Continued problems in Australia dragged down the Oceania results, Venezuelan sales dropped dramatically because of low oil prices and earnings from international farming operations were disappointing in a low milk-price environment.
By contrast, the bright spots were fast-growing consumer and food service sales in China and the continued strong earnings from ingredients when large volumes were diverted from China to Africa, the Middle East, Latin America and north Asia.
“Until we see sustained momentum across Fonterra’s value-add businesses, we remain cautious about its goal of raising earnings by 50% or 100% in three to five years,” Forsyth Barr analyst James Bascand said.
The company’s long-term target was revenue of 1.2 times the volume of milk processed – eg, $30b revenue from 25b litres of milk – but that ratio was only 0.7 in the first half of the 2016 financial year, he said.
Fonterra’s 123% jump in net profit was expected and boosted by the sale of DairiConcepts in the United States but it stopped short of being spectacular.
Earnings per share of 25c only returned the company to its achievement level before Trading Among Farmers.
Analysts said the very low cost of inputs (milk prices) boosted gross margins on value-add products to 28% and on ingredients to 21%.
Despite a 10% volume growth only 20% of total milk went into consumer and food service – 2.5 billion litres versus 12b into ingredients.
However, consumer and food service generated 30% of sales revenue.
Fortunately, the ingredients side of the company delivered a good result, helped by higher sales of non-reference products, no adverse peak costs, improved product optionality and positive stream returns.
“Operating costs were well managed and the business transformation benefits showed up,” First NZ Capital research head Arie Dekker said.
During the first half non-reference products (cheese, casein) sold around an average $5000/tonne compared with reference products (milk powder, butter, anhydrous milk fat) at $3000/tonne.
Only reference products were used to set the farmgate milk price so the improved margins from a much greater volume of non-reference products flowed into earnings, profits and dividends.
The reverse situation applied in Australia where Fonterra paid higher farmgate prices for milk in competition with Murray Goulburn but was unable to maximise processing into cheese and specialty ingredients like infant formula.
That was because fire destroyed the Stanhope cheese plant and Darnum plant lost its number one customer, Danone, after the botulism scare.
Stanhope was now being rebuilt and Chinese infant formula company Beingmate had taken up residence at Darnum along with a couple of other new customers.
A $28m earnings loss from the adverse product mix in Australia dragged down the Oceania divisional profit, where 38% of Fonterra’s total consumer goods and food service sales were made.
International Farming operations in China posted a similar loss ($29m) despite doubling the milk volume from two farming hubs.
Essentially, the China farms were struggling to break even along with dairy farmers elsewhere.
Dekker observed that close to $700m had been invested into Chinese dairy farming and a similar amount on buying into Beingmate, for little direct yield so far.
But he called the Greater China consumer and food service earnings of $68m (compared with $15m in 1H15 and $30m in 2H15) a highlight of the interim results.
Food service sales in more cities, Anchor UHT milk and the widening Anmum reach through Beingmate were all building momentum in that market.
Bascand noted the company’s worries that its food service success could come under strong competition and said the Beingmate Anmum distribution arrangement was performing below expectations.
Analysts seemed satisfied that support to farmers in dire straits was being channelled through early dividend payments rather than more loans.
That would help farm cashflows during winter, bolster milk volumes next spring, help Fonterra stay on strategy and reduce the impact of surplus stainless steel.
They also commented favourably on Fonterra’s free cashflow of plus $346m, compared with negative $1761m in 1H15, the first interim positive cashflow since company formation.
“Cash poured in . . . from numerous working capital changes and divestments,” Bascand said.
The dividend yield for unit investors arising from the forecast annual 40c payment was going to be 6.5%, twice as much as the yields for much higher-priced shares in international competitors like Danone, Dean Foods, Kellogg, General Mills and Nestle.
But not for the Murray Goulburn unit trust, which had a similar yield.
Disclosure: Hugh Stringleman is a Fonterra Shareholders Fund unit investor.
