Deciding which dairy company to supply when buying a farm is an important decision when it comes to shares.
Dairy company shares make up a substantial part of a farm purchase. For an average sized Fonterra farm to be fully shared up producing 100,000 kg/ms at $6.00 per share equates to $600,000.
There is the option to supply a dairy company where no share purchase is required. This is viewed by many as an attractive option. Without the need to invest in shares, a farmer significantly increase’s available working capital, and with that they significantly increase their options.
Imagine buying the farm you have dreamed of sooner or expanding into a larger farm with the funds that would have otherwise been used to purchase shares.
To remain competitive and assist farmers with purchasing shares Fonterra has revised and introduced new share purchase options. The aim of these is to remove the requirement to be fully shared up on day one.
Fonterra Strike Price contract
Under the Strike Price contract farmers have up to nine years before they have completely paid for their shares. Farmers purchase 20 percent of the shares up front based on an estimate of the first three season’s production.
The requirement to purchase the remainder of the shares is only when the farm gate milk price goes above the strike price, currently set at $5.25 kg/ms for the 2018/2019 season.
For an average farm producing 100,000 kg/ms the initial share up of 20 percent would be 20,000 shares at an average of $6.00, which totals $120,000.
The requirement to purchase shares in the current season at the milk price of $6.40 and the current strike price of $5.25 is a difference of $1.15. Of the $1.15, 50 percent would be required to purchase shares, and would total $57,500 (57.5 cents @ $100,000kg/ms).
At the end of season one, the farmer would have paid $177,500 for shares and at $6.00 per share, own 29,583. At the current strike price this equates to just under one third of the total shares required to back milk production at an estimate of 100,000 kg/ms.
The current Strike Price contract lasts for a minimum term of six years. If farmers are not fully shared up at the end of the six years, they will need to buy at least one-third of their remaining shares in each of the subsequent three years. If they cease supplying Fonterra before the end of the full term they may be required to pay compensation.
Share up over time contract
Another option is the Share up over time contract. This offers two options the three year contract or the six year contract.
The three year contract requires the farmer to purchase the shares over three years with a minimum of one third per year, based on estimated production.
Under the six year contract shares are only required to be purchased in seasons four, five and six – effectively deferring the requirement to purchase shares. The number of shares required to be purchased is calculated as equal to one third of the average actual quantity of milk solids supplied in seasons one, two and three.
Similar to the Strike Price contract there are minimum contract requirements that apply.
As outlined the Fonterra share options are different and appear to offer some flexibility for sharing up in the Co-operative. In addition, the option still remains to supply a dairy company where no share up is required at all.
In reviewing which option is right for you, it is important to consider:
- Estimating milk production.
- Commitment to supply Fonterra.
- Budgeting for share purchases and dividends. For every paid share the Fonterra dividend is payable (even if you are not fully shared up).
- Taxation Payments – the purchasing of shares is a capital item even when it is spread over time. If funding shares out of cash flow, remember to budget for tax payments.
- Bank – understand how your bank capitalises the share transaction under the various share up options, as the banks differ in their treatment.
In deciding which option is right for you, there is no one size fits all approach and what works for you may be different than what works for the neighbour. Please contact your rural professional if you would like further information on deciding what option is right for you.
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