Fonterra farmers face one of the biggest votes in the co-operative's history today.
In Fonterra's view, the present system poses a risk to farmer's grip on the co-operative. Photo: Photo / AFP
Shareholders will decide on a proposed change to its capital structure to make it cheaper to join the company, preserve farmer ownership, and offset the risks from falling milk supply.
The country's largest company was forecasting that milk production could fall, or at best flat line, in the future, as a result of regulatory changes, climate change, alternative uses for dairy land and competition for farmer's milk from other milk processors.
Fonterra farmers are currently required to hold one share for every kilogram of milk solids they produce, so-called "wet shares".
In the past, when milk supply falls due to an unexpected event such as a drought, farmers could sell their excess "dry shares" to non-farmers through its associated shareholder's fund on the local stock exchange.
These shares would be converted into units, and buyers would not have voting rights.
In years when supply increased, farmers could buy the units back from the fund, which would see them converted back into shares.
However, Fonterra is concerned that declining milk supply in the future could see more farmers sell their dry shares to non-farmers, which would result in the shareholder's fund accounting for more and more of Fonterra's total capital base.
In Fonterra's view, this posed a risk to farmer's grip on the co-operative.
On top of this, farmers have often complained about the capital costs required to match shares with milk supply, which have made competing milk suppliers that did not operate under a co-operative model more attractive.
In response to these challenges, and after several months of consultation with farmers, the board had settled on a proposal to reduce the number of shares farmers need to join the co-operative, allow new types of farmers to own shares, and cap the size of the associated shareholders fund to no more than 10 percent of shares on issue.
"The board is unanimously recommending the changes to our capital structure to put us in the best position to deliver the value outlined in the strategy and protect farmer ownership and control of our Co-op," Fonterra chairperson Peter McBride said in November.
Analyst reaction
The head of research at Jarden Securities, Arie Dekker, said the changes would help Fonterra retain farmers, as the cost buying shares to meet milk supply would be reduced.
However, he noted that limiting the size of the associated shareholder's fund could affect the value of retiring farmers shareholdings.
"On the one hand you have incoming farmers to having hold to less shares and you also have constraints on the exchangeability into units, and the size of the units market.
"That will affect the demand levels for exiting farmers."
Dekker said that farmers have not just been leaving Fonterra because of the costly milk standard, they also cared about the company's performance.
He said if the company could get the new capital structure approved and continues to build on recent momentum in its business, it should support it in achieving its long term goals of increasing its operating profit by up to 50 percent by 2030 and returning $1 billion to shareholders by 2024.
Chances of passing
The proposal already has the overwhelming support from Fonterra's elected body of farmer representatives, the Co-operative Council.
The next hurdle would be to get the backing of at least 75 percent of its 10,000 farmer shareholders at today's special meeting.
"I think the support is out there on whole for the changes," Fonterra farmer Wayne Langford said.
"And I think our farmers have appreciated being listened to through the consultation period, and the tweaks that have gone on."
At the company's first quarter trading update last week, chief executive Miles Hurrell expressed confidence the vote would pass.
However, even if Fonterra gets the thumbs up from shareholders it still needs the government to amend the Dairy Industry Restructuring Act (DIRA) to approve the changes.
When Fonterra was formed in 2001, special legislation (DIRA) was created to allow the country's two biggest co-operatives at the time, New Zealand Dairy Group and Kiwi Co-operative Dairies, along with the marketing and export agent the New Zealand Dairy Board, to merge.
In a letter to Fonterra's chairperson, Agriculture Minister Damien O'Connor, expressed reservations about the proposal.
"The current proposals envisage a legislative change to remove key mechanisms that risk weakening performance incentives on Fonterra," it said.
"Without alternative measures, I am not yet assured that these proposals would deliver the best long-term outcomes for farmers or the dairy sector as a whole."
He also said he was particularly concerned that current proposal risked creating diverging shareholder interests between farmers with small shareholdings against those with larger ones.
"At this stage, it would be difficult for the Government to support an amendment to DIRA to facilitate the proposals."
However, Arie Dekker said a strong "yes" vote today could sway the minister.