Fonterra's 60c drop in farmgate milk price payout in line with weak expectations

Wednesday 10th December 2014

Fonterra Cooperative Group has slashed its forecast farmgate milk price for the 2014/2015 season by 60 cents per kilogram of milk solids to $4.70/kgMS, but has left the dividend range unchanged at 25-35 cents per share.

The lower payout would translate to a $1.1 billion revenue drop for the dairy industry and $6.6 billion less than last season, according to Bank of New Zealand senior economist Doug Steel, while Westpac Banking Corp estimates the drop from $8.40 last season to $4.70/kgMS forecast would result in a $6.1 billion reduction in income for the industry, or 2.7 percent of gross domestic product.

The reduced forecast is line with expectations that Fonterra's board, which met yesterday, would be forced to downgrade its $5.30/kgMS forecast to below $5 due to weak global dairy prices. Chairman John Wilson said that although farmers were expecting this lower forecast, the revision will put pressure on their farming business budgets.

“There is still considerable volatility in global dairy markets,” Wilson said. “Right now we are seeing a number of factors that are delaying a sustained return to higher global prices.”

The global milk supply remains greater than demand, which has resulted in GlobalDairyTrade prices for whole milk powder falling 16.9 per cent since late September, while skim milk powder prices have fallen 7.7 per cent. Whole milk powder sold at US$2,229 a tonne in last week’s GlobalDairyTrade auction.

“Falling oil prices, geopolitical uncertainty in Russia and Ukraine, and subdued demand from China as it continues to work through inventory are all contributing to ongoing volatility and weak demand,” Wilson said.

“Today’s revised forecast reflects the board and management’s best estimates at this time. Given the uncertainty we are advising farmers to continue to be cautious with budgeting and we will update them as the season progresses,” he said.

Westpac chief economist Dominick Stephens said the new forecast was at the lower end of its expectations of a $4.80/kgMS result.

“To date, rural confidence has remained surprisingly robust in the face of falling payout forecasts. The general sentiment has been that farmers can weather one low payout. We suspect that the reality of a payout as low as $4.70 is going to dent that confidence," Stephens said. "What is more, we are now forecasting a fairly low farmgate milk price of just $6.20 for the 2015/2016 season, and that is assuming that global milk prices rise rapidly over 2015.”

ASB Bank has also shaved back its 2015/2016 milk price forecast to $6.00 kg/MS although its long term view for diary prices still holds. It expects global dairy production growth to moderate and Chinese demand to rebound heading into 2015. A lower NZ dollar over 2015 and 2016 should also be supportive of the milk price.

ANZ Bank New Zealand economist Con Williams said the main impact of the latest drop would be felt on farmers’ cash flow in the 2015/2016 season when deferred payments will be a lot less than this season’s.

“Probably one year of sub $5/kgMS or mid $4.00/kgMS is manageable for the dairy sector but if there is continued softness in dairy prices in the 2015/2016 season there will need to be more dramatic changes in their cost structures and trimming of capital and operating expenses,” he said.

BNZ's Steel was surprised the board had left the estimated dividend unchanged because normally dividends go the opposite way of the farmgate milk price, though the board has said it will review the dividend at the time of its interim result in April next year. He said Fonterra may make better margins with a reduced milk price which should see the dividend rise but that “may come when the season is done as it's extremely volatile out there yet.”

Fonterra Shareholders’ Council chairman Ian Brown said farmers would be expecting a tangible return on their investment in the cooperative once the board revises the dividend.

“Fonterra has had a significant focus on implementing the strategy over the past couple of years and it is important, especially in a season where the milk price is down, that farmers receive the full benefit for their investment in the integrated supply chain that their co-op provides,” Brown said.

The New Zealand dollar fell to 76.70 US cents from 77.10 cents immediately before the 8:32am announcement.

BusinessDesk.co.nz

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