Over 30 months Fonterra spent $1.4 billion on 10 of its 33 NZ processing sites, most of it borrowed money.
Only the $130 million Stanhope cheese plant rebuild in Australia remained to be completed.
The work was done to boost capacity to receive and process up to 95m litres of milk a day after Fonterra was caught short in 2013 by farmers’ productivity in a bumper spring.
It was forced to dump some products because of lack of storage, compromise environmental standards, make lower-grade products and miss out on market premiums.
Although the 2013-14 season set a payout record of $8.50/kg milksolids, Fonterra admitted the lost opportunity was worth more than $1b or 70c/kg off what could have been an even higher milk price.
Turning away milk in future was not an option for the co-operative, required to be the processor of default by the Dairy Industry Restructuring Act.
Chief executive Theo Spierings proposed and had approved by the board an accelerated capital works programme to enlarge processing capacity by 10%.
It was to cope with peak milk flows, provide a buffer against future milk growth, produce more food service products and give greater optionality – the ability to make the best-priced ingredients on the day.
Good milk prices and dairy farm conversions lifted NZ peak milk production from 81m litres/day to 90m over three seasons between 2012 and 2015.
But as Lichfield’s $350m build came to an end, Fonterra’s peak daily milk collection for spring 2016 was only 81m litres, back where it was five years ago.
As Fonterra boosted capacity by 10%, dairy farmers reduced their output by 10%, minus 3% last season because of financial pressures and a forecast minus 7% this season because of wet weather and gutless grass during the North Island spring.
Chairman John Wilson acknowledged the divergence but refuted any suggestion of “stranded assets”.
The milk tide was flowing against Fonterra as a result of sound financial decisions made by its farmers in difficult conditions.
The Dairy Companies Association said Fonterra’s share of milk collection was 82.5% in October, compared with 84.5% the previous October.
Wilson said Fonterra’s milk market share was not deteriorating, judged by the number of shareholding farms, but competitors did tend to collect from larger farms running more intensive systems.
And the adverse weather effects had been felt most in Waikato, Fonterra’s largest collection area.
“The investment we make in processing plants is very much for the medium term.
“We have every confidence that milk production will come up again because that’s what farmers tell us.
“Now that a payout of $6.40 has been forecast farmers will be cautiously revisiting their cow feeding and farming system decisions.”
He was not prepared to put a timeline on milk production recovery, saying only that price volatility and therefore milk production changes were a fact of life.
Wilson argued a big, modern drier like that at Lichfield was adding value to NZ milk because of its technologies and efficiency.
“The big driers do a wonderful job of converting milk into a powder form that is very suitable for many dairy products around the world and has a long shelf life.”
He explained the concept of “square curving”, where Fonterra could broaden the peak by turning the bulk of daily collection to milk powders while still running specialty ingredient, food service and consumer product plants.
Essentially, that meant Fonterra was able to cope with the most productive period for its farmers, who in turn were among the most efficient in the world at making milk, subject to the pasture curve.
“Our unprecedented investment into more consumer and food service capacity ($400m of the $1.4b) only works if we also have the big driers to buffer fluctuating milk supply.
“Also, at present, whole milk powder is leading the price table and has become our highest-returning product.”
If Fonterra did only high-value products for consumers and the food industry it would require all its farmers to be year-round producers, taking them away from the pasture curve and into feed supplementation.
“That would considerably raise our cost of production.”
For comparison, Australian dairy companies had a peak-to-trough ratio of six or eight to one versus Fonterra NZ’s 87 to one – 87m litres a day at peak in October and only 1m a day sometime in June.
Wilson used Waitoa as an example of square curving.
It ran most of the year producing nutritional powders for infant formula but at the peak, because of milk volume demand, had to switch to skim milk powder.
“That was the right decision for the co-operative’s requirement to process all milk every day but it reduced profitability – having the Lichfield drier nearby changes that.”
Because Waikato was down 14% at peak this year some plants did not run 24/7 but Fonterra was able to optimise premium products and maximise gross margins.
Older, less-efficient plants might be mothballed, as was done in Taranaki recently, but good contingency planning required all assets to be available.
