The real problem with the Crafar farm deal

I didn't really mind if the Crafar farms were sold to the Chinese. I would prefer they were not, but at the end of the day they can't take the land away with them.  As an immigrant my self I don't mind that people can come from overseas and buy land in NZ.


But I have changed my mind on Shanghai Pengxin.  What concerns me is that Shanghai Pengxin have stated that they may process the milk from the farms.  They have made this sound like it is an advantage of their application to purchase the Crafar farms as it will create jobs etc.


Now I read this article.  

 The Chinese buyers of the Crafar farms have registered two brands – Nature Pure and Pure 100 – to cash in on New Zealand's 100% Pure marketing. 

Hang about, I'm not so sure about this at all.  Shanghai Pengxin are now going to process and market the milk into China as "New Zealand Milk" with the trade names "Nature Pure" and "Pure 100"!


This changes everything for me.  We now have a Chinese company which owns NZ land and the processing facility and the distribution networks in China but they will be marketing the milk essentially as 'New Zealand milk".  They own the whole value chain.  They own our brand!


Then I then read this.

Mr Kelly said while he wasn't speaking for Shanghai Pengxin, it had paid a premium for the farms because it wanted to secure the raw milk and add significant value in China.

By way of example he said when he visited China recently he saw a litre of UHT milk sourced from New Zealand that cost 28 RMB ($5.60) and the same litre of milk sourced from China was 6 RMB ($1.20.

"They believe they can capture that top 28 vs 6 part of the market which will then create enough money for it to be a successful enterprise and therefore they are prepared to pay a premium in their view for the farms back in New Zealand."

New Zealand milk gets a premium in China because it is safe and it can be trusted.  The Chinese don't trust their own dairy companies, and for good reason too.  New Zealand has a true competitive advantage and a strong brand, this is what we need more of, this is what is the key to our success in the future.


We have this reputation for a reason, it has been forged by generations of good ethical food safety and business practices by New Zealand farmers.  


I am against anything that can damage our reputation and brand.


It is one thing to own NZ land, it is a totally different thing to own the supply chain and branding.  The value of our branding to NZ dairy farmers internationally, is massive.  The $210M paid for the Crafar farms are dwarfed by the value of our brand.


Lets get some things straight here,  

• Shanghai Pengxin will be taking milk that would have gone to Fonterra.
• Shanghai Pengxin are taking the margin from processing that milk.
• Shanghai Pengxin are taking the margin from distributing and wholesaling the milk.
• Shanghai Pengxin are using our branding
• In short  Shanghai Pengxin are taking milk from New Zealand farmers and competing against New Zealand.

The only way New Zealand benefits from this deal is via landcorp and the money they get for managing the farms.  Which is a tiny amount in the whole shceme of things.

I don't mind competing in China with other global brands including Chinese brands.  Because each brand has its point of difference.  NZ point of difference is very valuable.  I don't see any advantage to New Zealand in allowing other companies (of any nationality) to essentially take our unique selling point and compete against us.

And this raises the point; what about Bright Dairy and Synlait?  Well this is slightly different in my opinion, as this example is essentially a 50-50 (well 51-49) joint venture between a NZ company and a Chinese partner. Both these companies are bringing different skills and advantages to the table, to build a brand in China. The milk suppliers are from NZ, the brand (Canterbury Pure) is owned by New Zealanders, well 49% at least.  Bright Dairy provided the capital to fund the infant formula plant and also provides the supply chain and contacts in China.

I would prefer that New Zealanders owned all of Synlait, but they had their chance and NZ decided that it didn't want to invest with Synlait when they tried to raise the funds for expansion via an IPO in 2009

I have no problem with foreign people or companies buying land in New Zealand, farming the land and integrating into New Zealand's supply chains by suppyling Fonterra, Open Country or Silver Fern Farms.  But I think it is a loss to New Zealand to allow foreign firms to come in and use our brand and our uniqueness and compete with New Zealand companies in international markets.


The Shanghai Pengxin deal is bad for our companies forging markets in China, because the very people who the Chinese public don't trust enough to produce their milk products, are here in NZ producing milk products but under a different guise. 


As a nation, we are selling our selves short.  We have no real plan or strategy for how we integrate into the world or what our goal is or what is important to our growth.  The OIO has criteria to meet but that criteria is not matched to a clear plan.  With a clear plan and strategy in place, the bureaucrats in the Overseas Investment Office could ask, "does this fit our international Brand/strategy?

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.

How much money do dairy farmers make?

This article in the press last year caused a few headlines and even prompted me to call talk back.  

Inland Revenue Department figures provided to Labour revenue spokesman Stuart Nash show that, in the latest full year for which figures were available, the average tax paid by dairy farms was $1506 a year. The 17,244 registered as being in the dairy sector, including companies, trusts and individuals, paid only $26m in tax.

It caused me to do a bit of research and look into the subject a bit further.   


Are all businesses listed as being in the "dairy sector" dairy farmers? Can you be in the "dairy sector" and not be a dairy farmer?

