24 Sep 2015

Brightness amid gloom from Fonterra

7:08 pm on 24 September 2015

ANALYSIS: Six weeks ago the sky looked to have fallen in on the New Zealand dairy sector when Fonterra, the world's biggest dairy exporter, slashed its forecast payout to farmers by 27 percent and said it would make interest free loans to prop up cash-strapped suppliers.

Dairy cow north of Matamata.

Dairy cow north of Matamata. Photo: RNZ / Alexander Robertson

The background of prices in free-fall, an oversupply on world markets and a pull back in demand from the key Chinese market offered little comfort to the co-operative's 10,500 supplier-shareholders.

"This year's market is one of the most difficult I've known," Fonterra chief executive Theo Spierings said at the time.

But today the company announced a bumper $506 million annual profit and an increase in its forecast payout to $4.60 a kilo of milk solids, and an added dividend of 40 to 50 cents, brightening what looked to be an otherwise-grim outlook.

Key to the turn around in Fonterra's fortunes has been its increase in processing capacity which has allowed it to move away from making bulk milk powder to high-margin, value-added products.

"In the second half we made the most of this flexibility, favouring production of products where we could secure higher prices and changing production from powders to cheese and casein to capture shifts in customer demand," Fonterra said in its results statement.

The diversification of the product mix has also helped to broaden its market base and lessen its reliance on China, with double digit earnings growth in the rest of Asia, and Latin America.

The increased payout forecast will also lift farmer incomes and rural businesses, as well as reduce the $7 billion hit to the economy from the slide in prices.

"Today's announcement overall and the milk price has been set at a level that will be encouraging compared to where it was," ASB Bank chief economist Nick Tuffley said, adding farmers may be slightly less reliant on their banks and seasonal debt facilities than they might otherwise have been.

But the challenges remain for Fonterra and the dairy sector.

The supply and demand imbalance which has ravaged prices since the start of last year is far from resolved and auction prices are still down 25 percent from the high point in February.

Milk production is expected to fall 5 percent, which will be a further weight on earnings, although a weak New Zealand dollar will go some way to offset that.

Fonterra has a hefty debt burden from building new factories, investing in Chinese infant formula maker Beingmate and supporting farmer incomes, which is a threat to its credit rating.

The gloom may have lightened for the country's biggest export earner but it looks set to be a long haul back to the heady days of just two years ago.

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