Australia’s largest milk processor, Murray Goulburn, was counting on the success of its dairy foods in China to shield its farmers and investors from a dramatic collapse in global commodity prices. Instead, the cooperative shocked its suppliers by cutting prices, plunging much of the industry into crisis. David Lewis investigates what went wrong.
On his property near Wangaratta in Victoria’s north-east, Justin Evans wears a smile but seems resigned to a tough year ahead.
His carefully planned budget for the next financial year has been thrown into disarray thanks to Murray Goulburn’s shock decision to cut the price it pays its 2,600 farmers for milk.
‘Everyone I know was just absolutely gutted,’ he told Background Briefing.
‘A lot of people were in the expanding phase too, so they were increasing stock, purchasing more land, building new dairies, and all of a sudden there’s no return on that investment.’
Evans had been receiving $5.60 per kilogram of milk solids for most of this financial year but in April, Murray Goulburn announced it would have to be revised down to somewhere between $4.75 and $5.00.
To soften the blow of this ‘step down’, as it is known in the industry, the cooperative has been supplementing milk cheques for the past two months of this financial year as part of a support program.
There is a catch, however: the money farmers receive to help them through this difficult period will have to be repaid, with interest, over the next three years.
One consultant estimates the typical farmer will end up paying back to the cooperative around $100,000.
‘It’s not fair on the farmers because we’ve worked within our budgets on the advice we’ve been given from the board of the directors and we are the ones that are going to have to pay the price for it,’ Evans said.
The step down came as a total surprise, arriving as it did so late in the season, just two months out from the end of the financial year.
According to Evans, Murray Goulburn never indicated the milk price was at risk of collapsing.
‘They were very confident. They said they had changed the fundamentals of the business and that they were particularly shielded from the global commodity prices,’ he said.
The plan to conquer China
Once hailed as a ‘visionary leader’, Gary Helou was appointed as managing director of Murray Goulburn in 2011 with the aim of shaking things up.
His dream was to transform the humble, farmer-owned cooperative into a dairy foods powerhouse by increasing exports to Asia.
China, with its huge population and seemingly insatiable appetite for Australian milk powder, was seen as the most lucrative market.
Playing to Murray Goulburn’s advantage was a series of contamination scares between 2008 and 2013, which had shaken confidence in China’s agricultural sector.
Consumers there were looking to our shores for products they could trust.
‘I think China is an incredibly interesting emerging market that will change the form and shape of trade in dairy and that’s the nirvana we’re all looking for,’ Helou told Business Spectator last July.
To reach that nirvana, as Helou called it, Murray Goulburn planned to move away from the raw ingredients side of the business—which was especially vulnerable to the volatile global commodities market—and focus instead on so-called ‘value-added products’ like baby formula, cheese snacks, and adult milk powder sachets.
‘This shift away from commodities has given us a 70 per cent portfolio that is anchored in consumer brands and nutritional powders that have higher prices and more stable margins,’ he told the ABC last August.
Critics sceptical from the start
The strategy had broad support from Murray Goulburn’s dairy farmers but there was one initial stumbling block: money.
A lot of capital was needed to invest in building new factories to produce the specialised dairy foods for which Asian consumers were crying out.
Gary Helou proposed a radical solution to the problem.
He wanted to partially list the business on the stock exchange, allowing outside investors into the farmer-owned cooperative for the first time.
The move was designed to raise half a billion dollars.
‘When co-ops go and raise money outside their membership they typically have this argument that says the farmers can’t put the money in, they don’t have any money, we have to go to Collins St and Pitt St to get it,’ said David Williams, an investment banker based in Melbourne.
Williams had identified what he considered a fundamental conflict of interest between the Murray Goulburn’s farmers and would-be investors.
He argued that, as a cooperative, Murray Goulburn’s job is to return as much money as possible to its suppliers but shareholders might not like that.
‘When you are a co-op and you raise money from the outside world, you’ve got these two competing influences,’ Williams said.
‘Farmers want the highest price possible and no profit, outside investors want the lowest price possible and a high profit.
‘So how do you solve that dilemma? The short answer is you can’t solve it.’
