Fonterra yanks product out of global dairy auctions

PLUS: Rating agency puts it on creditwatch negative

Fonterra [NZX: FCG] is to cut volumes of whole milk powder it offers in the GlobalDairyTrade (GDT) auction for the next year.

That came just moments after credit rating agency Standard & Poor's put the dairy cooperative on creditwatch negative over concerns about its high debt levels at a low point in the global price cycle.

It follows trenchant criticism last week over volumes offered in the auction that saw prices collapse to 2009 levels. Some critics argued that volumes offered triggered the price collapse.

The co-operative says its forecast offer volumes over the next 12 months will significantly decrease by 56,045 metric tonnes.

Another 62,930 metric tonne decrease will occur over the next three months but 6885 metric tonnes of planned volumes will be added back later in the year in anticipation of changing market conditions, the co-operative says.

Fonterra managing director global ingredients Kelvin Wickham says the changes come in response to current conditions on both the demand and supply sides of the global dairy market.

“In response to current conditions in the global dairy markets, we have further modified our product mix to shift volumes away from base whole milk powder (WMP) and into our other products in our portfolio such as value-add ingredients, consumer and foodservice,” he says.

Last week, overall dairy prices at the GDT dropped by 9.3%, making it the 10th consecutive auction it has declined.

He says Fonterra is now selling approximately 70% of its total product via channels other than GDT and as a result we do not expect a material impact on inventories, it says.

“From a supply perspective, Fonterra’s reduction of GDT volumes reflects the latest production forecast for the coming season where the co-operative currently expects its farmers to reduce milk supply by at least 2%,” Fonterra says.

“This reflects the likely impact of farmers using more traditional practices to manage their farm businesses within the limits of a low payout forecast.”

Meanwhile, S&P credit analyst Brenda Wardlaw says S&P  was concerned about Fonterra’s debt , which is at very high levels due to a large acquisition and peak capital expenditure at a low point in the global price cycle.

She says this has placed pressure on Fonterra's key financial metrics.

“While the lower forecast payout to its supplier shareholders supports our view of the co-operatives' superior financial flexibility, the likely weakness in its key financial metrics in the short term may place downward pressure on the credit ratings on the company,” she says.

Last week, Fonterra slashed its forecast farmgate milk price payout to $3.85 per kg of milk solids for the 2015/16 season, down from the most recent forecast of $5.25.

That came after overall dairy prices dropped for the 10th consecutive time at the GlobalDairyTrade auction.

Ms Wardlaw says high debt levels reflect the sizable acquisition of a shareholding in China-based Beingmate, combined with peak capital expenditure at a low point in the dairy price cycle will place Fonterra's key credit metrics under pressure in the short term.

"We expect to resolve the crediteatch following a review of Fonterra's financial results for fiscal 2015, which will provide further visibility on the level of buffer in its key financial metrics.

“The creditwatch negative indicates that we could affirm or lower the ratings on Fonterra following our review. We would expect that, if we were to lower the ratings, the downgrade would not exceed one notch." 

First NZ Capital said in a research note earlier this week that it continues to highlight the extremely high debt levels in Fonterra, following a period of significant capital expenditure and benign earnings.

“The potential response from ratings agencies will be interesting to watch out for,” the note said.

Fonterra’s chief financial officer Lukas Paravicini says Fonterra has taken proactive and positive steps to maintain the financial strength of the cooperative. 

“We have continued to exercise financial prudence and discipline in challenging times for dairy globally.”

He says measurements, such as reducing capital expenditure, setting a prudent advance rate payment to our farmers and progressing well with its business transformation “reinforce our sound financial position.”

“While current global prices are unsustainably low, we take a longer-term view of the cyclical nature of the international dairy market and have confidence in the fundamentals for dairy,” Mr Paravicini said.

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