Murray Goulburn's capital plan aims for the big cheese

Murray Goulburn’s Gary Helou has made no secret of his ambition to aggressively expand the giant Victorian dairy co-operative. The update on his plans to raise $500 million of capital to fund those ambitions details the arguments he will put to his farmer members as he seeks their support for a radical change in the co-operative’s capital structure.

The ambition is obvious. Murray Goulburn is the country’s largest dairy group. Its milk pool now represents 37 per cent of Australia’s milk supply. Helou wants to leverage that position to gain a greater exposure to the long term growth in demand for dairy products in Asia.

To do that, he has told the co-op’s members, Murray Goulburn needs to increase its manufacturing footprint and invest $500m over the next three-to-five years in plants that will manufacture and supply 'customised' dairy foods, primarily for Asian markets. The key target segments are nutritional powers, consumer cheeses and dairy beverages.

The core argument Murray Goulburn is making to its suppliers is that the expansion will lead to higher farmgate prices for their milk.

To fund that without relying largely on debt funding, however, Murray Goulburn needs access to equity funding.

At the heart of the logic of Murray Goulburn’s strategy for raising capital is a mutuality of interest between the co-op and its suppliers.

One of the great constraints to expanding Australia’s dairy production to take advantage of the growing and long-term opportunity in Asia has been in creating the capital and incentives at the farm level for an expansion in production.

Australian production (and the land devoted to dairy production) has been shrinking ever since deregulation of the sector in 2000. By contrast, New Zealand’s dairy acreage and production has been expanding and its flagship co-op, Fonterra, now has about 20 per cent of the global market compared with Australia’s 7 per cent.

The keys to reversing the trends in the Australian sector and improving its ability to capitalise on the growth in Asian demand are higher farmgate prices, better access by the farmers to capital to expand their production -- and access to equity by the bigger co-ops.

The Murray Goulburn proposal to raise capital would help tick those boxes.

At present, Murray Goulburn’s ordinary and preference (non-voting) shares have a face value of $1. The value of the shares generally isn’t recognised by banks and therefore aren’t of meaningful economic value to the farmers, although they do generate dividends.

Under Murray Goulburn’s scheme to raise capital by creating an ASX-listed trust, its members wouldn’t relinquish control, as the units in the trust would be non-voting. However, the co-op members would have a facility to sell their shares, which means there would be a market value for their interests in the co-op that they could borrow against.

There a lot of technical detail in the Murray Goulburn proposal to explain the mechanics of how it would work, but the most significant aspect of it from the farmers’ perspective is that all the major banks and rural financiers have indicated their support for the proposal. They have also indicated that they would attribute a market value to ordinary shares in the co-op when assessing loans to farmers.

Farmers traditionally have had far more interest in milk prices that the value of their shares or the dividends they receive. Murray Goulburn says it will align the interest of its suppliers with unitholders in the proposed trust by raising dividends when farmgate prices are higher and lowering them if farmgate prices fall.

If Murray Goulburn meets its timetable a final proposal will be distributed to its members in December, with an extraordinary meeting to vote on it in late January or early February.

The plan to raise capital was always independent of the failed attempt to acquire Warrnambool Cheese and Butter but has become more important to Murray Goulburn because it wasn’t able to buy the most logical and complementary business available.

That failure places greater emphasis on the need for the co-op to accelerate an already aggressive expansion of its share of the milk pool (its national market share grew from 33 per cent to 37 per cent in the latest financial year) and the manufacturing facilities to exploit that.

The capital raising offers the prospect of a virtuous cycle for the co-op and its farmer suppliers, with the returns on that capital -- if Helou can execute the expansion successfully -- increasing Murray Goulburn’s profitability, its capacity to pay dividends and its ability to increase farmgate prices.

The farmers would, if all goes according to plan – and as Fonterra’s farmers in NZ have experienced – not only get access to stronger flows of income but would be able to borrow against their shares, if they wished, to increase their acreage and production.