NZs Dairy Sector Institutions Philip Barry Law and Economics - - PowerPoint PPT Presentation

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NZs Dairy Sector Institutions Philip Barry Law and Economics - - PowerPoint PPT Presentation

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NZs Dairy Sector Institutions Philip Barry Law and Economics Association Wellington Sept 4, 2019 Contents 1. What did DIRA do? 2. Has DIRA worked? 3. Is DIRA still needed? www.tdb.co.nz 2 1. What Did DIRA Do? 1. Created a

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NZ’s Dairy Sector Institutions

Wellington Sept 4, 2019 Law and Economics Association

Philip Barry

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Contents

1. What did DIRA do? 2. Has DIRA worked? 3. Is DIRA still needed?

www.tdb.co.nz 2

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  • 1. What Did DIRA Do?

1. Created a near-monopsony for Fonterra at the farm-gate 2. Removed the monopsony of the Dairy Board at the factory-gate 3. Preserved competition in the domestic dairy-products market

www.tdb.co.nz 3

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  • 2. Has DIRA Worked?

www.tdb.co.nz 4

5 10 15 20 25 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 2016

Litres (billion)

Milk processed (billion litres)

Growth in the sector until reaching peak-cow in approx. 2015-16

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Fonterra’s Place in the Sector

www.tdb.co.nz 5

60% 65% 70% 75% 80% 85% 90% 95% 100% 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021

Market Share

Actual Forecast

Fonterra’s Farmgate Market Share

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Increasing Competition

www.tdb.co.nz 6

Market Share at Farm-gate

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Dairy Processors’ Performance

www.tdb.co.nz 7

19% 11% 9% 6% 2% 0% 8% 16% 24% Tatua* OCD Synlait Fonterra Westland

Average Return on Capital Employed, 2014-2018

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Market Capitalisation

www.tdb.co.nz 8

$0 $2 $4 $6 $8 $10 $12 $14 August 2016 April 2017 December 2017 August 2018 April 2019 Market cap, $ billions

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Fonterra’s Financial Performance

  • Downward trend in performance

www.tdb.co.nz 9

0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 2006 2008 2010 2012 2014 2016 2018 2020

ROCE (%)

Fonterra Return on Capital Employed

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Fonterra: Commodities vs “Value Add”

www.tdb.co.nz 10

  • 2%

0% 2% 4% 6% 8% 10% 12% 2006 2008 2010 2012 2014 2016 2018 2020

Fonterra ingredients Fonterra value add

Return on Capital Employed

Source: Northington Partners and TDB Advisory analysis

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What went wrong at Fonterra?

  • Structure or Strategy?
  • Co-op structure not inherently flawed: but

– sources of capital limited – agency costs increase with size

  • Was there a clear strategy? volume/commodity and

“value-add” – both are capital intensive

  • Fonterra’s structure did not match its strategy

www.tdb.co.nz 11

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Adding value vs adding costs

www.tdb.co.nz 12 2010-2018

Excluding Tatua, there is no clear relationship between economic value (NPAT/KgMS) and where a company is on the “value chain” (revenue/KgMS)

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  • 3. Is DIRA Still Needed?
  • Proposed changes are at the margin
  • Preserves open entry and open exit
  • Detailed changes:

– access to DIRA milk – dairy conversions – milk-price setting

  • Reviews of DIRA every four to six years

www.tdb.co.nz 13

DIRA Amendment Bill, 2019

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  • 3. Is DIRA Still Needed?

www.tdb.co.nz 14

74% of milk collected has access to more than one processor

Farm-gate Market

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  • 3. Is DIRA Still Needed?

www.tdb.co.nz 15

ComCom Part IV regulation typically applied where one supplier

Farm-gate Market

Dairy Region Total production (millions kgMS) Percentage of national market (kgMS)

  • No. of processors

Waikato 503 27% 3 Whanganui / Manawatu 81 4% 2 Westland / Nelson / Tasman 85 5% 2 Canterbury 385 21% 4 Otago 101 5% 2 Southland 223 12% 3 Rest of NZ (5 regions) 483 26% 1

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  • 3. Is DIRA Still Needed?
  • Under DIRA, Goodman Fielder has guaranteed access to 250M litres of raw

milk p.a. at a regulated price

  • The Commerce Commission has estimated that if the DIRA Regulations were

removed, the domestic raw milk price would increase by around 25%

  • Leading to an estimated:

– transfer of wealth from New Zealand consumers to suppliers of $51M to $92M p.a.; and – an efficiency (deadweight) loss to the economy of around $6M p.a.

www.tdb.co.nz 16

Domestic Dairy Products Market

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Conclusions

  • Under DIRA:

– The dairy sector overall has fared well; but – Fonterra has struggled

  • With increased competition there are valid questions

whether DIRA is still needed at the farmgate

  • Given the domestic presence of Fonterra, regulation is

still needed for the domestic dairy products market

www.tdb.co.nz 17

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Over Paying for Milk?

www.tdb.co.nz 19

  • The Farm-Gate Milk Price shows a general increasing trend
  • Fonterra's constitution states that it’s goal is to maximise pay-out for milk

to farmers, this has incentivised farmer volume production, requiring investment in processing capacity and not value add business

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Over Investing in Processing?

  • Fonterra has out-spent competitors

www.tdb.co.nz 20

Invested Capital since 2001

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Debt to debt plus equity, 2018

www.tdb.co.nz 21

17% 26% 40% 52% 67% 0% 20% 40% 60% 80% OCD Synlait Tatua Fonterra Westland

Debt/(debt+equity), (%)