23 Mar 2016

Beware of promises of higher milk prices

8:29 pm on 23 March 2016

ANALYSIS: Fonterra's financial performance may be important to New Zealand, but the message from its chair, John Wilson, during today's half-year result was clearly aimed at its owners.

"Our management is aware of the need for strong performance to ensure that we get every possible cent back into farmers' hands during a very tough year."

Fonterra duly delivered, doubling its half-year profit to $409 million, while earnings before interest and tax (EBIT) rose by three quarters to $665m.

Lincoln University honorary professor of agri-food systems Keith Woodford said these figures were very much in line with expectations.

"The reason for this is that when milk prices to farmers are low, then Fonterra has low input costs. Accordingly, there is more scope for corporate profit."

The growth from its consumer and food services operations, which includes higher margin, higher value products like UHT and mozzarella, outpaced those from its ingredients, or commodity products, arm.

While farmers rely mainly on the milk price payout, heftier profits from Fonterra's consumer products also benefit them too.

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And Mr Wilson ensured the 40 cent a share dividend payment would flow through when needed, by promising to fast-track the instalments and "support farmers at a time when cash flows are extremely tight".

Certainly, non-farming investors are unlikely to complain about getting paid earlier.

Coupled with expected reductions in interest costs due to the Reserve Bank cutting rates earlier this month, farmers should get a bit more breathing space in dealing with their banks.

Nevertheless, Federated Farmers national dairy chairperson Andrew Hoggard pointed out most farmers wanted to see a lift in global dairy prices.

"We still need a better milk price. And that is largely out of Fonterra's hands. It is largely a global problem."

Fonterra could offer little solace in the near term, though it did expect prices to lift later this year.

Given the many false dawns, there is every reason to be cautious about predicting when any upturn may occur.

In the meantime, Mr Wilson could offer its farmer-owners only more of the same.

"The business will continue to work on capturing demand and margins in the second half of the year, just as it did in the first half, by focusing on our consumer and food service volumes and those of speciality ingredients."

ANZ Bank rural economist Con Williams said Fonterra still faced significant challenges.

"The big thing for them is probably getting the product mix right to try and maximise earnings."

That includes shifting away from whole milk powder into relatively higher value products.

Cracking the China market remained the key, including Fonterra developing its relationship with Chinese infant formula maker Beingmate, Mr Williams said.

"So you talk about Beingmate and infant formula into China and trying to do more of that. That's the longer term play."

"If they can frontload that and do that more quickly then that will help balance out the global ingredients market as well, which will improve the stability of the dividend earnings and the milk price outlook."

Professor Woodford also pointed out some parts of the business were still under-performing, with Australia yet to return to profitability, while its China farming operations also continued to lose money.

"The red ink has continued, showing that more work has still to be done."

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