Chairman John Wilson, while defending his board’s decision this season not to pay out to farmer-shareholders $1 billion Fonterra’s milk price manual formula says they should be getting, said if the market situation continued the model would be revisited.
“In two years, or three or four years time, if we find ourselves still in this position and it is not an extraordinary, one-off position then we will have another look,” he said.
But Wilson, involved heavily in devising the pricing manual, which was controversial when it was introduced five years ago, said the board had confidence in the milk price setting mechanism and did not envisage a repeat of this year’s situation.
Critics in 2009 said the manual would distort the milk market, which would affect competitors negatively, and was open to manipulation by Fonterra’s board. Fonterra controls most of the country’s raw milk market.
Their predictions were recalled when, in December, Fonterra announced it would not be paying farmers $9 a kilogram of milksolids as prescribed by the manual, but would hold payout at $8.30 despite soaring demand. The 2013-2014 season milk price forecast has risen since to a record $8.65.
The farmer-owned co-operative also announced a big drop in its 2014 dividend forecast, from 32c a share to 10c.
For financial investors in Fonterra’s NZX-listed Shareholders Fund, launched after the manual, the announcements were further unpleasant reminders Fonterra does not behave like other companies.
Fonterra said the reason for the measures was that milk powder was fetching high prices in a year of strong global demand, but 30% of milk production was used to make cheese and casein products, which are wanted less.
Analysts said the intervention in the milk pricing formula to withhold 70c/kg would prevent a potential loss of up to $400 million, allowing Fonterra to report a profit.
The board confirmed and expanded on the measures in Fonterra’s recent half-year financial results.
Before the milk price manual, Fonterra employed consultants to calculate a milk price range.
Critics have said intervention in the pricing formula showed Fonterra’s operating system was under stress.
Wilson said if the board stuck to the milk price manual this year the company would have to borrow to pay the prescribed $9.35/kg milksolids, which didn’t make sense.
The board’s decision in a unique situation was the reality of Fonterra inheriting from its legacy companies stainless steel assets of varying ages and efficiency, he said.
“These are not milk-price assets.”
“This is not 70c we withheld, it is 70c we weren’t able to generate.”
The high global prices are being earned by milk powder, but Fonterra does not have enough milk powder making capability at spring peak production time, so has had to make a lot of this season’s milk into cheese and casein.
However, the manual assumes all Fonterra’s milk is used to make milk powder.
The reason for the pretence is that new investment in factories is almost always to make milk powder, so the manual’s architects regarded the powder price as representing the market best.
After assuming all Fonterra milk is used to make milk powder products priced and sold through the GlobalDairyTrade auction, the manual formula deducts production and capital costs and what is left is the milk price.
Wilson said while global demand for milk powder had been growing, Fonterra’s peak milk collection in the past three years had ballooned by six million litres to 87.3m litres this season.
The peak production period had also stretched from 14 days to 50 days in that time, he said.
Since 2004 nearly all Fonterra’s investment had been in lifting whole milk powder capacity, from 600,000 tonnes to 1.2 million tonnes.
Wilson rejected the suggestion its operating system was in trouble because the manual made a false assumption.
“It’s quite the opposite,” he said. “What you have is a manual which is totally transparent. Anyone can see how we generate the milk price.
“There is a degree of transparency you have never had in the New Zealand dairy industry and that is fantastic, because it means everyone knows every morning what they have to beat as far as the milk price goes.
“But the reality is we have still got a historical asset base, so we have to carve that out for now.”
The board was not under pressure from stakeholders to review the manual, he said.
Its confidence that the departure from the manual would be a one-off event was based on the past five years of market history.
Meanwhile, planning was under way to accelerate the roll-out of Fonterra’s 10-15-year new-capacity programme, he said.
A decision on the first new construction in the $400m project could be expected soon after the new Pahiatua plant was completed.
