Dairy farmers brace for tougher times while Fonterra ducks for cover
As Fonterra faces up to its involvement in China’s milk contamination disaster, the co-operative’s farmer shareholders are still creaming it, but that could change quickly.
The company’s results announced yesterday were well and truly overshadowed by the melamine poisoning that has killed at least four children and sickened 53,000 in China.
The tragedy sees Fonterra write-down the value of its San Lu investment by $139 million as the fallout from the Chinese killer milk tragedy continues to worsen.
This comes as Chinese reports say Fonterra's 43 per cent owned San Lu had misled government officials for eight months.
The $139 million impairment charge over San Lu reflects the cost of the product recall and Fonterra’s anticipated loss of San Lu brand value.
Fonterra’s estimate of the current book value of its investment in San Lu, after the impairment charge, is approximately $62 million.
“We are focusing all our efforts on what Fonterra can best do to work with the Chinese authorities and help get safe dairy products to Chinese consumers,” Fonterra chairman Henry van der Heyden says.
“The latest revelations that an official Chinese Government investigation has revealed San Lu management was investigating complaints of sick infants as early as eight months before the San Lu Board and Fonterra were first informed on August 2 is deeply concerning. That Fonterra was not informed earlier is frankly appalling,” Mr van der Heyden added.
For New Zealand dairy farmers the incident is an issue as far as their company’s reputation is concerned.
But their immediate attention will still have been on the final payout for last season and this season’s forecast.
Fonterra issued a final payout of $7.90 per kg of milksolids, of which farmers will receive $7.66.
The remaining 24c will be retained to strengthen Fonterra’s balance sheet in the light of instability in financial markets, the board said.
In total Fonterra will distribute $9.1 billion this season from the amount available for payout of $9.3 billion. This is a 65 per cent lift on the prior season’s distribution of $5.5 billion and should hearten economists.
However, that’s where the good news ends.
The 2008/09 forecast payout has dropped from the earlier prediction of $7.00 per kg of milk solids, to $6.60.
The $6.60 forecast includes a milk price of $6.25 and a value return component of 35 cents.
The value component is just marginally ahead of last year and must be of a concern for the company as commodity prices drop.
“Since [May] we have seen prices fall away from last year’s record highs. High prices have dampened global consumer demand and, at the same time, have encouraged production increases in exporting regions around the world. With buyers playing a waiting game, there is the possibility of further softening of prices before supply and demand come back into balance,” Mr van der Heyden says.
“Although the New Zealand dollar has been moving in our favour this season, we can’t be confident that a lower currency will fully offset price movements – indeed, there’s still a chance of currency upside or downside.”
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Comments and questions6
Interesting that the farmers payout is forecast to reduce 5.7%. Yet the price of dairy commodities in New Zealand have risen by over 75% in the last year. The impact on the consumer has been greater than the possible impact of the price reduction will be on the dairy farmer.
As a former member of the Governments Food & Beverage Task Force some 4 or so years ago, I spoke my thoughts about the unwise decision by Fonterra to withdraw from the Russian market, to focus on China.
My view was, and still is, that Russia presents a massively greater opportunity than China. That country is oil rich, happy to import a large part of their food needs. China is committed to boost production of all sorts of outputs including foods. Has been buying up to 50,000 heifers a year from NZ and Australia for some years. Planted 100, 000 Ha of grapes for wine production.
I saw a Press Release some months back from China, on their FTA with Chile, Peru etc. It specifically said how delighted they were that it included Dairy Products. Their aim is to become a nett exporter of dairy products and compete with Fonterra in their international markets.
Our FTA with China has Chinese Duty on Dairy reducing by tiny amounts for some years, by which time they will not be importing any real volumes anyway.
So why Fonterra considered this a good market to invest both large amounts of money and time into, is hard to understand.
