But are we focusing on the right areas?
The government has set a target of doubling the primary sectors export earnings from $32 Billion to $64 Billion by 2025.
Nobody doubts that this is a difficult ask.
New Zealands primary sector has a strong record of productivity gains.
The sheep industry alone has increase productivity (expressed as meat sold /ewe) by 80% over the last 25 years.
Thats 2.5% productivity gain every year. Any business analyst will agree that that is impressive.
But are sheep farmers any better off?
Despite 20 years of productivity gains sheep farmers recently experienced their lowest level of profitability, according to Beef & Lamb NZ data.
New Zealand farmers are very good at on farm production productivity, such as milk solids/ha or meat/ha or tons of grain/ha.
But its the off farm productivity that needs some serious work and that is where the big gains are available.
Rod Oram is a business journalist and he gave a very good example recently.
Fonterra has a total asset value of $4 billion.
One Fonterra plant manufactures infant formula for Pfizer, the pharmaceutical company.
Pfizer's infant formula business has an 8% share of the Chinese market.
Recently Pfizer sold that business to Nestle for $12 billion! Thats three times the size of Fonterra's entire business!
So, Fonterra supplies the milk, manufactures the milk into infant formula and packages the formula into tins.
Pfizer puts its branding on the tins and wholesales the formula to retailers. That part of the value chain, the branding and the wholesaling is worth $12 billion.
Fonterra or New Zealand farmers receive a small portion of the value of the final product.
You could say, if Fonterra owned that formula brand which has an 8% market share and took the formula right through to the retailer. Then Fonterra would be worth its current $4 billion + $12 b to be worth $16 billion dollars!
I think you could say that the payout to farmers would also be three times its current rate.
How does a $21/kgms payout sound?
We could put it another way, if Fonterra was just that one factory and all it did was produce infant formula for 8% of the Chinese market under its own brand. It would be worth three times what all of Fonterra is today.
New Zealand is very good at producing quality product, but not very good at keeping paid for it.
The graph below is from a Corileus report that they have made public. As you can see Fonterra is one of the largest dairy companies in the world from a volume perspective. Pfizer is way down the bottom by size. But Pfizer's dairy business makes a hell of a lot more money than Fonterra does from its products.
The graph below shows the profitability of the different dairy companies.
Fonterra is making a 4% return on Asset, while Nestle, Kraft, Danone which have their own retail brand products are making 14%-15%.
The nutritional dairy businesses which deal with infant formula etc are returning well over the 25% right up to 65% return on assets for BMS Nutritionals!
These graphs are exciting, they show that Fonterra has plenty of room to increase profitability.
Fonterra have been saying that their "strategy refresh" will focus on increasing the value they receive for their products.
Last year Fonterra announced that they are launching their own branded infant formula into Asia. Which is a good start.
What will Fonterra look like in 10 years? Imagine if Fonterra is successful in growing the portion of its business that is branded.
The increase in profitability is potentially huge.
Some of the thoughts that are going through my head are:
- How will a more profitable Fonterra affect land use change? If dairy returns are much greater than sheep/beef while Fonterra operates at the commodity level. How can other land uses compete with a payout of over $15/kgms?
- Will the payout actually increase in line with profitability? You assume it would.
- What will Fonterra shares be worth? Assuming greater profitability increases the dividend paid.
- What will happen to land prices?
- What environmental impacts will this have on New Zealand?
What ever your views of Fonterra or the dairy industry are, you can't deny that the future is bright for New Zealand dairy farmers and the flow on will benefit the whole NZ economy.
But the same challenges still exist for the industry such as public perception, environmental impact and staffing issues.
Glen,
ReplyDeleteYou appear to be conflating several issues here.
1,Sheep farmers still have plenty of potential in productivity. 300kgmeatskinwool*$5 vs 1200kgMS * $7. Dairies greatest strength is output
2, Value of a business is not directly correlated to profits
3, Infant formula might be value-add. But at a significant cost. Some of the inputs to infant formula cost hundreds of dollars per gram.
4, Accessing value add markets does not necessarily mean higher return. Many have tried and failed.
5, Cooperatives are designed to return a high share profits to their suppliers. Profit is removed before EBIT is calculated . Private businesses are designed returned to shareholders . EBIT is an unfair benchmark
To answer some of your questions.
Are sheep farms better off? Take away the productivity gains and ask them
How does a $21/kgMS sound? Great. Then again pigs flying dropping lolly pops from the air sounds great too.
What will Fonterra look like in 10years? Who knows? Swim or float, I hope it is bigger and better.
How will more profitable Fonterra affect land change. Fonterra's factory foot print is small. More profits might lead to factory growth or strategic investment. Who knows?
How can other land uses compete over $15kgMS? I'd bet pig farmers will make great coin out of flying lollypop dropping pigs. Don't rule them out.
WIll payout increase with profitability? Again most cooperatives don't like big profits. It is a poor measure of cooperation.
What will Fonterra shares be worth. Not much. People will be investing in flying pigs.
What will happen to land prices? I'd be more worried about the cost of converting a dairy shed into a pig runway.
