NZX dairy futures curve flattens ahead of Fonterra's revised payout forecast

Fonterra Cooperative Group [NZX: FCG] may cut its forecast milk payout by a fifth this week with dwindling prospects that the price of whole milk powder will recover enough to support its current estimate.

Whole milk powder sold at US$2,229 a tonne in last week's GlobalDairyTrade auction and would need to surge 57 percent by March to reach the US$3,500 a tonne level that Fonterra chief executive Theo Spierings has said the current forecast payout of $5.30 a kilogram of milk solids is predicated on.

The chances of that sort of recovery are slipping away. NZX Whole Milk Powder Futures contracts have tumbled in the past three weeks, with contracts scheduled to expire in April to July 2015 dropping more than nearer-dated contracts. For example, May 2015 WMP futures have fallen to US$2,410 a tonne from US$2,950/tonne on Nov. 18. June 2015 futures have declined to US$2,500/tonne from US$3,025/tonne.

That's led to what is known as a flattening of the price curve. While some recovery is seen in 2015, based on futures prices, it is now expected to be more modest. The AgriHQ Seasonal Farmgate Milk Price for the 2014-15 season, a reasonable proxy for Fonterra's forecast price, fell to $4.25/kgMS after last week's auction.

"No-one seems to be as optimistic as Fonterra," said AgriHQ dairy analyst Susan Kilsby. "The things that drive WMP prices are supply out of New Zealand, the biggest producer, and demand in China, and as yet there's no solid pickup in demand from China."

As China has run down inventory levels, New Zealand has emerged from a record year of production. The New Zealand Dairy Statistics 2013-14, released by LIC and DairyNZ last week, show the country's 4.92 million cows produced a record amount of milk, surpassing 20 billion litres in the 2013/2014 season. Today, Westland Milk Products, said it recorded its highest ever one-day collection on Oct. 31, with its tankers bringing in slightly more than four million litres of milk.

Spierings' assumption of a recovery to US$3,500/tonne for WMP, which he made back in September, was an educated one, since that's been about the weighted average price over the past five years.

Westpac Banking Corp economist Michael Gordon is predicting a more modest cut to Fonterra's forecast this week to $4.80/kgMS, which he left unchanged after last week's auction. He pointed to price gains for some other products sold at the auction - rennet casein jumped 9.3 percent, butter gained 7.3 percent and cheddar rose 5.2 percent.

"That mix is more consistent with the 'Chinese overstocking' story rather than weak demand per se, which supports our view that the current price weakness will prove to be temporary," Gordon said in a note. "Nevertheless, it doesn't bode well for returns for this season."

(BusinessDesk)