Fonterra says no light at the end of the tunnel

By NZPA

Monday 12th August 2002

International commodity prices show no signs of recovery from their plunge to the lowest levels in two decades, and farmer payouts are being further hurt by the weakening United States dollar, Fonterra Co-operative Group Ltd said today.

"In the longer term, reform of the barriers and subsidies that hinder international free trade in dairy products remains the key to sustainable improvements in commodity prices," Fonterra chairman John Roadley said.

Mr Roadley made his comment in the company's first annual report, for the year to May 31, 2002, which was mailed to its 13,000 farmer shareholders around the country today.

Farmers have already received much of the company's bad news for the financial year, including a reduction in milk payout for the current season of $4/kg milksolids, down from last year's record $5.33/kg, and most recently, a further downgrading of the current season forecast to just $3.70.

Mr Roadley said in the report that last year's high international commodity prices, export-friendly exchange rate, and strong milk flows had created an "extraordinary year".

"However, the market deteriorated rapidly during the second half of the year, and commodity prices now stand at their lowest levels in recent memory.

"When these factors are combined with a rising exchange rate, it is clear that returns for 2003 will be reduced significantly."

The report highlighted the rapid falls in commodity prices in the second half of the year, Fonterra chief executive Craig Norgate said.

He warned these would have a substantial impact on shareholder returns in the current year.

"It also shows the fundamental strength of the company's balance sheet, and this will stand us in good stead," he said.

In an operational review, the report said national milk production reached record levels in the year to May, and the 1.1 billion kilograms of milksolids processed by Fonterra was an increase of nearly 6 percent over the previous year.

The company's turnover was a record $13.9 billion from total assets of $11.8 million. The payout to shareholders of $5.33/kg milksolids (less 3c/kg for industry good activities) totalled $5.667 billion -- but notes to the accounts disclosed the company had actually been forecasting in its budget a payout of over $5.50/kg, on lower volumes of milk.

"While total payments to suppliers were almost exactly in line with forecasts, milksolids volumes were 34.9 million kilograms (3.2 percent) higher than forecast and payout 20c/kg (3.5 percent lower than forecast)."

Total borrowings of $4.555 billion were $647 million higher than forecast, mainly because the costs of carrying a higher level of inventory in the second half of the year when more milk was received than expected, and less sold than budgeted.

The company was also caught out by a need to value US dollar-denominated offshore assets at an exchange rate of $US47.5c to the kiwi dollar, compared with its budgeted US43.0c.

Equity of $4.485 billion was $685 million lower than the forecast $5.170 billion, and today's report blamed this partly on "the fair value" of assets and liabilities $471 million less than forecast.

Also, an additional $249 million having to be provided as a foreign currency translation reserve, partially offset by $214 million in contributions from owners which had also not been forecast.

Significantly, notes to the accounts showed that though the company valued its total intangibles at $1.587 million -- including brands at $1.514 million -- the total figure was $345 million lower than forecast.

Accounts from Fonterra's "legacy companies" the Dairy Board, Kiwi Cooperative Dairies, and New Zealand Dairy Group, showed the combined value of their intangible assets was only $492 million in the year to May 2001, but in the creation of Fonterra directors assigned nearly $1 billion more value to those assets.

Today's report showed property, plant and equipment was $141 million higher than forecast, while the inventory adjustment was $185 million lower than forecast.

In a press release, the company said a highlight of the report was progress ahead of schedule in realising the merger benefits promised to shareholders in the run-up to formation of the company at $74 million, exceeding its 31 May target by $43 million.

But Fonterra reported a $50 million loss in the year to May 31, apparently because it persisted in paying farmers the $5.30/kg milksolids which its chairman publicised before an official announcement at which it could have lowered the per-kg figure to accommodate its reduced earnings.

The company said today highlights of the past year had included a busy programme to extend the international reach of the company, including a joint venture with Nestle in the Americas, which was expected to contribute to the company's results from the 2004 financial year.

There had also been a restructuring of operations in Australia and New Zealand to form Australasian Food Holdings (Australia), a $2.3 billion trans-Tasman consumer dairy business, extension of the joint venture with Dairy Farmers of America to cover milk protein concentrates, and establishment of Fonterra as the largest exporter of skim milk powder from the United States through an agreement with Dairy America.

The company's new joint venture with Arla Foods would lift its position in the yellow fats market in the United Kingdom and Europe, and purchase of La Mesa and Eugenia businesses had made Fonterra a market leader in Mexico's cheese sector, and number three in spreads in that country.

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