Murray Goulburn disagreed. Its solution to this potential conflict of interest was to link the price it pays its farmers for milk with the dividends paid to outside investors.
This was reassuring to those farmers who were wary of the big end of town wanting to squeeze as much money out of their pockets as possible.
Under this arrangement, they were told, financial incentives for both groups would be aligned.
‘A lot of the industry and a lot of the press were seduced by this novelty and there was a lot of talk about Gary being a visionary and Murray Goulburn being a visionary and so on and so forth,’ Williams recalled.
‘Where’s that now? There’s no talk of that now. We had a very different view of how visionary it was. We thought the construction of the instrument to raise the money was actually naive.’
Commodity prices collapse
As Murray Goulburn doggedly pursued its new strategy, storm clouds were gathering on the horizon.
In July 2014, a year before Murray Goulburn would partially list on the stock exchange, a Malaysia Airlines flight was shot down above Ukraine, killing almost 300 people.
Australia, the United States, and Europe suspected pro-Russian rebels were to blame and responded by imposing tougher economic sanctions on Russia, which returned fire by banning imports of western dairy products.
‘Russia was the European Union’s largest export market and they sold a lot of butter and cheese into that export market and then, almost overnight, that market was shut off from them,’ said Michael Harvey, a senior analyst with Rabobank.
All that butter and cheese that was supposed to be sent to Russia had to be redirected to other markets, resulting in an oversupply, which put downward pressure on milk prices.
‘Commodity prices went from $5,000 a tonne to below $2,000 a tonne for some commodities, so they more than halved in price and they’ve stuck there for about two years and that’s been the problem,’ Harvey said.
Compounding the problem was the decision to lift production caps on dairy farmers in Europe from May last year.
For the first time in three generations, farmers there could produce as much milk as they wanted, which exacerbated the oversupply and resulted in demand from China slowing down.
‘The Chinese dairy industry basically went from being short on milk to long on milk because they over-purchased and supply locally improved better than some people expected,’ Harvey said.
‘They needed to destock what they’d purchased through 2014, hence we saw very weak export volumes in 2015.’
Murray Goulburn sticks to its guns
Despite all the turmoil on global markets, Murray Goulburn clung to its rosy sales forecasts.
The cooperative’s chairman, Philip Tracy, told Background Briefing a couple of products were still selling strong in China.
‘Particularly the adult milk powders, the one-kilo sachets. We saw significant growth in the first six months and, in fact, they were filling the void left by global commodity prices,’ he said.
Investment banker David Williams thought it was foolish to rely on just a handful of products to prop-up aspects of the business that were underperforming.
‘China is slowing down. It’s not the gravy train that everybody thinks it is. It’s not a merry-go-round that’s going to keep going,’ he said.
‘People need to get used to the fact that, infant formula, for example, has been very successful but every man and his dog is putting up new plants around the world. This fat margin people have been making is going to get completely eaten away.’
Murray Goulburn went ahead with its partial public listing on the stock exchange in July last year.
At the time, the processor was so confident in its performance that it was still forecasting a milk price of around $6.
In February, however, Murray Goulburn had something of a reality check.
In its half-yearly results, a forecast profit of $85 million was lowered to just $63 million.
The cooperative also backed away from predictions of a $6 milk price in the future.
Still, the company’s chairman believed the popularity of its adult milk powder sachets would remain strong.
‘We were being abused by our customers for not being able to meet the demand,’ Tracy said.
‘We invested in increasing production capacity so we could meet the demand for these one-kilo milk powder sachets. Naturally you go for the high volume, high margin generated businesses.
‘We saw the figures that we announced in the half-yearly result—significant growth.’
Sales forecasts miss the mark
That growth quickly deteriorated.
Sales figures for the month of March, presented to the Murray Goulburn board in April, exposed the flaws in the cooperative’s business strategy.
‘That April board meeting was when we realised the volumes of adult milk powder sales were not meeting the sales forecast,’ Tracy said.
As the board digested this sobering news, Gary Helou appeared at an industry event where, in spite of declining sales, he was again talking up the chances of an increase to the milk price in the future.
David Williams was in the audience and reflected on Helou’s speech in an interview with the ABC’s Landline program.
