Fran O'Sullivan: Forced to read between the Fonterra lines

Cash-strapped dairy farmers will be grateful Fonterra has not jettisoned its forecast $5.l0 per kg of milk-solid payout for the current season given the substantial revenue hit it unveiled yesterday.

Lower commodity prices and a large inventory of unsold milk powder combined with net foreign exchange losses of $1.3 billion and humungous debt levels weighed down the giant co-operative's performance in its interim financial result.

Despite this - particularly the halving of milk powder prices that killed the aptly named "White Gold Rush" - the co-operative's overall revenue was down just 7.6 per cent for the only period in which the company was able to post a true comparison: the six months to November 30, 2008, directly analogous with the co-operative's last formal interim reporting period of November 30, 2007 (the interim reporting date has since changed to January 31).

Fonterra chief executive Andrew Ferrier's bottom-line focus also resulted in a 2 per cent reduction in operating expenses over the unadjusted period (six months to November 30, 2008).

But the headline statements told of a solid result with revenues up 9.6 per cent to $8 billion in the current interim period - the upshot of including the two strongest months of the selling season (January and February) in the new interim period.

The decision by the Fonterra board to shift its full-year balance date to July 31, to better reflect the financial performance achieved from the total sales of milk supplied in the season, seemed sensible.

But it has resulted in considerable confusion down the track, not helped by yesterday's foggy press release and even foggier financial statements.

Dropping a press release to journalists just 10 minutes before chairman Henry van der Heyden and Ferrier broke from the board meeting for a midday press conference and omitting to first send out the underlying financial statements on the dubious excuse that "some journalists can't receive attachments" did not help informed questioning either.

However, the company did note the $8 billion figure was driven by the inclusion of two high sales months due to the change in balance date, stronger contributions from Fonterra's regional consumer business and the lower kiwi dollar - offset by lower global dairy prices.

It listed a few items:

Commodities & Ingredients revenue up 2 per cent to $5 billion.

Australia/New Zealand revenue up 12 per cent to $1.5 billion.

Asia/Africa Middle East revenue up 53 per cent to $1.2 billion.

Latin America revenue up 12 per cent to $358 million.

The company also noted that "adjusting for timing factors and including exchange hedging" total revenues would have been down by 7.6 per cent, reflecting the lower international dairy commodity prices.

But there the true comparisons ended.

There was no attempt to fully disaggregate the results so direct comparisons could be made against the previous interim result. Companies are not required to do this.

But when there has been considerable volatility in the time since a change in balance date was announced it would further a more acute judgment on a company's overall financial health to at least include a draft set of accounts on an unadjusted basis so shareholders and analysts can drill down into the numbers.

It might seem a bit pedantic. But with $800 million retail bonds expected to be listed on the NZX, it is important that the market is fully informed.

Here's an example: Fonterra does not disclose the volumes or tonnages of milk powder it has tucked away in warehouses waiting for international demand to ignite at a palatable price.

Ferrier said yesterday: "That's a very, very sensitive market issue. It's above normal [the volumes]. In general terms it is a few weeks behind where we would normally be. But it is not a material number in size of Fonterra's annual production and sales."

The interim accounts put inventories at $5.095 billion at January 31, 2009 - which does occur at near the height of Fonterra's bumper production period, or, peak of the milk curve.

This is well up from the $4.307 billion recorded in the last formal interim period (November 2007) and nearly twice the $3.288 billion recorded at the 2008 July balance date.

Ferrier noted later it was possible the volume of stocks would be higher at the forthcoming July 31 balance date compared with the 2008 full-year.

But if the milk price has not recovered substantially the inventory in dollar terms at the July full year could be lower than the $3.288 billion posted last year. The best that can be said here is that in future years comparisons will be easier to make.

At January 31, the debt gearing level was 61.5 per cent - well outside the company's internal comfort levels and above the 57.4 per cent recorded at the 2008 balance date.

It put this down to:

The cost of carrying higher inventories over the season's peak.

The devaluation of the New Zealand dollar, which resulted in foreign currency debt increasing when converted to NZ dollars.

A higher-than-usual advance rate percentage Fonterra has been paying farmer-shareholders this season, which resulted in more than $700 million extra in payments to farmers over and above the normal schedule.

Ferrier's contention is that if Fonterra's currency hedge is backed out the gearing would in fact be two percentage points lower. Pare back the abnormal inventory level and advance payments to normal levels and it is possible to produce a debt gearing figure neared 52 per cent.

The company is forecasting its debt levels will be substantially below 57.4 per cent by July 31.

At January 31, Fonterra was sitting on a $1.3 billion net foreign exchange loss. But Ferrier expects the position will reverse as contracts crystallise at the lower NZ cross-rate against the greenback. "By the end of the year we will wind that down."

Fonterra's top brass clearly believe the worst is now over - barring a "catastrophic event" (van der Heyden's words) - but it will need to tightly manage its farmer shareholder base in the meantime.