Fonterra's biggest Australian unitholder, Perpetual, has backed the New Zealand dairy giant's decision to protect its balance sheet and slash its dividend payment in the face of extreme market conditions.
The world's biggest dairy exporter cut its 2014 dividend forecast to $0.10 from $0.32 in the face of "abnormal circumstances", as surging milk powder prices broaden the price gap between milk powders and cheese and casein to record levels.
Chinese demand causes dip Surprisingly, Fonterra has been hurt by skyrocketing Chinese demand for milk powders because the milk price it pays dairy farmers is based on powder prices.
About 70 per cent of Fonterra's production is milk powders but the remaining 30 per cent of its product mix - which is not seeing prices surge - is struggling with an inflated cost of milk that cannot be passed on to customers.
Fonterra, which accounts for 20 per cent of total global dairy trade and is the second-largest milk processor in Australia, estimates the price gap between powders and other products has had a negative $800 million impact.
The dairy farmer co-operative said it expects earnings before interest and tax of $500 million to $600 million for the year ending July 31. The forecast EBIT is a huge drop on the previous year's EBIT (Earnings before interest and taxes) figure of $1 billion.
Units in the Fonterra Shareholders' Fund, which is listed in Australia and New Zealand, plunged 7.3 per cent on the Australian ASX to close at a record low of A$5.19 ($5.73) on Wednesday.
Perpetual portfolio manager Nathan Parkin said Fonterra had been hit by a perfect storm.
"Everything that's gone against them has," Parkin said.
"If you look at the big sensitivities in the IPO [initial public offering] documents, the big ones have all gone against them and clearly that's negative for earnings.
"We were aware going in that it's a commodity price driven business and whilst we are not happy that things have gone against them in the shorter term it doesn't dissuade us from the investment."
The farmer co-operative said it would maintain its record 2013-14 farmgate milk price of NZ$8.30 a kilogram of milk solids but decided not to meet the theoretical farmgate milk price of $9 calculated in accordance with the Milk Price Manual.
Regulation requires Fonterra to consider its farmgate milk price every quarter based on powder prices.The forecast price is based on processing and manufacturing milk powders. The soaring cost of powders means margins on other dairy products - like cheese and casein - are being squeezed by the high cost of milk.
''They are protecting the balance sheet''
"In such abnormal circumstances, the board has the discretion to pay a lower farmgate milk price than that specified under the manual if it is in the best interests of the co-operative," chairman John Wilson said.
Fonterra also appeared to leave the door open to crimp milk payments to its farmer shareholders.
"Today's is our best estimate but given the current volatility, it may change over the course of the season," Wilson said.
Chief executive Theo Spierings said the dairy giant would maintain financial discipline and "not pay the milk price out of borrowings".
Parkin said he was pleased the company had moved to protect its balance sheet.
"By limiting the milk payout and cutting the dividend, they are protecting the balance sheet which is a key metric for us. We are happy to see the board taking this stand."
The dairy giant said it has devoted the maximum possible volume of its 22 billion litres of milk to production of milk powders to capitalise on the stronger prices but has been unable to shift more than 70 per cent of production to powders because of the nature of its existing infrastructure.