The move last month to maintain milk price at $8.30/kg MS but slash the dividend to 10c dropped the co-operative’s full payout forecast 22c to $8.40/kg MS.
It created consternation among some farmers and analysts who said that by not lifting the forecast to the theoretical $9/kg MS set by the milk price panel, Fonterra’s board had effectively kept the cost of goods to the co-op’s value-added businesses artificially low. That in turn would boost earnings, “engineer” a profit and justify the dividend.
Forsyth Barr analyst Andy Bowley said maintaining the $8.30/kg MS milk price amounted to $1.1 billion farmers would not receive.
He said Fonterra had indicated that at a $9/kg MS milk price the co-op would have suffered an earnings before interest and tax loss of $300-$400 million rather than a $500-$600m profit.
Wilson disputes the reasoning that the lower milk price also lowered the cost of goods to Fonterra’s consumer and added-value businesses because they pay the prevailing market price for the specific commodity inputs their businesses use, not the milk price.
But NZX Agrifax analyst Susan Kilsby said while that’s true for the consumer businesses, Fonterra’s New Zealand Milk Products business will benefit because the milk price is that businesses’ main cost.
Fonterra chief financial officer Lukas Paravicini said the December announcement was based on the extraordinary divergence between stream returns from the predominately powder products which inform the milk price and those from products such as casein and cheese.
Continuing strong demand from China as well as South East Asia and the Middle East is holding powder prices at near record levels, creating an $800m gap in stream returns.
Fonterra’s legacy assets and a super flush of milk from New Zealand farms meant the co-op had no option but to process a portion of milk into lower-earning products. It also couldn’t achieve the mix produced by the hypothetical efficient processor used in the milk price manual calculation.
Wilson said the processing split between milk price input products and the others was about 70:30 when averaged across the whole season.
Instead of borrowing to pay a milk price to farmers that the co-op couldn’t achieve in reality, the board had elected to sit on the current forecast. But farmers and analysts alike have little insight into how close that is to Fonterra’s actual returns for its commodities.
The much acclaimed transparency promoted as part of Trading among Farmers (TAF) has gone blurry.
Wilson accepted that was the case in the short term and said Fonterra, quite rightly, was expected to explain clearly why it had acted as it had.
But it wouldn’t be until the interim accounts that more definitive figures would be available.
“The question we are asking ourselves is, is this going to be a one-off or is this likely to be repeated?” Wilson said.
“As you can tell from our announcements over the past few months our expectation was those stream returns would converge and come together because that’s always what’s happened. But in fact they’ve actually increased and stayed out there for a longer period of time. But do we think the milk price system is fraught? No.”
Bowley said that given Chinese demand for imported powder was continuing to grow at a faster rate in absolute terms relative to cheese and casein he suspected stream headwinds would remain an issue for Fonterra over the medium term under the current milk price methodology.
If the shift was structural Fonterra would either have to continue to “engineer” its annual profit outcome on an arbitrary basis or change the methodology in the milk price manual. Either approach would be unpalatable to key stakeholders.
Fonterra’s actions are clearly heightening the perception of risk around the units with Bowley going as far as saying “the very existence of TAF may be threatened” if either approach is taken over any extended term.
The share and unit value fell to below $5.50 on the day of the forecast announcement in December but recovered a little to sit close to $5.60 later that week.
Analysts have revised their unit values down to $5.50.
