Fonterra’s price cut a blow to farmers
High debt and tight margins have forced Fonterra to pare back its farmgate milk price for the season just ended, and ditch plans for a second-half dividend in a bid to shore up its balance sheet.
In a statement to the NZX yesterday, Fonterra said it would cut its 2017-18 milk price forecast by 5c to $6.70 per kg, and won’t pay farmers and investors a dividend for the second half of that financial year.
A 5c fall in the milk price it pays to farmers represents an $80 million benefit to Fonterra’s earnings for the July 31 year. Fonterra affirmed its guidance for normalised earnings per share at 25-30c, but indicated that they were likely to be at or slightly below that range.
The co-op anticipated no dividends would be paid for the year, beyond the 10c per share interim payment made in April. Farmgate milk prices are dictated by Fonterra’s Milk Price Manual, which was how the original $6.75 forecast was arrived at.
But in just the second time in Fonterra’s nearly two-decade history, the company has crimped the milk price — its biggest input cost — in order to benefit earnings.
ASB senior rural economist Nathan Penny said the moves collectively equated to a $150m-$225m hit to 2017-18 farm incomes.
Fonterra’s chief financial officer, Marc Rivers, said the decision to revise the milk price was made as the company was finalising its accounts for the July 31 year.
“As we were going through it, we realised that we were coming out at the lower end, or even below, the earnings range that we gave,” he said.
Margin pressure was evident across the co-op’s global ingredients business, and its consumer and food service businesses, he said.
He said high milk prices made it difficult for Fonterra to capture attractive margins over the fiscal year.
Rivers said the revisions were aimed at curtailing Fonterra’s high debt levels, relative to the co-op’s earnings.
At the company’s first-half result in May, Fonterra said its year-end gearing ratio was likely to be above the 40-45 per cent target range by the end of the 2017-18 financial year. It said then that the ratio was expected to return to the range over 2018-19.
“Really, it’s about having the right level of earnings to sustain the debt level that we have, and to sustain the investment that we need to continue to grow the business,” Rivers told the Weekend Herald.
Ratings agency S&P Global Ratings said its ratings on Fonterra were not immediately affected by the announcement, but it sounded a warning if Fonterra’s finances did not improve soon.
“We expect Fonterra’s debt to Ebitda will be materially outside our downward threshold of four times for fiscal 2018,” it said. “The rating will come under immediate downward rating pressure unless we believe the group’s credit metrics will rapidly improve over fiscal 2019. A lower dividend and reduced farmgate milk price indicated the group was willing to actively manage its debt levels.”
As well as tight margins, Fonterra’s upcoming result will be hit by the already-announced €105m ($182m) settlement with Danone and a $405m impairment charge on its investment in Chinese company Beingmate.
Harbour Asset Management senior analyst Oyvinn Rimer said Fonterra’s deviation from the Millk Price Manual could have implications for the upcoming review of the legislation governing the co-op.
“You have to wonder as well, whether the comments around balance sheet pressures might trigger a bigger review of the capital structure of the company,” he said.
Fonterra’s new chairman, John Monaghan, said the revisions had been made with a strong balance sheet in mind. “It is important for our cooperative to have a strong balance sheet and, as we indicated in May, the higher milk price, which is good for our farmers, has put pressure on Fonterra’s earnings, and therefore our balance sheet in a year which was already challenging due to the payment to Danone and the impairment of the cooperative’s Beingmate investment,” he said. “You never want to have to reduce the milk price at the season’s end, but it is the right thing to do and $6.70 remains a strong milk price.”
Fonterra’s NZX-listed units, which allow investors outside the co-op access to its dividend flow, weakened immediately after the news and closed yesterday down 13c at $4.98.
ASB’s Penny said it looked like the $7.00 forecast for the current 2018-19 year was also set for a downward revision — perhaps to $6.50.
Anyone thinking new Fonterra chairman John Monaghan has been given a hospital pass should save their sympathy and instead worry about what’s going on at New Zealand’s biggest company.
