Fonterra forecasts fourth highest milk price in its history

Fonterra has lifted its farmgate milk price to $7.30 a kg, which would be the fourth-highest price in its history, and has raised its earnings in the first quarter.

The forecast range has shifted up to $7.00 to $7.60 per kg, up from a previous forecast range of $6.55 to $7.55 per kg, and lifting the mid-point by 25c to $7.30/kg.

The co-op said the higher milk price would put downward pressure on its earnings.

Nevertheless, Fonterra retained its previous earnings per share range forecast of 15 to 25 cents for the current 2019/20 year.

For the first quarter, Fonterra said it had generated normalised earnings before interest and tax (EBIT) of $171m, up $145m, and a reported EBIT of $259m, up $233m.

In September, Fonterra reported a net loss of $605m, its biggest ever, for the 2018/19 year to July 31.

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Milk prices are Fonterra's biggest input cost and high prices can put pressure on its margins.

Fonterra has, from time to time, adjusted the milk price - which is calculated using a mixture of reference products traded on the Global Dairy Trade platform.

In the 2013-14 season the theoretical Farmgate Milk Price was $8.93/kg MS, but Fonterra actually paid its suppliers only $8.40/kg MS that season.

Chief executive Miles Hurrell said that from that perspective, Fonterra was comfortable with the new, higher, range.

"We are still very comfortable with our range," he said on a conference call for journalists.

"It's only the first quarter, so we need to take the higher milk price as one of the cogs and understand the impact that it will have on our consumer and foodservice markets in particular, to see at what point the demand comes away," he said.

Since the end of the last financial year, Fonterra said it had:

- Improved the underlying financial performance of the business, delivering a gross margin of $740m, up from $646m.

- Reduced operating expenditure by $104m.

- Generated a normalised EBIT of $171m, up $145m, and a reported EBIT of $259 million, up $233 million.

- Improved free cash flow by $595 million compared to last year.

Chairman John Monaghan said the Co-op had continued to earn good prices for its milk, reflecting slightly higher demand.

Fonterra's milk production was forecast to be up 0.5 per cent on last year.

Annual milk production in the other key global supply regions of the United States and the EU were both growing at less than 1 per cent.

"On the demand side, Global Dairy Trade prices have increased by about 6 per cent since our previous forecast," he said.

Whole milk powder prices - a key driver of the milk price - were at their highest level since December 2016.

Hurrell said the co-operative had made good progress moving to its new strategy and had had a strong first quarter.

The focus remained on reducing debt to no more than 3.75 times earnings.

"This will require us to achieve a gross margin of $3 billion, further reduce operating expenditure, lower capital expenditure by $100m to $500m, and also divest some more assets," he said.

Fonterra expects there to be several one-off adjustments, such as divestments of assets, that will impact reported earnings for the year.

Its reported EBIT in the first quarter included positive one-off items such as the proceeds from the sale of its interest in foodspring and the revaluation of Beingmate shares.

During Q1, Fonterra's Ingredients business increased its EBIT by $32 million to $139 million.

EBIT from the Consumer and Foodservice business was $118 million in the first quarter, up by $56 million compared to the same period last year, with improvements across all regions.

"The Australia Consumer business has delivered record market share in the chilled spreads category, and we are starting to see early signs of a turnaround in our New Zealand Consumer business," Hurrell said.

"The lift in China Foodservice sales in the fourth quarter of last year has continued into the first quarter of the year".

Sales volumes in China were up 43 per cent and gross margins were up $23m in the first quarter on a year-on-year basis.

Fonterra's NZX-traded units last traded at $4.08, up six cents from Wednesday's close, and up from their record low $3.15, set in August this year.