By rights, New Zealand dairy co-operative Fonterra should be profitable. Global milk prices have gained steadily over the past three years and the world’s sixth-largest dairy group has been busy investing in high-margin products.

Instead, shares have fallen to near three-year lows and the group has announced a profit warning. On Friday, Fonterra cited balance sheet pressures to justify dividend cuts and lower milk prices paid to farmers.

Fonterra’s predicament is triangulated between farmers, shareholders and debt investors. The group’s proposed change to its milk price benchmark deviates from a formula that investors and farmers have both come to take for granted. More flexibility in pricing means less predictability for investors.

But the co-operative’s structural problems go deeper than that. Debt is forecast by S&P Global to exceed ebitda (a cash earnings measure) by three times in the full year. The investments it has funded have had problems. The most recent half year ended with a loss because of arbitration payment and the writedown of an investment in Chinese milk powder group Beingmate. Fonterra’s chairman and chief executive both announced their resignations earlier this year.

As a co-operative, the group’s stakeholders are split between farmer members and equity investors with tradeable stock focused on dividend payments. Farmers want steady milk prices. But they are limited in number and capital. Non-farmer shareholders benefit from higher earnings and higher margin consumer products. They want investment in downstream businesses like milk powder. Over the past five years Fonterra has invested NZ$5.7bn ($3.7bn), while issuing roughly half of that in net new debt.

But Fonterra’s capital structure is too rigid to support capital intensive growth in high value downstream businesses. Either Fonterra needs more flexibility or it must abandon its expensive expansion plans and concentrate on cutting costs.

Lex recommends the FT’s Due Diligence newsletter, a curated briefing on the world of mergers and acquisitions. Sign up at ft.com/newsletters.

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