The figures also show that more than half – 9014 – reported a loss for the 2009 year and another 2635 reported trading income of between $1 and $20,000.

So, 2635 had a income of between $1 & $20,000. Its probably fair to say that these businesses are not active dairy farmers or they are very small hobby farms.
  
If we subtract the 9014 businesses that lost money and also subtract the 2635 that had an income of less than $20,000. We are left with 5595 business that paid tax of $26m.  $26m divided by 5595= $4,647 of tax paid per business.  Which is still a very low number.


Every year accountants around the country collate their client’s financial data and release a summary document.  It is a great way to compare the different farming types and the changes in financial performance from year to year.

I have been reviewing the client data from my accountants, Malloch Mclean in Invercargill.  They have a large farming client base that gives a good insight into farming in Southland.

I find this table very interesting.  In the 2009 year (that is referenced in the article) shows the average dairy farming client paid $32,754 in tax.  This is quite a different figure from the $1,506 quoted in the press. This figure will include sharemilkers and farm owners. I would expect that sharemilkers will pay more tax than a farm owner would.


Its interesting that the average dairy farm made a cash loss of $7,137 in the 2009 year.  So I bet it sucks when you have made a cash loss and then you still have to pay $32,754 in tax!


My thoughts are that; the IRD numbers are for entities that consider them selves to be in the dairy sector.  This does not mean they are dairy farmers.  Client data from accountants is collated from their clients that they deemed to be dairy farmers, so I am more inclined to believe these figures.


Either way 2009 was not a flash year for dairy farmers.  The years from 2005-07 had an average payout of $4.38, then out of the blue the 2008 year had a record payout of $7.66. Dairy farmers went crazy trying to produce as much milk as possible to benefit from the high payout.  The price for fertilizer went up by about 30% and farmers scrambled to find additional stock feed and grazing.  But the sheep/beef farmers were on the ball and demanded top dollar for grazing and feed.  As a result stock feed/grazing costs increased by 32%.  Then all of a sudden the payout dropped back to $5.20 but the farm working expenses didn't fall.  The result was an average loss of $7,137. 


Other interesting facts from the Malloch McClean 2009 client data:

•  Whopping interest bill of $376,914!
• Tiny Principle payments of $16,943
• Working expenses were 66% of income in 2009 and 43% in 2008
•  2007-2010 the average principle paid was $29,263.  And then in 2011 it jumps to $151,009, so it is obvious that the banks have tightened up on things and are demanding that debt be repaid. So essentially any increase in operating profit achieved now is being passed straight onto the banks. 

And finally, a quick look down the net farm cash surplus line and we see that the average surplus over the five years from 2007-2011 is $330,269.


So I haven’t quite got the violins out for the dairy farmers just yet.

What, who and why

My name is Glen Herud and this blog is about creating my ideal dairy farm.  The dairy industry according to Glen.

After a brief run in with Robert Magabe's new minister of agriculture, my parents felt it was prudent to leave their birth place of Zimbabwe and begin a new start in New Zealand.

Starting again with no money and a young family they took a farm workers position in the Bombay hills. I grew up watching my parents move their way up the dairy ladder in the Waikato, from farm worker to manager, from contract milker to sharemilker then onto a larger sharemilking position and finally onto farm owner. It took them 11 years to progress from farm workers in 1984 with $1,000 cash and a 1976 Yellow Ford Cortina to owning a 350 acre dairy farm in Southland.

They did what countless people have done over the decades and they took part in a progression system that is the envy of many farmers around the world.  The NZ dairy system is unique in that it has the share farming system. This system has allowed people of any background, with or without a formal education, or capital, to become farm owners.  All you needed was a good attitude and be prepared to work hard. This system is what has made the dairy industry in NZ great.  In other countries like England, for example, there is a clear separation between land owners and non land owners, particularly in the the rural sector.  There is really very little opportunity for the tenant farmers to become land owners. 

With this in mind I left school and my plan was to follow in my parents footsteps.  I scraped into Lincoln by the slimmest of academic margins and studied agriculture.  After three years I graduated with the academic heavy weight qualification of a Diploma in Farm Management.  I didn't know it at the time, but the real value of a tertiary education is that it teaches you to think and to analyse things. I can't remember really learning anything about soil science or plant science but I learnt how farmers make money and more importantly how to evaluate things and how to think.

So I left Lincoln and decided that I would not take part in this wonderful dairy system, I decided that the downsides of the dairy industry were too great.

I left the dairy farm and started a retail business in Invercargill.  After 8 years of being off the farm I can reflect and think, did I make the right decision? The 2000's were boom years for the dairy industry, land prices went up, we had record milk payouts and farmers were scrambling to find good people to help them, offering all sorts of partnership opportunities. 

I think I would be slightly better off financially if I had invested in the dairy industry, simply due to the increase in the price of land. But I don't regret my decision for a minute. 

This blog is about dairy farming, its about fixing the downsides of the industry and its about addressing the issues and creating a dairy industry that New Zealanders best people want to be involved in and be proud of. It's about thinking differently and getting a little bit radical.