Farmers likely to be wary with cash

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The economy is in for a $2 billion transfusion from Fonterra's forecast of a potential record 2010-11 season payout of "well over $8" – but the patient is being warned not to party up large again.

Yesterday Fonterra startled the industry and financial circles by following up a respectable opening forecast payout of $6.90-$7.10/kg milksolids for the season, which begins next week, with a longer range forecast of a possible $8-plus final season payout – if international dairy prices and foreign exchange rates hold at current levels.

The opening forecast, which combines a milk price of $6.60 and a forecast distributable profit of 30-50c/kg, means around $650m more for the economy in the 2010-2011 year – but an $8-plus payout would mean a $2b economic bonanza, says Bank of New Zealand head of research Stephen Toplis.

The $8 payout would mean a close to $1m income for a farmer producing the industry average of 120,000kg in the season. Out of this has to come the farm's running costs, tax, labour, family costs and new Emissions Trading Scheme taxes.

Fonterra heavily stamped its new season forecasts announcement with cautions about market volatility, big swings in foreign currencies and economic turmoil overseas.

The expectation in the industry is that farmers will keep their wallets firmly shut while they repair balance sheets battered by the global economic crisis and recent drought in some regions. They would reduce debt run up before the payout dropped like a stone overnight last year on the back of plummeting international market prices.

Fonterra chairman Sir Henry van der Heyden said many farmers had suffered financial hardship and would use the higher payout to get their books in order. Mr Toplis said New Zealand farmers would be "wealthier" as a result of the payout hike, but it gave them a choice whether to invest more, save more or spend.

"In the current environment one would assume they would probably save more than in past cycles.

"There is a golden opportunity now to get the dairy sector back on its feet, not just on its feet, but sustainably. The choice is in farmers' hands now. Twelve months ago it was not in their hands because they were in dire straits."

Farmers would want to avoid a repeat of 2008-09 when the payout forecast went to a record $7.90, sparking speculation that it would end the season at $8.50 or $9 and prompting farmers to borrow accordingly, Mr Toplis said.

The payout turned out to be $5.20, which was historically quite a high distribution.

Federated Farmers also warned that while welcome, the opening $6.60 forecast would "not be 2007 revisited". In 2007 dairy prices were booming and many farmers borrowed heavily for expansion and land conversion.

The federation's dairy chairman Lachlan McKenzie reminded farmers that this time last year the opening forecast was only $4.55.

"I should add that current Ministry of Agriculture modelling shows that it costs a staggering $4.88 to produce one kilogram of milksolids ..."

Mr Toplis said the $8-plus projection was a surprise.

But Sir Henry said the number people should concentrate on was the opening forecast of $6.90-$7.10.

The company had put $8 into the announcement because: "People are doing the modelling [on prices and forex] and would have asked, so we might as well tell them now."

The forecast had been set at the lower amount, reflecting a more cautious outlook given the high degree of volatility in the market. Fonterra said it intended to retain 25 per cent to 35 per cent of the forecast 30c to 50c distributable profit.

Chief executive Andrew Ferrier said the forecast distributable profit was an early signal that Fonterra believed there would be a rebound in operating profits in its trade and operations and ingredients businesses.

The board of directors yesterday set Fonterra's fair value share price for 2010-2011 at $4.52 a share.

- © Fairfax NZ News