Fonterra Fair Value Share Price

For Immediate Release
29 May 2003

FONTERRA FAIR VALUE SHARE PRICE

Fonterra Co-operative Group Ltd has set a fair value share price for the 2003/04 season of $4.38 - an increase of 14 per cent on the previous season's price of $3.85.

Fonterra's Board of Directors adopted the midpoint from within a valuation range provided by independent valuer Standard & Poor's, in accordance with Fonterra's constitution and the Dairy Industry Restructuring Act.

Fonterra Chairman Henry van der Heyden said that the Board was pleased to see that the independent valuer had concluded that the value of the company was increasing.

"This confirms that Fonterra is making progress despite the difficult international trading conditions we've faced over the past year, and the higher New Zealand dollar," said Mr van der Heyden.

"While there have been both positives and negatives influencing the valuation
a significant contributing factor driving the increase in value has been the degree to which Standard & Poor's have recognised that we have been able to take costs out of the business."

The Fair Value Share is also a key contributor to total shareholder return (TSR), and its increase suggests Fonterra is likely to exceed its goal of achieving a sustainable annual TSR of 13 to 15 per cent, said Mr van der Heyden.

Standard & Poor's view on the Group's value builds on the independent report on merger benefits by Deloitte Touche Tohmatsu. That report, which analysed data to the end of November 2002, confirmed Fonterra was well on track to achieving promised total merger benefits of $320 million within three years of its October 2001 formation.

Standard & Poor's valued the shares at between $4.05 and $4.71 (compared with $3.65 to $4.25 a year ago).

Fonterra will announce its final payout figure for the 2002/03 season when it releases its full year accounts in July. Mr van der Heyden said there was no change to the $3.60 forecast signalled in February.

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APPENDIX: Background to Fonterra's New Economics

The merger that created Fonterra and the deregulation of the New Zealand dairy industry brought a new set of economics to evaluate Fonterra's performance. The two key elements of the new economics are the Commodity Milk Price (CMP), and the Fair Value Share Price.

The Commodity Milk Price is intended to make it possible to separate business performance from the underlying commodity price cycles and movements in exchange rates.

The Fair Value Share Price serves as the basis for valuing shares on entry and exit to and from Fonterra for shareholders and is the key measure of long-term performance of the business.

The way these metrics were calculated is explained below:

* Commodity Milk Price (CMP) Because Fonterra buys 96% of the milk produced in New Zealand there is no benchmark to which Fonterra's payout for the milk it receives can be compared. To overcome this limitation, Fonterra's Constitution requires an independent estimate of the highest theoretical price that an efficient competitor can afford to pay for New Zealand's milk while making an adequate return on capital. This measure is called the CMP.

The CMP is forecast at the beginning of each season by Standard & Poor's based on historical international commodity prices, forecast foreign exchange rates and an assessment of the operating and capital costs incurred by a hypothetical, efficient manufacturer of a balanced portfolio of products.

The CMP is then recalculated at the end of each season and is used as a benchmark for Fonterra's Actual Milk Return (AMR). This is the payment for milk that Fonterra makes that enables it to recover all its costs, including a return on invested capital. The gap between the CMP and AMR is the result of differences between Fonterra's actual performance and that of a hypothetical efficient competitor. Some of the reasons that could explain the gap are differences in installed plant, product mix, working capital, plant utilisation and operating costs. Reducing the gap is one of Fonterra's focus areas and a key performance target. The historical CMP for the 2002/03 season will be announced in July when Fonterra releases its annual accounts (alongside the final payout for 2002/03).

* Fair Value Share Price Prior to the merger, shareholders in Fonterra's legacy companies could not assess the value of their shares because there was no market for them and transactions between the companies and shareholders were based on nominal value. After the merger, the Shareholders' Council assumed responsibility for appointing an independent valuer to estimate before each season the Fair Value Share Price. In 2002, and again this year, the valuer was Standard & Poor's.

The fair value range is estimated by performing a discounted cash flow valuation. The most important variables taken into account are the likely future earnings of Fonterra's separate businesses, corporate overhead, Research and Development and other operations, as well as the forecasted volume of milk supplied to Fonterra, expected exchange rates, and the number of shares. The projected earnings are measured using forecasted CMP as the cost of milk.

Accordingly, it is the long-run sustainable margins that Fonterra obtains above the long-run cost of milk that are reflected in the valuation. Margins that are relevant for valuation purposes are therefore likely to be less volatile than changes in commodity prices. Long-run sustainable margins will also reflect efficiencies that Fonterra is able to make over time. As a consequence, the fair value of a share will not necessarily change in line with payout.

After the valuer determines the fair value range, it is up to the Board of Directors to then set the fair value share price from within that range. The fair value is used as the price for the sale/purchase of shares between Fonterra and its shareholders. Shareholders are required to sell/purchase shares in response to changes in their milk production so that they maintain one share for every kilogram of milksolids supplied to Fonterra during the year.

* Payout The payout is the return farmers receive for supplying milk to Fonterra. It has two main components: the actual milk return (AMR) and the value added component. The AMR is calculated by Fonterra using the same methodology as applied by Standard & Poor's to calculate the CMP. The difference is that the AMR is calculated using actual revenue and actual costs instead of the theoretically efficient ones used for the CMP.

The value added component includes cash generated from Fonterra's investing activities in high-value consumer markets and in value added dairy ingredients, less the retentions required to fund future investing activities.

* Total Shareholder Return Total Shareholder Return (TSR) is a measure of return on investment expressed in percentage terms which is calculated as the total return earned over the past year, divided by the value of shareholders' equity invested in Fonterra at the start of the year. The total return earned by a supplier/shareholder comprises the increase in the Fair Value Share Price over the past year plus the value added component of payout, i.e.

TSR = Change in share price + Added value component of payout
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Opening share price

The added value component is the difference between the total payout and the CMP (the arm's length milk price). Calculating the TSR is the same as adding the dividend to the change in share price to get the total return in a listed company.

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