That was the no-nonsense feedback — from the co-op’s farmer-owners, business leaders, primary industry specialists and former directors — after an 11th-hour decision by Fonterra directors that they couldn’t afford to deliver the milk price or dividend forecast for the 2017-18 year — the dairy season just ended.
The Fonterra board’s announcement yesterday followed the first board meeting chaired by new chairman Monaghan, who took over last month from John Wilson, who retired for health reasons.
The announcement that to protect its balance sheet Fonterra would have to shave 5c/kg off its $6.75/kg forecast milk payment to farmers, and that the full-year dividend would be the 10c already paid in April, was by all accounts an anti-climax compared with the potential horrors conjured up by the trading halt on Fonterra shares.
The milk price cut is not too devastating, given that the value of annual milk production is about $12.5 billion. For the average dairy farmer there will be $20,000 less in the bank than had been relied on, said agriculture consultant Will Wilson.
But coming as it did at the last minute, the reaction was swift and harsh.
Business leaders warned Fonterra that getting the milk price signal wrong rattled the economy. “That milk price is a very important price signal for the New Zealand economy. It drives behaviour. If you get that wrong you scare the entire economy,” said one, who declined to be named.
The conclusion in the dairy industry was that Fonterra had over-promised and underdelivered. “It’s just a continuation of the mess they’ve got us into,” said a major industry participant who declined to be named.
Most disappointing for former Fonterra director Leonie Guiney was that “the governance would wait to be forced there”.
“It was made clear by farmers at the halfyear results that they questioned how an interim 10c dividend could be paid when [Fonterra] had made a loss,” said the Southland dairy farmer, who has taken a defamation case against the Fonterra board.
Former Fonterra deputy chairman Greg Gent said the announcement would be “a bitter pill to swallow but it’s the right thing to do, rather than the expedient thing to do.”
Fonterra’s back-pedalling on the milk price has again put the spotlight on two issues — how it is allowed to set the country’s milk price and how it has become a hybrid company with two lots of shareholders to please: its co-operative farmer-owners and nonfarmer listed unit holders.
The price Fonterra sets each season becomes the price guideline for the dairy industry because of Fonterra’s dominance of the raw milk market. Fonterra says the price it pays for milk is a reflection of world prices.
Fresh debate was triggered yesterday about the regulatory wisdom of allowing Fonterra to set the milk price. Market watchers told the Herald they were hopeful, but not confident, that the current Government review of legislation governing the dairy industry and Fonterra would grapple with the issue.
Agriculture Minister Damien O’Connor, who called for the review, did not respond to a Herald request to discuss the way milk prices are set.
For new chairman Monaghan, there was no sympathy.
Fonterra Shareholders’ Council chairman Duncan Coull, who represents the interests of farmer-owners, was unusually publicly grumpy about Fonterra’s decision.
He said the move was an “absolute disappointment” and the “situation is unacceptable”.
“I totally accept it is the right thing to do from a governance perspective but the reason for having to do that is totally unacceptable. The milk price is sacrosanct to farmers.” Asked if Monaghan had been handed a hospital pass, Coull disagreed, saying the board worked “as a collective”.
Former directors said Monaghan had been a long-serving director before becoming chairman. “He’s been there and part of what has taken us to this point. His accountability is high. He knew what he was getting into,” said one.
Attention now turns to whether Fonterra’s $7/kg forecast for the new season can be trusted. ASB Bank expects Fonterra to lower it closer to $6.50 later this month.
Coull said yesterday’s developments had no bearing on the forecast. “Will the board need to do this again? I hope not. This year we had two big hits with the Danone [damages payment] and Beingmate impairment.”
Former director Gent said, “it’s very hard to forecast this far out and have it accurate. Farmers have just got be conservative and believe the money when it’s in their account.”
The milk price is sacrosanct to farmers. Duncan Coull, Fonterra Shareholders’ Council