Friday, March 29, 2024

Beating the bulge

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Fonterra is fast-tracking new investments and changes to its processing plants to help limit the impact that gaps in stream returns have on milk price.
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Fonterra chief executive Theo Spierings said the co-operative would be spending $400-$500 million on assets over the next three to four years that aimed to give it about 10% flexibility in product mix processing capacity over the peak. This year’s “super flush” meant the co-op had to process about 25% of the milk received over that period into products that don’t inform the milk price despite milk price input products having the highest return.

Spierings said Fonterra needed to have choices at peak and would look at options to scale down or even stop processing through some of its legacy assets.

Chief financial officer Lukas Paravicini said funding for the extra capital expenditure, which is to be done in addition to the business as usual expansions required to cope with 2-3% annual supply growth, would not create any significant hurdles.

And chairman John Wilson said Fonterra would be aggressively “de-bottlenecking” its plants in time for next season’s peak as new capacity, the first of which will be the new dryer at Pahiatua, won’t be on stream by then.

De-bottlenecking, is done every year but this year could include additional actions such as installing more evaporators at existing sites, building more reverse osmosis plants to take water out of milk for transport, new pipework, and new sensing and pumping technologies.

Wilson said the peak had grown higher and wider, moving from a 14-day peak just a few years ago to 50 days because of improved farm management and additional supplementary feeding.

That challenged normal plant activities which have to be done regularly as they now had to be done during peak production, not on either side of it.

Ongoing investments in food service and consumer products would continue but the extra $400-$500m expansion is likely to be in efficient milk powder dryers.

The added capacity aims to reduce the impact of commodity price volatility on earnings. Paravicini said the difference in stream returns would have had a $560m impact on earnings before interest and tax (EBIT) if a milk price generated by the milk price manual calculation was used.

Without the $519m counter-balancing adjustment to milk Fonterra’s board made at the end of last year, the co-op would have had to dip into its balance sheet or increase borrowings.

Fonterra Shareholders’ Council chairman Ian Brown said farmers understood the co-op couldn’t pay out the additional 70c/kg milksolids (MS) because it hadn’t earned it but there had been concern over an artificially positive impact the move could have had on Fonterra’s NZ Milk Products (NZMP) earnings.

Paravicini said NZMP’s half year earnings had fallen from $412m last year to $236m this year, largely because of the difference in stream returns and peak production costs.

The gap between theoretical and actual milk price had cut $41m from NZMP’s earnings while the disparity between the theoretical price returns for milk sales within the co-op and to other processors through the Dairy Industry Restructuring Act requirement slashed another $75m from EBIT.

Processing the higher, longer peak, the extra costs of transporting milk to the South Island and disposing of dumped product cut another $76m from NZMP earnings. Paravicini said it was important that NZMP makes a profit because it has to be able to cover the cost of capital and depreciation.

Fonterra has about $7-$8 billion of assets in its NZMP business with the expectation it should achieve a return on that capital of close to 7% in the full year. If the milk price adjustment hadn’t been made NZMP would have operated at a loss.

Despite this season’s problems created by the product price gaps Fonterra’s management and board had full confidence in the ongoing robustness of the calculation. Even with the adjustment the forecast is for a record total cash payout of $8.75/kg MS with 10c/share coming from earnings, 5c/share of which will be paid out on April 17.

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