consequences for sector efficiency, productivity, and innovation.”

Fonterra and the Government continue to work on ways the proposed share and capital restructuring can be implemented through the Dairy Industry Restructuring Act.

Fonterra disputes report findings

Fonterra has dismissed a report by consultancy Castalia into possible effects of the capital restructuring plan currently being considered by the government.

The report was commissioned by Fonterra’s largest rival for milk supply, Open Country Dairy.

Castalia said flow-on effects could include higher consumer prices for dairy products, harm Fonterra’s competitors and a further 40% fall in the value of Fonterra shares and units.

Fonterra said it disagreed with the report and a number of its conclusions including assertions that protections for a fair milk price will be eroded and the restructure will cause the milk price to increase.

Fonterra also notes that Castalia estimates its future share price on the basis of possible dividends up to 2030 but appears to assume that Fonterra has zero value at that time.

“Fonterra considers this to be a misleading approach to valuing its shares,” director of capital markets Simon Till said.

“The report contains no perspectives not previously considered by Fonterra and discussed with shareholders in the lead up to the 2021 vote, when over 85% of shareholders supported the capital structure changes.”

Long-time Fonterra analyst Arie Dekker, head of research for Jarden, says the valuation by Castalia of $2 for Fonterra shares is not supported by the figures and declared intentions of the dairy co-op.

“Fonterra is currently generating 30c a share earnings supporting a 20c dividend.

“It hopes to increase earnings and dividends over the next 10 years with meaningful investment to support that.

“Even if dividends don’t grow, discounted dividends currently supported by the earnings results in a share value well above the suggested $2,” Dekker said.

Fonterra has also signalled its intention to return $1 billion in capital to shareholders, which would be about 60c a share.

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