Murray Goulburn, Australia’s largest dairy wholesaler, has been forced to slash prices for its suppliers. How did a co-op end up treating its members so badly?
In April 2016, Murray Goulburn (MG) issued a profits warning after it was caught out by a global decline in milk prices over the previous year and was unable to meet the dividend payouts it had promised to its investors.
To try to shore up profits, it made a retrospective cut on payments to its suppliers from AUD$5.60 per kilo of milk solids to below $5. This applied to the previous 10 months’ payments and will be clawed back over three years. Suppliers have been left with a large hole in their finances – which many are unable to fill.
All too frequently, we hear of wholesalers and large retailers squeezing suppliers to improve returns to investors and increase market share. This appears to be yet another example – but MG is a co-operative. It is owned by its suppliers, small and medium-size dairy farmers. How on earth did it end up treating them so badly?
The story starts with deregulation of the Australian milk industry. Prior to 1999, the supply and pricing of milk in Australia was set by the state. This enabled MG to maintain high and stable prices for suppliers.
Founded in 1950, it quickly grew, becoming Australia’s largest dairy company by 1973. The rise of Asian economies in the last two decades created export opportunities, which it eagerly grasped: over half of its income now comes from exports.
But over-reliance on exports makes a company vulnerable to global price changes. Milk is a global commodity, and its price varies with global supply and demand.
While MG’s domestic market was regulated, it was to some extent shielded from supply and demand changes elsewhere in the world, because the domestic market was stable. But the deregulation of the Australian milk industry changed all that. Suddenly, MG’s income – and hence the price it could pay to suppliers – was entirely driven by global commodity markets.
After deregulation, MG – as the largest Australian dairy wholesaler – effectively set farm gate prices, since smaller producers were forced to follow its lead or lose business. Because dairy production works on a yearly cycle, MG set its expected farm gate price a year in advance, enabling farmers to plan their expenditure on feed and equipment.
In effect, MG acted as a shock absorber, buffering suppliers from the effects of global market price volatility. As long as MG was owned by its suppliers, this worked well. But it exposed MG to the risk that accumulated reserves would be insufficient to enable it to maintain a stable farm gate price if there was a sustained fall in market prices.
In 2011, MG appointed a new CEO, Gary Helou. He had spent many years in Asia and was CEO of a rice co-op in Singapore. His idea was to protect MG from global milk price falls by diversifying into branded milk products, which could be sold at a higher price and over which the company might have more control.
Once you start to raise capital from people outside the co-operative, as Murray Goulburn did, then in my experience, almost always, it ends in tears
To achieve this, MG needed investment – so Helou had to raise capital. He did so by means of the MG Unit Trust, a type of non-voting preference share which listed on the Australian stock exchange. Had the capital raising been limited to MG’s existing owners, as a rights issue in a joint stock corporation would be, there might not have been a problem. But the shares were also sold to external investors. And that decision proved disastrous.
Investors were promised dividends equivalent to the farmers’ payments. But the farmers’ payments are a business cost, while the investors’ dividend is a share of the surplus remaining after all costs, interest and taxes have been paid. As long as times were good and the co-operative’s gross income was rising, the link between payments to farmers and investor dividends could be maintained. But as soon as income came under pressure, that link became be impossible to maintain.
Even if there were no link, pressure on MG’s income would quickly set farmers and external investors against each other, as merchant banker David Williams explained in an interview with the Australian Broadcasting Corporation’s Pip Courtney.
“Once you start to raise capital from people outside the co-operative, as Murray Goulburn did, then in my experience, almost always, it ends in tears,” he said.
“And it ends in tears because the people who are putting equity in – normal investors – want exactly the opposite of what the farmers want. So, as an outside investor putting money into a co-operative, what is it I want?
“I want maximum profits, if I can get them, in order to get dividends out of the business and that implies that I want lowest commodity prices… Farmers on the other hand want exactly the opposite. They want the highest milk price.”
Helou’s strategy rested on the belief that MG could balance the demands of farmers and external investors. Had the global price of milk been stable, it might have stood some chance of success. But global milk prices are anything but stable. They have long been subject to “boom and bust” dynamics.
Australian academics James Lockhart, Danny Donaghy and Hamish Gow have described how the price of milk was driven up by rising demand from Asia. “Since the mid-2000s a strong increase in demand for milk products across Asia, largely on the back of rising middle-income wealth, led to the complete depletion of surplus dairy stocks in the European Union and the US,” they said.
“To a large extent this imbalance had been driven by regulation of the global supply market in which only a few export nations competed – Australia and New Zealand included. It resulted in higher than historical average dairy prices in global markets.”
Unfortunately, MG’s board had short memories, as did its suppliers. The academics continue: “A critical assumption that appears to have emerged among producers during this period, as evidenced by continued investment and expansion, was that the real price for global dairy commodities was increasing, a trend they expected to continue in the long term.”
In 2014, in expectation of continuing price rises, MG promised farmers it would increase prices to $6 per kilo of milk solids. But global prices were starting to fall. Imposition of sanctions on Russia drove European Union producers to seek markets elsewhere, competing with MG and other global producers. Concurrently, demand from China slowed. By March 2015, the global price for milk products had fallen significantly.
In May 2015, the EU removed all quotas on milk production, increasing the global over-supply of milk and milk products. But in June 2015, the ever-optimistic MG told farmers it could still deliver a farm gate price of $6.05 per kilo of milk solids, and promised investors a net profit after tax of $20m. It is, of course, a measure of the co-op’s strength that it was able to do this. But it all depended on Helou’s diversification strategy. And this proved too little, too late.
By February 2016, it was clear that MG was in trouble. The 2015 results were worse than expected, and MG revised down its forecasts for 2016. It told farmers that farm gate prices would remain at their present level of $5.60 per kilo, substantially less than promised.
Diluting co-operative principles in order to increase investment almost always ends badly. Investors and co-operators have fundamentally different objectives. They don’t mix.
This was followed in April 2016 by suspension of MG Unit Trust share trading, the aforementioned profits warning and farm-gate price cut, and the resignations of Helou and several other board members. MG’s management disarray had repercussions not only for its owners, but for the entire Australian dairy industry.
MG is by no means the first milk wholesaler to come to grief because of a foolish financial strategy. But because of its co-operative ownership, the hit is being taken by its suppliers.
When a co-operative gets too big for its boots, it is the small co-operators who get hurt.
There is much to learn from this saga. Firstly, as I have noted before, diluting co-operative principles in order to increase investment almost always ends badly. Investors and co-operators have fundamentally different objectives. They don’t mix.
Secondly, executive managers of co-operatives should be open and honest with their owners. The MG board did not tell farmers the truth. Only a week before the price cut, Helou was reassuring everyone that things were fine. Had farmers known earlier that farm-gate prices were likely to fall, they would have made different financial decisions.
And finally, an overly rose-tinted view of global markets is unwise. Prices can fall as well as rise, and booms are always followed by busts. Prudent financial management, in co-operatives as much as elsewhere, should look to ride out the effects of price swings and be appropriately sceptical of large price rises.