Jamie Gray is a business reporter for the New Zealand Herald and NZME. news service.

End in sight for dairy slump after Fonterra upgrade

Fonterra reported a record annual profit of $834m last week and expects earnings to increase further still in the current year.
Fonterra reported a record annual profit of $834m last week and expects earnings to increase further still in the current year.

A bumper profit and a milk price upgrade from Fonterra has raised hopes that the dairy slump may finally be coming to an end.

Those involved in the industry are fully aware of last year's false start, which saw whole milk prices rally by more than US$1000 ($1379) a tonne in just two months before slumping by almost the same amount a short time after.

This time round, the rally is looking better than a flash in the pan.

Fran O'Sullivan: Fonterra emerging from long winter

Still, as analysts are quick to point out, the commodities markets - particularly for dairy - are notorious for their volatility.

"The run-up for milk powder and milk fat prices looks to be more sustainable, so that is going to make the outlook for the next 12 to 18 months better than it has been," ANZ rural economist Con Williams said.

Farmers are used to fickle commodity prices but the severity and duration of the downturn caught many farmers - and their bankers - by surprise.

DairyNZ said the 50c upgrade in the milk price to $5.25 a kg of milksolids was good news, but that farmers still needed to keep a lid on costs.

"This ($5.25) brings many farm businesses to around the 2016/17 break-even milk price of $5.05 per kg once retrospective payments and dividends are taken into account," chief executive Tim Mackle said.

"This means fewer farmers will need to borrow extra funds this season."

Fonterra reported a 65 per cent increase in net profit to a record $834 million and confirmed that it expected earnings to increase further still to 50 to 60c a share in the current year.

True to expectations, Fonterra reduced debt, taking its gearing ratio back down to a more conservative 44.3 per cent from 49.7 per cent a year earlier.

After extensive surgery, Fonterra's long-troubled Australian operation returned to profit.

Analysts expect to see bigger things from Australia once Fonterra - with its Chinese joint venture partner Beingmate - start making infant formula at their Darnum plant.

Analysts gave a generally favourable review of Fonterra's result, with a few qualifications.

The result was helped in no small part by very low milk prices, which lowers Fonterra's input costs and helps to widen its margins.

Analysts said was difficult to separate the milk price factor from management's actions in terms of their beneficial impact on Fonterra's results.

"It's certainly proof that what management has been working on for the last couple of years is on track and that they are making progress on that front," said Mark Lister, head of private wealth research at Craigs Investment Partners.

"Lower input costs have given them a tail wind but it's unfair to not give them credit for doing some good work on the things that they can control."

On the consumer and food service side, earnings before interest and tax (EBIT) came to $580 million, up 42 per cent on the previous year.

On the ingredients side, normalised EBIT rose 24 per cent to $1.2 billion.

Harbour Asset Management analyst Oyvinn Rimer said the result showed that Fonterra was getting results from its strategic initiatives, which are aimed at wringing more money out of the billions of litres or milk collected by its tankers each year.

"There seems to be even more firepower in Australia, given that the Darnum plant has not really started producing infant formula yet," Rimer said.

"What is always difficult to do is attribute the correct amount to cheap ingredient inputs versus management's achievements," he said.

"It's always quite hard but there is no question that they are doing quite a few things right ... The proof of the pudding will be when and if the milk price pushes up again and those ingredients are not cheap any more."

As expected, Fonterra shifted more product into its consumer and food service business, and more product was diverted off the GlobalDairyTrade auction into higher margin areas.

Forsyth Barr analyst James Bascand said key volume growth trends into China and towards Consumer and Foodservice operations showed that strategy execution was continuing to unfold.

"The supportive low input cost environment has boosted key metrics and incremental underlying changes need to compound before we have confidence that Fonterra justifies trading on a materially higher multiple," he said in a research note.

Looking ahead, Harbour Asset's Rimer said he could see some "positive momentum developing" from here.

"But as is always the case with Fonterra, there are many moving parts."

- NZ Herald

Get the news delivered straight to your inbox

Receive the day’s news, sport and entertainment in our daily email newsletter


© Copyright 2016, NZME. Publishing Limited

Assembled by: (static) on production bpcf04 at 21 Oct 2016 08:58:06 Processing Time: 688ms