Agribusiness, Finance

Murray Goulburn and the consequences of choices: Lessons from the big end of town

Michael Stapleton /

“Turning and turning in the widening gyre
The falcon cannot hear the falconer;
Things fall apart; the centre cannot hold;
Mere anarchy is loosed upon the world…”

— “The Second Coming”, W. B. Yeats

Just over 12 months ago Murray Goulburn shocked its farmer suppliers by announcing, late into the season, deep and unexpected cuts to its financial year 2016 (FY16) Farmgate Milk Price (‘FMP’). Effectively, Murray Goulburn told its farmer suppliers they had been ‘overpaid’ and it wanted to clawback that overpayment over a three-year period from 1 July 2016.

All choices have consequences. Murray Goulburn revealed some of the consequences of its choices earlier this week. In brief, Murray Goulburn will:

• Close three manufacturing facilities with a loss of 360 jobs;

• Abandon the clawback from farmer suppliers of the ‘FMP overpayment’;

• Incur write-downs of up to $410 million; and

• Suspend its dividend with immediate effect and review the dividend payout ratio.

The cause of all these actions is significantly lower milk supply, expected to be 22% lower than last year. The lower milk supply is a consequence of farmer suppliers reacting to the April 2016 announcement and leaving the Co-Op.

By abandoning the clawback proposal, Murray Goulburn has admitted it did the wrong thing by its farmer suppliers.

The real question is whether this admission has come quickly enough to stem the loss of farmers and milk.  

The loss of milk supply has had entirely predictable outcomes on Murray Goulburn’s production efficiencies. Factories have high fixed costs and when throughput is reduced, the cost of production rises. So, in the absence of milk, Murray Goulburn had no option other than to reduce its production capacity.

The corollary of a rising cost of production is an inability to pay farmer suppliers a competitive rate for their milk.  Murray Goulburn’s FMP for financial year 2017 (FY17) at $4.95/kg of milk solids is the lowest amongst its competitors. Bega Cheese is currently paying $5.13; Fonterra is paying $5.10; Saputo is paying $5.25 and Lion $5.10/kg of milk solids.

To make matters worse, Murray Goulburn expects to receive only $4.60/kg of milk solids from its trading activities and is covering the last 35c/kg from higher borrowings.

Murray Goulburn was the price setter for milk payments in Victoria, South Australia and the New South Wales Riverina. It looks to me like that is no longer the case — another consequence of its self-imposed problems that led to the April 2016 decisions.

Okay, let’s see if we can put some meat on the bones of Murray Goulburn’s cost of production.

I looked at this last year in a related article, comparing FY16 to FY15. Let’s now look at the first half of FY17 compared to the first half of FY16 and see what lower milk supply did to Murray Goulburn.

Murray Goulburn

From the table, it is apparent that:

• Milk volumes of 1.61 billion litres in H1 FY17 are down from 2.03 billion litres in H1 FY16;

• Revenue fell to $1.18 billion in H1 FY17, from $1.38 billion in H1 FY16.

• The cost of raw materials (milk Payments to suppliers, disclosed in the notes to Murray Goulburn’s accounts) fell to $459 million in H1 FY17, from $664 million in H1 FY16. The cost of raw materials represents 39% of Sales in H1 FY17, which is a much lower level than the 48% of Sales in H1 FY16. The remaining farmer suppliers are getting a smaller piece of a smaller pie; and

• The cost of production rose to $550 million in H1 FY17, from $514 million in H1 FY16. Not only did Murray Goulburn receive less milk but it cost more in absolute terms to process that milk. It is not surprising then that the cost of production represents 47% of Sales in H1 FY17, well above the 37% in H1 FY16.

If Murray Goulburn can’t bring its cost of production down quickly then it risks losing more farmers and more supply to other processors. It is on the edge of a spiral that it may not be able to control.

Murray Goulburn, like all export orientated milk processors, is a business that cannot control the major drivers of its earnings — commodity price, currency and weather. Its only defence is a strong balance sheet. Right now, because of the write-off it has just announced, its balance sheet has been weakened. If it continues to borrow to move its farmgate price closer to that of its competitors, then its balance sheet will continue to weaken; borrowing to supplement its FMP to maintain a competitive position is code for borrowing to covering a loss. Further, it is unlikely to get support for a recapitalisation from the investors it has just burnt.

In short, Murray Goulburn needs everything to go right in terms of the commodity price, currency and weather factors that influence its earnings.

We’ve seen this before with Bonlac in the early years of this century. Bonlac’s issue, while different, had the same impact in that it was unable to pay a competitive milk price. Add to this pressure on its balance sheet from an expansion program and that business eventually fell into the hands of Fonterra.

So, what are the lessons from recent events at Murray Goulburn for owners of small and medium size business? Here are a few:

  1. 1. When faced with a crisis you must identify which of your stakeholders are most important to the survival of, and then the recovery of, your business;
  2. 2. Acknowledge your mistakes (we all make them) immediately and honestly. It allows you to plan a response that will address the heart of the issue;
  3. 3. Go to that key stakeholder with the plan addressing the core problem, get their support and then move onto the next most important stakeholder with that plan and key support in place;
  4. 4. You waste time otherwise, and other, unforeseen consequences are likely to emerge. Murray Goulburn had a choice a year ago, to acknowledge the self-imposed nature of its problem immediately and take steps to mitigate the impact on its most crucial stakeholder — its suppliers. It didn’t and suppliers have voted with their feet, taking their milk elsewhere, ruining Murray Goulburn’s production efficiencies and ability to compete;
  5. 5. Don’t waste a good crisis. It is a threat, for sure. But it is also an opportunity to make changes to enhance and improve your business and set it up for the future; and
  6. 6. Understand the key drivers of your business. The less you can control, the less risk you can take on in your business.

So, what do you think? Are there other lessons for owners of small and medium size business from this situation?

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Michael Stapleton

Michael Stapleton is a founding member of the Association of Virtual CFOs. He operates a Melbourne-based Virtual CFO practice, helping owners of small and mid-size businesses understand the drivers of their cashflow and make financially informed decisions.

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