'Abnormal' situation hits Fonterra forecasts

An "extraordinary situation" in the dairy market has forced Fonterra to hold its milk price forecast at $8.30 a kilogram of milksolids, despite soaring demand.

The giant co-operative also announced a huge drop in its 2014 dividend forecast from 32 cents a share to 10c.

Chairman John Wilson said milk powders were selling at high prices because of strong global demand and limited supply, but "only four months into the season, we are in an extraordinary situation".

While milk powders were fetching high prices, 30 per cent of milk production was used for cheese and casein products, which were in less demand.

"In such abnormal circumstances, the board has the discretion to pay a lower farmgate milk price than that specified under the [milk price] manual if it is in the best interests of the co-operative," Wilson said.

"Today's forecast is our best estimate, but given the current volatility, it may change over the course of the season. As a result of this volatility, the board has also lowered the dividend forecast for the 2014 financial year to 10c per share."

The new forecast payout is well below the $9 a kg that would have been paid if the milk price manual had been strictly followed.

Chief executive Theo Spierings said: "Doing nothing and forecasting a farmgate milk price that is higher than we can afford to pay at this stage in the season is not an option.

"We will maintain our financial discipline and not pay the milk price out of borrowings, particularly in a year when we are forecasting a record payout for our farmers."

Federated Farmers dairy chairperson Willy Leferink believes farmers will have split views today's developments. While they will be pleased with that confirmation they will be less pleased to see the dividend forecast being cut by two-thirds to ten cents per share.

"The dividend is a direct marker to the financial performance of Fonterra as a company," Leferink said.

"Farmers will be happy to see the milk price confirmed but since 85 per cent of the dividend payout goes to farmer-shareholders, they will have mixed feelings since it’s a 22 cents per share haircut.

"But knowing what my farms have produced in the season to date, it's no surprise to find that Fonterra has been pushed to process what our farms have produced.

"We don't wish to see the surge in milk volumes and then milkpowder to mask wider issues in the product portfolio.

"Management needs to note the concerns we shareholders will have on the value-add, which seems to be struggling right now. While key markets continue to struggle for growth that is set against a backdrop of improving economic numbers, so why are we missing out?

"At least milkpowders are doing the business for 'New Zealand Inc' right now. There are billions in direct export income being generated which gets multiplied in the domestic economy many times over.

"The export performance in North Africa, Asia and of course China should put the naysayers on free trade in their rightful place."

Fonterra Shareholders' Council Chairman, Ian Brown said today's announcement was a practical decision given the unusual market conditions.

"I have had discussions with the chairman of the board, John Wilson and it has been made clear that there is a significant gulf between the higher price the market is paying for Whole Milk Powder (WMP) and the price paid for Fonterra's other products such as cheese and casein,'' Brown said.

"While the Milk Price Panel recommended a price of $9 per kg/MS this is not the price Fonterra is being paid for its cumulative product mix."

Brown said that WMP is a lead indicator of the Farmgate Milk Price and comprises around 70 per cent of Fonterra's product mix whereas the other products which make up the remaining 30 per cent have less bearing on the Milk Price.

"This has resulted in strong upward pressure on the Farmgate Milk Price which if Fonterra was to follow would cause an unacceptable increase in debt and gearing," he said.

"While it is unusual for the Board not to follow the Milk Price Panel's recommendations, they are duty bound to act in the best interests of the Co-op and make appropriate decisions with this in mind.

"The forecast Milk Price of $8.30 is still a record and with the 30 cent increase in the December advance rate payout to $5.80 Farmers can continue to feel positive about the outlook for the season.

"Fonterra is working to manage potential risk based on the signals it is receiving, as we do on farm.

"As we know our industry is a volatile one and the dividend announcement, while significant, has come only four months into a season during which the high Milk Price has made it apparent that it will be a tough year in terms of profitability, particularly for the consumer business.

Alongside the payout announcement, Fonterra said it was investing $235 million in a new processing plant at its Pahiatua site in Manawatu.

The new dryer will enable the co-op to process an additional 2.4 million litres each day.

The move follows controversy over excess buttermilk dumped by Fonterra at waste sites in Eltham in Taranaki and Atiamuri near Taupo.

Fonterra director of operations and logistics Robert Spurway has confirmed the company is discharging excess byproduct into the sea off Hawera in Taranaki.

While high milk prices benefit dairy farmers, they lead to lower profits for Fonterra and reduce its headroom to pay dividends.

With investors in the NZX-listed Fonterra Shareholders Fund able to access only the dividend stream, there was concern among some farmers that Fonterra could harm the co-op if it had kept its dividend at 32c in the face of falling profits.

"The dividend should be a true dividend," South Canterbury farmer David Ellis said last month.

"I would think it's quite alarming that they would use our balance sheet to top up the dividend – it's not a true result of the company."

In September, Fonterra forecast a 2014 dividend of 32c a share, matching this year, although profits were likely to be hit by high milk prices.

"Fonterra can draw upon its balance sheet and cashflow performance to support the estimated dividend," it said.

One farmer, who asked not to be named, said Fonterra was right to restrain the milk payout, but he was surprised the dividend was still 10c.

"If 70c is coming off the milk price, the dividend must be slaughtered," he said.

"[Shareholders fund] unit-holders must be distraught."