Conversely, in Russia, they handed over control of that market to a Distributor who reputedly used leather coated hoods to extract premium prices from their buyers. The nett effect over those 4 or 5 years, is that Anchor Brand products, which were once as well known there as Coke, have totally vanished off the supermarket shelves. Buyers tned to resist being exploited and often find ways arouns such pressures. But will not easily forget of forgive!
I am amused at fonterra saying its strategy in China is still fundamentally right and trying to brush of San Lu as a one time bad luck story. As an importer from China for a number of years I well know that China is a very difficult place to do business.If you want to import from China it is a very difficult thing to do correctly unless you understand the Chinese expectations and intentions, just imagine how difficult then will it be to actually do business in China itselt. If you want to do business in mainland China then you have to think and act like them and follow thier thinking, if you believe you can change them then you are in for a big shock.If you want to swim with the sharks then you either eat them on let them it you, either way it is a dangerous situations.
Maybe something is lost in translating New Zealand speak into English. The final payout is $7.66 per kg of milk solids? That's about $3.59 per lb, which makes it about $43.00 per cwt in NZ dollars. Converting that to U.S. dollars produces a price of about $33.00 per cwt. Am I missing something, or is this simply more bullshit from Fonterra?
The payout drop will be 14.9%, not 5.7%. Combined with the huge increases in on-farm costs, especially fertiliser, the drop in next years net profit will be very significant. As for the constant whinging about dairy prices, milk is still cheaper than a lot of brands of water in the supermarket. As far as value for nutrition goes it is probably the cheapest source of calcium and protein available.
Following the release of an official notification from Fonterra's board to contract milkers, it may look to many as though Fonterra is facing more immediate liquidity problems than at first thought. All contract milkers supplying milk to Fonterra will be required to purchase their full value is shares over the next 3 seasons, or milk will no longer be picked up. This will result in many millions of dollars of new debt to contract suppliers, many of whom will be unable to meet this new demand. End result, bank foreclosures, farm walk off, and who knows what other consequences. Read on!
CONTRACT SUPPLY – 2009/10 SEASON
OCTOBER 2008
KEY CHANGES
• For the 2009/10 season contract supply will only be available to growth milk and all of this milk will be required to be share-backed within three seasons.
• This will apply to any production above your current shareholding and new milk from conversions. All growth milk will need to be at least one-third share-backed in the first season, two-thirds share-backed the following season, and fully shared-up thereafter.
• Unshared supply will not be available for the current 2008/09 season.
• As currently provided for, contract suppliers can choose to terminate or reduce their contract to share-up by notification within the application period.
• All current contracts, including tactical pricing contracts, will be honoured for their full term.
• Although tactical pricing has been effective as a means of securing valuable milk, and had a net positive impact for all shareholders, no new tactical pricing contracts will be offered for 2009/10.
• To reflect the increased cost of capital and the value of share capital to the Co-operative, the price for contract milk will be set at 10 cents below the Milk Price for the 2009/10 season. This compares with the contract price for the current season which is 2 cents below the Milk Price.
WHY HAVE THESE CHANGES BEEN MADE?
• In a tightening credit market, one of the risks to our shareholders is a significant expansion of contract supply and the resulting redemption of shares. Currently about 4% of our milk is supplied on contract.
• Following last month’s announcement of retentions from the 2007/08 payout, the Board has been reviewing further options to ensure that Fonterra’s balance sheet remains strong during this period of instability in financial markets.
• While we need to encourage new milk into the Co-operative and growth from our existing farmers, in the current environment too much milk not backed by share capital will, over time, weaken our balance sheet and place an unnecessary financial burden on Fonterra’s capital structure.
• These contract terms will have an impact on many of our suppliers, and particularly new entrants. But they are both necessary and recognise the absolute priority your Board places on protecting the interests of our farmer-shareholders.
WHERE DO I GET MORE INFORMATION?
• Contract holders will receive a letter giving detail about how these terms will apply.
• If you have any questions in this regard, please talk to your Area Manager, our Services Team or your advisors.
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