Fonterra Sale to Lactalis Raises Questions on Future Strategy

Fonterra, New Zealand’s largest dairy cooperative, is facing scrutiny regarding its decision to sell its consumer brands business to French dairy giant Lactalis for $4.2 billion. An independent report by Northington Partners suggests that if Fonterra had pursued an initial public offering (IPO) for the consumer brands, it would have resulted in a lower valuation and potential retention of ownership stakes in the business.

The report was published just before Fonterra’s farmer meetings in Hamilton, where media access was restricted. It emphasized that executing an IPO would have been challenging, stating, “We believe that an IPO of Mainland at an attractive value would have been difficult.” The sale to Lactalis still awaits approval from Fonterra shareholders, with a crucial vote scheduled for October 30, 2023.

Market Challenges and Strategic Shifts

While the $4.2 billion acquisition has been characterized as “good value,” particularly for a business that has struggled to generate sufficient returns, Northington Partners noted significant challenges in the Australian market. The report highlighted that the highly concentrated supermarket sectors in Australia and New Zealand have limited the ability to achieve adequate margins for consumer brands, such as Mainland and Anchor.

The report further elaborated on the competitive nature of retail markets in these regions. “Australia and New Zealand are highly competitive retail consumer markets,” it stated, indicating that negotiating power rests heavily with the duopoly of supermarket giants. This has led to difficulties in maximizing profits from consumer products.

In addition to the sale, Fonterra is aiming to address the underutilization of its Australian assets. Matt Montgomerie, an analyst at Forsyth Barr, recognized this as a long-standing issue. He noted that the “intense” competition in the Australian milk supply market has driven milk prices to unsustainable levels, resulting in low and volatile returns for the consumer segment.

Fonterra’s Future and Global Strategy

The proposed sale represents a significant shift for Fonterra, which would emerge as a smaller entity focused primarily on its Food Service and Ingredients businesses. Should the transaction be completed, Fonterra expects a reduction of approximately 27% in its employee headcount, making it less diversified and increasingly reliant on the Chinese market. Currently, China accounts for 28% of Fonterra’s earnings, a figure projected to rise to 34% post-sale.

While this concentration could enhance Fonterra’s return on capital and support a capital investment program of around $1 billion per year, risks remain. The Northington Partners report cautioned that the Chinese market is undergoing structural changes, including an increasing domestic milk pool and growing local processors like Yili and Mengniu. These developments could pose challenges for Fonterra, which may also be exposed to geopolitical risks in a market that is becoming more competitive.

As Fonterra embarks on what it calls “Fonterra 2.0,” the cooperative is tasked with convincing farmers of the benefits of this transition. The capital released from the sale is intended to empower farmers to reinvest in their businesses or reduce debt. The upcoming roadshow meetings aim to communicate this vision and outline the potential opportunities that lie ahead.

In summary, Fonterra’s decision to sell its consumer brands business to Lactalis has sparked extensive discussion about the future direction of the cooperative and the challenges it faces in a competitive market environment.