Ham-fisted definitely, incompetent possibly

Fonterra’s succession of ultimatums to its suppliers smack of ham-fisted bullying and incompetence. The company’s first ultimatum was to push payment terms out to 90 days for a ‘small percentage’ of its New Zealand suppliers in line with its global practice , followed by an invitation to attend Dragon’s Den type negotiating sessions in which it has served notice it will demand 20% price reductions.

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Fonterra’s restructure more about poor strategy than milk price

When Fonterra was formed back in 2001, there was a great sense of optimism about the potential for a New Zealand dairy company to compete on a truly global scale. The industry’s infighting and parochialism would be a thing of the past and the clear intention was to use the greater efficiencies and scale to create a substantially better performing business model.

Two exciting years in a row

2014 and 2015 promise to be two of the most exciting years the red meat industry has seen for a long time and for a change the news is not all bad. There are some clouds around, but also silver linings like better beef and lamb prices, improved profitability and the possibility of positive developments in the industry’s structure.

 

At long last, after a slow start, there are plenty of signs the industry as a whole has recognised the need for change to address the main challenges of inadequate prices, declining sheep and beef numbers and excess capacity which have inexorably brought about land use conversions to more profitable activities.

 

The launch of the Red Meat Sector Strategy three years ago signalled the beginning of the change process which B+LNZ and the meat companies have adopted with support from the government funded Primary Growth Partnership projects. MIE has also gained traction during the past two years, having succeeded in gaining representation on the boards of Silver Fern Farms and Alliance as well as obtaining funding to develop its own industry reform strategy.

 

All these events and programmes have been happening against the background of an improving domestic economy and uneven global economic performance with Asia and North America doing better than Europe where political unrest has hindered the recovery. China has been the success story of the past year for the New Zealand red meat sector, providing an alternative export market for beef and particularly sheepmeat.

 

From the perspective of sector morale, it isn’t doing any harm to see sheep and beef returns outperforming the dairy industry for once. In spite of some retreat from the price peaks in the spring when product volumes were low, it is almost inevitable these returns will be better than the dairy payout during 2015 and quite possibly 2016 as well. The lower New Zealand dollar will be a help too.

 

But for all these encouraging signs, it won’t be all plain sailing for the red meat industry next year. There is already the strong possibility of drought conditions on the East Coast and some other regions, while trading conditions in major markets are uncertain. China has slowed, while many EU countries remain in recession and the Russian economy is in dire straits.

 

Meat processors and exporters all returned to profit during the 2014 year, although procurement prices will have to regain a greater sense of reality than has been the case in recent weeks, if 2015 is to allow a repeat performance. While lamb slaughter volumes are forecast to be about 20 million, not as low as 2011-12, but fewer than last season, the low milk payout will mean plenty of cull cows to process. If the US price holds up, the beef processors should be able to make hay to offset excessive lamb procurement costs.

 

Intriguingly both Silver Fern Farms and Alliance begin the year with new Chief Executives who will oversee some significant industry developments which will undoubtedly affect the companies they manage.

 

There are at least three big questions for the red meat sector in 2015:

1. What will be the findings of MIE’s meat sector reform paper when it is published in February;
2. Will farmers be prepared or financially able to invest further in ownership of the value chain; and
3. What will be the outcome of Goldman Sachs’ investment recommendations to SFF’s board?

 

My suspicion is the key to the future shape and structure of the sector lies in strategic developments in the country’s largest red meat processor and exporter. The announcement has already been made about dividing SFF into product based business units which provides the opportunity to sell them individually, quite possibly to an overseas investor.

 

CEO Dean Hamilton has been very open about the company’s need for $100 million capital to reduce debt and allow further investment in its value added business. He also admitted in last week’s Farmers Weekly it was unlikely farmers would be able to stump up much of this capital in spite of a supportive response from supplier meetings. Five years ago the company succeeded in obtaining $22 million from suppliers invested in $1 shares which are now worth 40 cents, so there isn’t much chance of getting nearly five times the investment from existing shareholders, many of whom will already have lost 60% of their initial investment.

 

Unless Alliance or another local investor is willing to buy all or part of the SFF business which is unlikely, the alternative options appear inevitably to be from overseas. An external entrant to the sector would not welcome any constraints on its right to expand capacity. This would effectively derail any industry reform involving farmer investment in owning the value chain that MIE may envisage or that might be agreed as a result of the moratorium proposal.

 

Therefore 2015 will be exciting for participants and fascinating for observers with a strong probability we will all be much clearer about the future by this time next year.