Fonterra overshoot on advance payment worsens farmer cash flows

Fonterra has offered interest-free loans to help farmers through the downturn after the world's biggest dairy exporter cut its forecast payout to farmers to $3.85 per kilogram. Photo / Alan Gibson.

Milk prices have dropped so dramatically that Fonterra Cooperative Group effectively overpaid farmers under an advance payments scheme last year, sapping funds available to pay out farmers at the end of the season and leaving them short of cash even before last week's deep cut to the 2016 forecast payout.

"Last year, Fonterra came out with a higher advance rate schedule during the year, effectively almost overpaying for milk as they went," Dairy Holdings chief executive Colin Glass told BusinessDesk.

"That meant there was nothing left at the end of the year to come through. That's effectively been the major impact on farm cash flows today.

"Those deferred payments for the previous year haven't been there and that's coinciding with what is now the lower advance rate schedule."

Fonterra has offered interest-free loans to help farmers through the downturn after the world's biggest dairy exporter cut its forecast payout to farmers in the 2015/16 season to $3.85 per kilogram of milk solids in response to a slump in global milk prices, from $4.40/kgMS in the 2014/15 season and a record $8.40/kgMS in 2013/14.

However, it also left the so-called advance rate - the sum farmers can receive ahead of the next season's final payout - unchanged at 70 percent of the forecast milk price.

As dairy prices and, thus, the milk payout fell through the 2014/15 season, Fonterra ended up completing its payments to farmers before the end of the season.

Farmers now face advance payment rates for September and April 2015/16 that are more than $1/kgMS down on its original forecasts in May, Glass said.

That means "the cash flow impact of this reduction has been felt at a farm level almost immediately," he said.

"They've delivered a very clear and a very frank message and signal to farmers right from the start of the season."

Timaru-based Dairy Holdings is one of the nation's biggest farmers, milking 46,000 cows across 58 dairy farms largely in Canterbury and Waitaki.

To help mitigate the impact on farmers, Fonterra is offering 50 cents/kgMS as an interest-free loan against the next season's payout.

It will spend up to $430 million on the support scheme in the first half of the season, with the loans to be phased in from October, to be repaid by farmers when the farmgate milk price or advance rate goes above $6/kgMS.

The sliding global milk price and its impact on New Zealand's terms of trade prompted the Reserve Bank to start cutting interest rates in June.

The central bank has said about quarter of farmers are currently operating in negative cashflow, while DairyNZ has estimated $5.70/kgMS is the industry average breakeven for most farmers.

Global ratings agency Moody's Investors Service this month said New Zealand's banks were strong enough to weather a downturn in the dairy sector, with farmers becoming increasingly cautious since the payout fell sharply in 2009, and who were wary even when Fonterra made its record payout in 2014.

Fonterra will cut capital expenditure by between $500 million and $600 million in the current financial year to pay for the scheme, something ANZ Bank New Zealand chief economist Cameron Bagrie said wasn't a strategy they should pursue for an extended period.

"It is a temporary, quick fix. You have to be very careful with those levers to ensure your credit rating doesn't come under pressure," Bagrie said.

Dairy Holdings' Glass said the scheme was a creative way of supporting farmers, and that Fonterra deserved to be commended "for trying to innovate and see how they can reward shareholders".

Dairy Holdings was prepared for the drop in the forecast payout, and would fine tune its business in response, but Glass isn't expecting any significant changes to the business.

"This is so significant that many haven't experienced payouts at this level probably in real terms ever, but at least with the business model we're running we'd like to think it lets us be a little more adaptable," he said.

Steve Carden, chief executive of state-owned Landcorp Farming, which has a dairy herd of more than 77,500 cows, said there was huge pressure on the industry as it enters its busiest time of the year.

"It is good to see Fonterra offering support to those farmers who will struggle, although clearly it runs into some potential conflict with its non-producing shareholders," Carden said.

Glass said prices paid to farmers in Europe haven't fallen as far as those for farmers in Oceania and hoped Fonterra's announcement on the additional financial support would narrow that gap.

"It's not a pleasant signal for anyone, but at least we're getting that clear signal, and out of that we hope the world sees where market prices are as well and that means that pain gets felt not just in New Zealand, but hopefully around the rest of the world as well," he said.

"It's a pretty sobering day for the industry. There are a lot of dairy farmers out there that will be finding times quite tough and they will need support, so it's really important that we're all aware and keeping our eyes and ears open for those out there needing help during these times," Glass said.