Will Fonterra catch the flu? Why NZ's largest company is vulnerable to coronavirus

There will be there will be disruption, the question is how severe and how long. Photo/Mark Mitchell

The fast spreading coronavirus poses another yet headwind for Fonterra's nascent recovery.

Units in the Fonterra Shareholders' Fund and farmer-owned shares were pushed back below $4 and whole milk powder prices dropped 6.2 per cent in last week's auction.

The units had rallied as high as $4.35 in early October after the dairy giant announced its somewhat familiar new strategy focused on extracting more value, primarily from its New Zealand business, as opposed to chasing volume through more and larger milk pools.

Fonterra is under pressure from a pending drought in parts of the country, regulatory environmental pressure and tougher credit restrictions. However, its strategy looked to be bearing fruit with first quarter earnings before interest and tax up nearly tenfold at $259 million.

And while the market responded positively, the reality is that Chinese buyers take a quarter of every drop of milk Fonterra exports. That's a lot of milk in one bucket.

Last November, Fonterra said it wanted to cut debt by as much as $700m by lifting earnings, stripping out capital spending and selling assets. The goal being a net debt of $4.4 billion to $4.6b by the end of July.

Given the cooperative's dependence on China, those earnings may be harder to lift, at least in the short-term.

Alex Azar, chairman of the Donald Trump's Task Force on the Novel Coronavirus, answers questions at a press conference. Photo/AP

Fonterra isn't seeing an impact from coronavirus yet, but is monitoring the situation closely.

Cooperative affairs managing director Mike Cronin acknowledged a sustained drop in consumption would impact sales.

"We'll be watching GDT results and our foodservice business over the coming month to get an indication."

The market, meanwhile, has already made up its mind with units and farmer owned shares off around 4 per cent since the beginning of the year.

The GDT auction wasn't as bad as some had feared, with the index down 4.7 per cent. And demand from China held up.

"Markets have been nervous that coronavirus and the associated practices to prevent spread of the virus will stop China buying but there doesn't appear to have been a large drop in Chinese demand," said NZX agri dairy analyst Amy Castleton.

Fonterra chief financial officer Marc Rivers said the drop wasn't unexpected.

"We expect to see some volatility in the market as the coronavirus situation develops.

"However, it's difficult to gauge the real impact of coronavirus on demand from this one GDT event. Other market dynamics need to be taken into account."

As the death toll tops 900, China's government has tightened travel restrictions and imposed virtual lockdown in parts of the country, measures likely to disrupt supply chains and curb consumer spending on popular products such as pizza topped with Fonterra cheese or tea macchiatos laden with Fonterra UHT cream.

Global rating agency Moody's Investors Service said the impact may be worse than the 2003 Severe Acute Respiratory Syndrome outbreak that dented China's GDP and financial asset valuations.

Why? A growing middle class.

"The amplified role of consumer demand as a driver of growth raises the risk that the economic dampening effect of the current coronavirus outbreak could be greater than in 2003," Moody's said.

Moreover, the epicentre of the outbreak – Hubei – and its role linking China's eastern coastal area with the central and western regions along the Yangtze River Economic Belt is key.

"The concern is that there will be many companies in the restaurant and general catering trade that will face serious challenges. