UPDATED: Fonterra farmers pin hopes on higher dividend following slashed farmgate milk price forecast

See also: Dairy slump prompts NZ to cut 2015 primary exports forecast by 3.6%

UPDATED 11am: Dairy farmers facing a slashed farmgate milk price will be pinning their hopes on a boosted dividend from the Fonterra Cooperative Group [NZX: FCG] to bolster their returns.

Dairy exporter Fonterra today slashed its forecast farmgate milk price for the 2014/2015 season by 60 cents per kilogram of milk solids to $4.70/kgMS but left the dividend range unchanged at 25-35 cents per share. The reduced milk price forecast translates to a drop of more than $6 billion in dairy industry income, or 2.7 percent of gross domestic product, compared to last season’s record farmgate milk payout of $8.40/kgMS.

The lower forecast was at the weaker end of weak expectations for the payout and the board has said it will revise the dividend when the interim results are announced next April.

Fonterra Shareholders’ Council chairman Ian Brown said Fonterra’s 10,600 farmers would be expecting a tangible return on their investment in the cooperative once the board revises the dividend.

“Fonterra has had a significant focus on implementing the strategy over the past couple of years and it is important, especially in a season where the milk price is down, that farmers receive the full benefit for their investment in the integrated supply chain that their co-op provides,” Brown said.

Units in the Fonterra Shareholders’ Fund [NZX: FSF], which are entitled to dividends on the company’s ordinary shares, were largely unchanged in trading this morning, rising just 0.2 percent to $6.18, with the widely-expected revised forecast milk payout having already been factored in.

At the Shareholders’ Fund annual meeting last month, unitholders said Fonterra should be able to raise its dividend forecast given input costs reduce when it pays farmers less for their milk. Fonterra gets caught in a bind when the milk price is high because it represents an input cost for its consumer and food service business but the opposite is true when the milk price falls.

Fonterra chief financial officer Lukas Paravicini said last year the cooperative increased whole milk powder production by 18 percent because it gave the best returns for shareholders whereas production of cheese and casein were up this year.

Bank of New Zealand economist Doug Steel was surprised the board had left the estimated dividend unchanged because normally dividends go the opposite way to the farmgate milk price.

But Fonterra's Paravicini said while milk prices had dropped in China and South East Asia in particular, not all milk prices were defined by the milk price in New Zealand and some had not declined by as much. He wouldn’t be drawn on whether the dividend was likely to rise.

Dividends are typically based on 65 percent to 75 percent of the adjusted net profit after tax but the board takes into consideration near-term earnings projections and investment needs, and the average paid out over the past three years. The dividend was 10 cents per share in the last season, 32 cents in 2013 and 2012, and 30 cents in 2011.

Salt Funds Management’s Matt Goodson said market expectation for the 2015 dividend was 27 cents a share. While there was likely to be a tailwind for the Shareholders Fund, which holds 7.5 percent of the world’s largest dairy exporter, he said it wasn’t as simple as saying milk prices down, dividends up.

Goodson said he was still figuring out the impact on Fonterra of a build up in milk inventories: “If you look at the volume of production versus the volume of sales and exports, there is a bit of an inventory build up for Fonterra but I’m unclear what that impact will be on the Fund.”

Although farmers had been expecting this lower forecast, Fonterra said the revision will put pressure on their farming business budgets. That impact is more likely to be felt in the 2015/2016 than this season because of deferred payments from last season. If confirmed, the payout would be the lowest since 2007’s payout of $3.87/kgMS.

Fonterra is also tightening its own belt, undertaking a targeted programme to generate more cash. Paravicini said the cooperative’s top executives would be expected to produce plans to cut costs before the end of the year, looking at what needs to be spent to meet short-term goals and what expenditure can be deferred, without affecting the V3 growth strategy. Its forecast capital expenditure for the 2015 financial year is currently $1.6 billion, including $555 million on expanding its processing facilities to deal with increased milk production.