What will the environmental impact be? Again, More cows = better water quality. You've not forgotten the MFE report have you?
Mr E
Hi Mr E
DeleteI'll respond to your points below.
You appear to be conflating several issues here.
1,Sheep farmers still have plenty of potential in productivity. 300kgmeatskinwool*$5 vs 1200kgMS * $7. Dairies greatest strength is output
Glen responds: The point of the post is that the branding/wholesaling of the product is where there is lots of room for growth. Of course farmers will still increase on farm productivity.
2, Value of a business is not directly correlated to profits
Glen responds: True, but in most cases it is. The price to earning ratio is generally a basis of the businesses value. Small businesses sell for about 3 x earnings and large biz sell for approx 15 x earnings. I admit it is a rough indication, but will be pretty close.
3, Infant formula might be value-add. But at a significant cost. Some of the inputs to infant formula cost hundreds of dollars per gram.
Glen: Fonterra already manufacture the formula for Phizer/Nestle consumer brands. So Fonterra are already doing what is required.
4, Accessing value add markets does not necessarily mean higher return. Many have tried and failed.
Glen: Yep the skills to run a consumer business are totally different to a commodity ingredient biz. But the point of this post is to point out how much extra value is available to NZ companies if they can concentrate on the consumer/branding side of the value chain.
5, Cooperatives are designed to return a high share profits to their suppliers. Profit is removed before EBIT is calculated . Private businesses are designed returned to shareholders . EBIT is an unfair benchmark
Glen: Co-Op suppliers are also the shareholders. A Co-op is designed to return value to the shareholders/suppliers. EBIT is a measurement of profitability, the higher the profit the more $ available for dividends or payout increases. Whatever you want to call it. Its a result of profitability. The graphs above show that Co-op make low returns either on a EBIT basis or return on assets.
To answer some of your questions.
Are sheep farms better off? Take away the productivity gains and ask them
Glen: They innovated to stay still.
How does a $21/kgMS sound? Great. Then again pigs flying dropping lolly pops from the air sounds great too.
Glen: Totally possible if Fonterra wants to be a consumer biz like Nestle, Kraft etc. But farmers/fonterra have to change there ways to be a consumer comp. Pretty sure everybody is happy with where they are now. So $21 payout unlikely. But certainly possible.
What will Fonterra look like in 10years? Who knows? Swim or float, I hope it is bigger and better.
Glen: Me too.
How will more profitable Fonterra affect land change. Fonterra's factory foot print is small. More profits might lead to factory growth or strategic investment. Who knows?
How can other land uses compete over $15kgMS? I'd bet pig farmers will make great coin out of flying lollypop dropping pigs. Don't rule them out.
WIll payout increase with profitability? Again most cooperatives don't like big profits. It is a poor measure of cooperation.
What will Fonterra shares be worth. Not much. People will be investing in flying pigs.
What will happen to land prices? I'd be more worried about the cost of converting a dairy shed into a pig runway.
What will the environmental impact be? Again, More cows = better water quality. You've not forgotten the MFE report have you?
Glen: No, I have not forgotten the Ministry for Environment report. The report will be covered in a separate blog post. More cows = better water quality!!! Did you read the same report as me?
Mr E
Glen -
ReplyDeleteThere is lots of room in productivity. Take the sheep industry. Ewes can have surviving quads. Hoggets can have triplets.
" I admit it is a rough indication, but will be pretty close" Okaaayyy?
Co-op vs private business. You missed the point - Point blank. Co-ops pay their shareholders in 2 forms. Supplier payments eg Milk cheq. And dividends. Most co-ops work it so that they pay little dividend and as high as possible supplier payment. Private companies do not want to pay high amounts for their goods. Co-ops do. EBIT is of course going to look worse for a co-op. It is intrinsic.
"They innovated to stay still". What a ridiculous statement. That statement offends me. Farmers innovated to stay in the market. To compete against heavily subsidised products. For many European farms their GFI = FWE. They farm for nothing other than subsidise. Here in NZ we have innovated to exist in this market place. To make profits when nobody else can. It has put us in a very strong position as governments consider reducing subsidise. Make no mistake. Innovation = Salvation.
Do you think Pfizer takes infant formula and sells it for no extra cost? Not transport? No insurance,assurance, marketing costs, overheads, etc etc.? Why do you think Silver fern farms sold its packaging business in Norwich? Sometimes value add is not that at all.
'$21 unlikely but possible' Getting struck by lightening is unlikely but possible.
Did we read the same report?
Here was the summary if you want it.
"Of the parameters we monitor, all are either stable or improving at most monitored sites. Four of our parameters show stable or improving trends in 90% of sites. However, nitrate concentrations are increasing in about a quarter of our sites. While long-term patterns and time lags make it difficult to attribute changes in water quality to any particular action, this may reflect a general improvement in land management and wastewater treatment practices"
I read over the last 10 years water quality is either " stable or improving at most monitored sites"." This may reflect improvement in land management and wastewater treatment practices."
What is the land management practice change? Not dairy surely? Maybe we just have more sheep farms?
Mr E
"I admit it is a rou