‘I heard him say two things: one is that a $6 milk price was justifiable and probably achievable and achievable into the medium term, and the second thing I heard him say was that there was an enormous amount of demand for Murray Goulburn product in China.’
Meanwhile, the board had ordered an urgent review of its forecast sales, which, only days later, revealed a $60 million gap between expectations and reality.
As Tracy recalls, that shortfall was ‘significant enough to reduce the milk price’.
After emerging from a trading halt, Murray Goulburn announced the devastating step down to dairy farmers and investors.
But there was more bad news. The cooperative’s expected profit for the end of financial year had shrunk for a second time in as many months to around $40 million.
Shares in Murray Goulburn tumbled and Gary Helou quickly announced his resignation.
‘Unfortunately we were very disappointed with the quantum of the miss and we’ve had to part ways with Gary,’ Tracy said.
When asked whether the board should also accept responsibility and resign, Tracy told Background Briefing that ‘execution of the strategy is management’s responsibility’.
Despite all that had gone wrong, Murray Goulburn released a statement describing Gary Helou as a ‘visionary leader who delivered a strategy that transformed the industry’.
Troubles spread to Fonterra
Murray Goulburn’s troubles quickly spread to another major milk processor, New Zealand’s Fonterra, which has around 1,200 Australian suppliers.
Fonterra was also paying its farmers $5.60 per kilogram of milk solids before the price cut.
A couple of days after Murray Goulburn stepped down, however, Fonterra followed suit, slashing the price to just $1.91.
Ron Paynter from Gippsland in Victoria’s south-east told Background Briefing that is not even enough to cover costs.
‘It really has tipped a very large number of farmers over into a position where it’s certainly not even a breakeven year,’ he said.
‘People are having to go back to their banks to look at renegotiating loan arrangements or extending loan arrangements.’
When Fonterra first came to Australia 15 years ago, it bought a stake in local milk processor, Bonlac.
Farmers agreed to the move on the condition Fonterra would always pay them the same price for their milk as the market leader Murray Goulburn was offering its suppliers.
That seemed to keep everyone happy until global commodity prices recently plunged and Fonterra was forced to pay its farmers more money than it could afford for as long as Murray Goulburn was holding its price.
Paynter says the arrangement must be reviewed.
‘Fonterra has got to come up with a much more transparent and robust way of setting milk price,’ he said.
In August last year, the head of Fonterra in New Zealand, Theo Spierings, was reported as saying the milk price in Australia was unsustainable and did not reflect the collapse in prices for dairy commodities but he was effectively powerless to do anything about it.
Fonterra declined an interview with Background Briefing but its managing director in Australia, Judith Swales, recently told a dairy industry breakfast that milk processors needed to do better.
‘For me that happens on many, many levels, but it starts by giving clearer price signals to farmers so that they can plan their businesses better,’ she said.
‘The clearer the signals the more that they can plan and ultimately be able to weather some of the storms we still see coming.’
Both the corporate and consumer watchdogs are already circling Murray Goulburn.
The Australian Securities and Investments Commission is looking at the cooperative’s disclosure practices while the Australian Competition and Consumer Commission examines the timing of the milk price cut and whether farmers received enough notice.
There is even talk of a class action with law firm Slater & Gordon investigating the matter on behalf of disgruntled investors.
And yet, if Murray Goulburn’s board members could go back in time, chairman Philip Tracy told Background Briefing, ‘we wouldn’t have done anything differently, unfortunately’.
As southern dairy farmers brace for a difficult season, there is a push for the Murray Goulburn board to be spilled and for fresh elections to be held.
Background Briefing has been told there is already enough support to force an extraordinary general meeting but Philip Tracy is refusing to walk away.
‘My responsibility is to Murray Goulburn and I will continue to meet that obligation,’ he said.
‘I’ve spoken to a lot of suppliers over the last six weeks and, yes, there is a lot of disappointment but I do believe, not only the board, but myself, as chairman, do enjoy strong support.’
Tracy should not expect to count on Justin Evans for support.
The dairy farmer from north-east Victoria is unequivocal about the need for new leadership.
‘I think the board should vacate all their seats,’ he said.
‘It’s hard to go forward with this co-op the way it is.’