(BusinessDesk)

UPDATED 9am: Fonterra's 60c drop in farmgate milk price payout in line with weak expectations

Fonterra Cooperative Group [NZX: FCG] has slashed its forecast farmgate milk price for the 2014/2015 season by 60 cents per kilogram of milk solids to $4.70/kgMS, but has left the dividend range unchanged at 25-35 cents per share.

The lower payout would translate to a $1.1 billion revenue drop for the dairy industry and $6.6 billion less than last season, according to Bank of New Zealand senior economist Doug Steel, while Westpac Banking Corp estimates the drop from $8.40 last season to $4.70/kgMS forecast would result in a $6.1 billion reduction in income for the industry, or 2.7 percent of gross domestic product.

The reduced forecast is line with expectations that Fonterra's board, which met yesterday, would be forced to downgrade its $5.30/kgMS forecast to below $5 due to weak global dairy prices. Chairman John Wilson said that although farmers were expecting this lower forecast, the revision will put pressure on their farming business budgets.

“There is still considerable volatility in global dairy markets,” Wilson said. “Right now we are seeing a number of factors that are delaying a sustained return to higher global prices.”

The global milk supply remains greater than demand, which has resulted in GlobalDairyTrade prices for whole milk powder falling 16.9 per cent since late September, while skim milk powder prices have fallen 7.7 per cent. Whole milk powder sold at US$2,229 a tonne in last week’s GlobalDairyTrade auction.

“Falling oil prices, geopolitical uncertainty in Russia and Ukraine, and subdued demand from China as it continues to work through inventory are all contributing to ongoing volatility and weak demand,” Wilson said.

“Today’s revised forecast reflects the board and management’s best estimates at this time. Given the uncertainty we are advising farmers to continue to be cautious with budgeting and we will update them as the season progresses,” he said.

Westpac chief economist Dominick Stephens said the new forecast was at the lower end of its expectations of a $4.80/kgMS result.

“To date, rural confidence has remained surprisingly robust in the face of falling payout forecasts. The general sentiment has been that farmers can weather one low payout. We suspect that the reality of a payout as low as $4.70 is going to dent that confidence," Stephens said. "What is more, we are now forecasting a fairly low farm gate milk price of just $6.20 for the 2015/2016 season, and that is assuming that global milk prices rise rapidly over 2015.”

ASB Bank has also shaved back its 2015/2016 milk price forecast to $6.00 kg/MS although its long-term view for diary prices still holds. It expects global dairy production growth to moderate and Chinese demand to rebound heading into 2015. A lower NZ dollar over 2015 and 2016 should also be supportive of the milk price. 

ANZ Bank New Zealand economist Con Williams said the main impact of the latest drop would be felt on farmers’ cash flow in the 2015/2016 season when deferred payments will be a lot less than this season’s.

“Probably one year of sub $5/kgMS or mid $4.00/kgMS is manageable for the dairy sector but if there is continued softness in dairy prices in the 2015/2016 season there will need to be more dramatic changes in their cost structures and trimming of capital and operating expenses,” he said.

BNZ's Steel was surprised the board had left the estimated dividend unchanged because normally dividends go the opposite way of the farmgate milk price, though the board has said it will review the dividend at the time of its interim result in April next year. He said Fonterra may make better margins with a reduced milk price which should see the dividend rise but that “may come when the season is done as it's extremely volatile out there yet.” 

Fonterra Shareholders’ Council chairman Ian Brown said farmers would be expecting a tangible return on their investment in the cooperative once the board revises the dividend.

“Fonterra has had a significant focus on implementing the strategy over the past couple of years and it is important, especially in a season where the milk price is down, that farmers receive the full benefit for their investment in the integrated supply chain that their co-op provides,” Brown said.

The New Zealand dollar fell to 76.70 US cents from 77.10 cents immediately before the 8:32am announcement.

(BusinessDesk)