While farmers are clearly thrilled at the prospect of a record-breaking milk price, investment analysts were almost wringing their hands at what they’ve essentially come to see as a profit warning.
Their predictions for earnings out of Fonterra’s dividend-returning businesses vary wildly, showing there’s still some way to go before the co-op is fully understood and information streams clear enough for accurate forecasting. Fonterra’s $8.30/kg milksolids (MS) forecast milk price coupled with what’s so far been a boomer season for most, could yet make 2013-14 a season of superlatives. It could also be one to break all records for farmers in terms of both income and volume of milk produced. Demand for whole milk powder (WMP), particularly from China, is largely behind its stubbornly high price.
High differential
Fonterra’s chief executive Theo Spierings is warning that at such prices dairy ingredients buyers will be looking at other, cheaper ways to reconstitute WMP from skim milk powder and anhydrous milk fat.
He said he’d never seen such a differential between the commodity product prices and it was only a matter of time before these stream return differences began to come back together.
In a report prepared by Forsyth Barr head of research Andy Bowley and analyst James Bascand, Fonterra’s high milk price, or cost of goods sold, is said to be the major reason behind the report’s predictions of a cut in group earnings of 24% for the 2013-14 year.
The higher cost of goods is likely to create significant pressure in the Asia, Africa, Middle East (Asia/AME) business too where earnings before interest and tax (EBIT) are predicted to plummet 56%, the report said. The market is materially underestimating the hit to Fonterra in light of the higher cost of goods sold, it said.
However, Craigs Investment Partners analyst Arie Dekker is less pessimistic about any earnings hit the Asia/AME business might take, instead predicting 14% growth in EBIT, reflecting an increasing contribution from the China farms in the mix.
He does note that greater investment in sales and marketing could neutralise short-term growth and acknowledges that a lack of visibility on both that and China farms makes the forecasting difficult. He’s also predicting a group EBIT growth of 11%.
Dekker said while there’s allowance made for the more difficult first half of the financial year due to high commodity prices the expectation is for prices to correct into the second half and this should allow for a neutralising of stream returns in then.
So the improved EBIT is driven by Fonterra’s focus on taking cost out of the business across overheads and supply chain as well as driving greater value performance through a focus on increasing food service, advanced nutrition and everyday nutrition in emerging markets.
Looking back, last season was one of two halves. Spierings said the autumn drought hit both volume and value, two of the three prongs in the co-operative’s Three V strategy – the third being velocity.
Production in the second half of the season was down 9% but it had been buffered by an excellent first half so that by season end it was down 2%. The net impact was sales totalling 4m tonnes of product, down from the 4.4m t it would have sold without the drought.
NZMP performed well in the first half of the season earning $422m but in the second half the higher milk price and stream returns that worked against profit caused a collapse in earnings to $72m so that overall it improved by just 1% on the previous year’s EBIT. Spierings said Asia/AME had shown pleasing sales growth jumping to 11% last season. That was in line with or above market growth so the co-op had grown market share in many instances.
Across Asia/AME the co-op achieved 21% normalised EBIT growth in everyday nutrition, 6% growth in advanced nutrition and 45% growth in foodservice.
The Latin American business (Latam) had also shown solid results with the Chilean business Soprole again shining with a normalised EBIT up 31% on the previous year and sales volumes up 4%. That business uses Chilean-sourced milk supply and so is less impacted by the high NZ co-op based milk prices.
Fonterra’s Dairy Partners America business counteracted Soprole’s performance in the Latam segment with its normalised EBIT down 54% and sales volumes up 2%. Australia also dragged down improved performances by NZ in the Australia/NZ segment.
NZ earnings were up slightly but overall the segment earnings fell by 37% and sales volumes dropped by 2%. Spierings said the co-op was reshaping its business in Australia cutting the number of brands to just four; Mainland, Bega, Western Star and Perfect Italiano.
Last year it had taken $49m worth of costs out of the business and work was continuing there.
