Fonterra faith wavers

By PHILIPPA STEVENSON agriculture editor

Dairy giant Fonterra is, at best, treading water.

Yesterday's 10c cut to farmers' expected payout of $3.70 a kilogram of milksolids wiped about $100 million off incomes already down by a third on last year.

Farmers and the New Zealand economy will now be about $1.9 billion worse off after the company warned that low commodity prices and a weakening US dollar had eroded earnings in the six months to November.

The effect of recently improved commodity prices will not flow through until the second half of the year because Fonterra's business is based on forward orders.

The payout reduction also obliterated the cost-efficiency benefits the company had achieved since its formation in October 2001 from the merger of the two manufacturers New Zealand Dairy Group and Kiwi Dairies, and the marketing Dairy Board.

Chief executive Craig Norgate agreed the payout downgrade was the equivalent amount to the merger savings of around $114 million.

"That is the nature of the business. Commodity prices fell by over 30 per cent.

"They've subsequently bounced back up. We've seen the currency rise by 15 per cent."

But industry watchers were wary of another unexpected event in the life of the company formed only 16 months ago, and queried what that signalled about the company's management.

Last year's surprise loss of $50 million was followed by the embarrassing $34 million mistake in the accounts of subsidiary NZ Milk, and now farmer shareholders expecting $3.70 or better had found their incomes further eroded.

"A well-run business shouldn't be having such surprises," said one observer.

"How much confidence can we have in it?"

Norgate said Fonterra executives watched commodity price shifts constantly but did not feel any need to recommend to the board that it reduce the payout forecast until a week ago.

Directors received the bad news in papers they got last Thursday, in time for yesterday's board meeting.

Norgate described the movement in payout from last year's $5.30 to $3.60 as an "unprecedented swing".

The company could only delay the impact of the exchange rate by hedging, he said.

"But ultimately the Europeans will set the absolute price because of their subsidies and the amount they export with subsidies. We can influence the way they do that and actually help, but the bottom line is that global supply and demand will dictate commodity prices."

Chairman Henry van der Heyden welcomed the company's foreign-exchange hedging, which started the year with 48 per cent hedged at 44USc, and now had 95 per cent hedged at an average of just over 47USc.

"That is hedging gains of over $500 million, [the equivalent of] over 50c a kilogram of milksolids."

The company had also reduced manufacturing costs by 8 per cent.

But van der Heyden warned that the $3.60 payout was the company's best estimate.

"I want to make it quite clear that achieving this figure will be dependent on our continuing to make inroads on costs and no dramatic deterioration in international market conditions."

The $1.4 billion payout to suppliers equates to $2.63 per kilogram of milksolids, which means the company will have to earn the equivalent of $4.57 in the second six months to deliver on its $3.60 promise.

Fonterra's operating revenue for the six months to November was $5.9 billion, compared with $7 billion for the same period in 2001.

Net profit was $18 million, down from $22 million. Ingredient sales were down $600 million to $3 billion, and consumer goods sales down $363 million to $2.3 billion.

Operating expenses were also down $995 million to $5.9 billion, including a halved payout to farmer suppliers of $1.4 billion.