A sudden and unexpected divergence in the price of milk powder relative to other dairy products has forced Fonterra to take a big knife to its dividend and earnings forecasts for the 2013/14 year.
The co-operative yesterday maintained its forecast payout farmgate milk price at $8.30 per kg of milk solids for 2013/14, against market expectations of an upward revision, but slashed its dividend forecast for the year to 10c from an earlier forecast of 32c.
Fonterra also said its earnings before interest and tax would fall to about $500 million to $600 million in the July 31, 2014 year, down from $1 billion a year earlier, mostly because of higher costs to the co-operative imposed by strong dairy prices, which are an added cost to its manufacturing activities.
Chief executive Theo Spierings said the company had lost money because of the "super flush" season when milk had to be returned to the farm because Fonterra did not have the capacity to process it.
The Fonterra Shareholders' Fund unit price took a big hit on the back of the news, dropping back by 10 per cent to $5.50, equal to its issue price and well down on its initial price of $6.66 when they listed on the NZX in November last year. By the close the units had clawed back some ground, trading at $5.75, down 35c from Tuesday's finish.
Economists had expected an upward revision to the farmgate milk forecast - thanks to high GlobalDairyTrade auction prices. Indeed - if the board had not opted to take the action that it did, the farmgate price could have struck $9 a kg, but chairman John Wilson said the cost of maintaining the dividend at 32c would have been too great, putting pressure on its balance sheet.
Milk powders were continuing to sell at high prices because of strong global demand and limited supply.
Just four months into the season, the co-operative was in an "extraordinary" situation, with the gap between prices for milk powders compared to cheese and casein being greater than ever. In abnormal circumstances, the board had the discretion to pay a lower farmgate milk price than specified under the manual.
Spierings said the current market dynamic meant Fonterra needed to face the strategic question of whether it should have more processing capacity in milk powder and less in products such as cheese and casein.
"This is kind of unique - it has never happened before - and the gap (between the product streams) is widening," Spierings said.
He said the big question facing Fonterra was whether the gap was temporary, or "the new reality" given the explosive demand for milk powder from China.
"It's a strategic question that the co-operative needs to ask," Spierings said.
ANZ Bank rural economist Con Williams said he expected the trend in dairy product markets to continue.
Williams said: "Personally, I'm of the view that it's more structural than temporary, which means that you are going to have a lower dividend over the longer term, and a lower unit price, by inference."