Report Card: Fonterra sees the honeymoon end

By David McEwen

Friday 16th August 2002

Many annual reports struggle to communicate what it is about their business that makes it special.

Some of the most important information from a stakeholder's view - a company's purpose, vision and strategy for achieving its goals - is rarely given the prominence it deserves.

Not so in Fonterra's first annual report, which sums it all up in one beautifully elegant line "capturing the value of milk."

Fonterra, the near-monopoly milk products organisation put together by an act of Parliament and in a series of mergers last year, is by far the nation's largest commercial entity. Everything about it is bigger than Texas.

The numbers it bandies about are enormous. Revenue in the year to June was $13.9 billion and 1.1 billion kilos of milksolids were processed. It has staff of nearly 7000 and sells products in 140 countries. Its board numbers 13 instead of the usual six or eight and even its annual report dwarfs most others at 88 pages.

A double-page spread near the front of the report shows a map of the world. Fonterra is everywhere that counts, making it one of the few New Zealand-owned businesses that can be described as globally significant.

In a joint report, chairman John Roadley and chief executive Craig Norgate stress that Fonterra's first year was a "building phase" and they are dedicated to creating a world-class company. They show their colours early by giving their review the heading "a commitment to performance."

Time and time again the report refers to performance and how it may be improved.

There is talk of creating "the Fonterra way" - a culture of open and honest communication, mutual support, encouraging performance and driving growth.

Staff are bound to a development system called simply Perform! using a platform called Grow! It has a programme to improve "environmental performance."

The company even benchmarks its payout to a "commodity milk price" that a mythical, similarly sized competitor might produce. That ideal payout of $5.45 per kilogram is 39c higher than Fonterra could achieve and closing this gap is a "key performance" target.

"At the core of Fonterra's success are two things - our shareholders' ability to produce high-quality milk in the most efficient manner; and the group's performance in manufacturing products of the highest quality at lowest cost and marketing them to customers who value the benefits they bring," Mr Roadley and Mr Norgate say.

Despite its huge revenues, the company recorded a net deficit for the year of $31 million. However, net operating cash flows were strongly positive at $354 million.

Shareholders' funds of $4.48 billion represent 38% of assets, which is a little on the low side to be called prudent.

Another area where the report excels is in its corporate governance statement. Rather than the usual staid phrases that look as though they have been strung together by a committee of lawyers, this one carries the signature of the chairman. Although it lacks detail, it gives the impression good governance is being given the importance it deserves.

Notes to the accounts offer excellent disclosure, including an "explanation of major variations" between this year and last year. Key among these is the statement that "as a result of the dramatic weakening of world commodity prices in the latter half of the year, profits were below forecast ..."

Reality has a way of puncturing optimistic visions and profit expectations. Fonterra still seems to be enjoying a honeymoon with its shareholder suppliers and other stakeholders.

The report is cautious about the future, talking of poor world prices, a falling US dollar and the evils of protectionism.

But in the year to come, some evidence will be needed that the company is able to lift performance when it counts - in the face of adversity. Given the size of the company, New Zealand's economic success probably hangs upon it.

David McEwen is an investment adviser and author of weekly share market newsletter McEwen's Investment Report. Web: www.mcewen.co.nz, Email: davidm@mcewen.co.nz

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