Dairy debt is a major concern for NZ economy, NZSA conference told
The high level of debt carried by Fonterra and dairy farms is a major concern for the New Zealand economy, said speakers at the annual New Zealand Shareholders Association conference.
Paul Glass, director of Devon Funds Management, told the NZSA conference in Hamilton today that Fonterra, the world's largest dairy exporter, had $7 billion of debt and less than $1 billion of earnings.
"Most banks will only lend three to four times earnings. Fonterra is very heavily indebted," he said.
Farmer debt had also risen significantly in the past 12 years to about $35 billion, with the average dairy farmer holding $19 of debt per kilogram of milk solids, Glass said. Given the farmgate milk price is likely to be, on an optimistic forecast, about $4/kgMS this season, he said that's a really high level of debt versus revenue, let alone earnings.
Economist Shamubeel Eaqub told the conference that Fonterra's forecast farmgate milk price of $3.85/kgMS was the lowest ever in real terms and combined with the downturn in the Chinese economy was a "very big deal for New Zealand."
He questioned why Fonterra management took on so much debt ahead of the massive downturn in commodity prices and why they hadn't seen it coming. He also questioned why it hasn't delivered the value it should have to unitholders in the company. Fonterra has forecast a dividend to shareholders, including unitholders, in the range of 40 cents to 50 cent for this season, reflecting the lower input costs of milk on the value add good it produces.
Eaqub said the low inflation, low interest rate environment investors now face is likely to continue for a long time, due to excessive capacity in the global market and the impact of faster technological change than ever before.
"I'm confident inflation is not the devil to fear, deflation is more of a concern. The growing youth unemployment and hollowing out of the regions - that's the risks and that's public policy and government which investors have to be mindful of."
In a low inflation, low interest world it can be difficult to know what to about investment stock but Glass warned investors shouldn't trust short-term forecasts from anyone.
"No-one knows short-term because it is extremely unpredictable. Not one economist predicted the GFC," he said. "You have to focus on what you do know and over the long-term it has been predictable that you get returns from sticking with good quality businesses," he said.
Devon Funds is forecasting China's GDP growth will slow to 3 to 4 percent this year rather than the 7 percent it has indicated.
The world has gone through an unprecedented period of central bank action, with central banks in the US, UK, Japan and Europe printing money to boost their economies while running zero interest rate policies, he said. "I've been surprised to see many central banks cutting rates again in the last few weeks including our own central bank last week, this is happening around the world as a number of economies are doing it tough," he said.
He said people were over-reacting to the likelihood of the US Federal Reserve hiking interest rates because it will be a good sign that the US economy is doing well, with forecast GDP growth there of 3.7 percent.
Glass said there were three main reasons why inflation was so low. One was growth in global labour pools with the marginal cost of unskilled labour close to zero in some countries and we're now seeing pools of skilled labour developing as well which causes a real issue for youth unemployment in developed countries, he said.
Another factor was the amount of global capital including sovereign wealth funds - some $6 trillion in capital looking to find a home. The third factor, and the one that is going to be the biggest going forward in keeping inflation low, is the disruptive impact of technology, Glass said.
He pointed to companies like Uber which has now become the number one company used by US corporates or Airbnb which will be the number one real estate provider for the Rio Olympic Games.
"You have old school operators who have lots of capital in fixed items and are being disrupted by companies that are being funded by a world awash with capital willing to accept losses in the short term. That's very deflationary," he said.
Banking is one of the sectors most vulnerable to this technological disruption in the future, he said, although banks in this part of the world are "ridiculously profitable", he said.
"Technology is currently the banks friend because it's enabling them to cut costs. Eventually it will eat their business and while that will be good for all of us, it will be deflationary," he said.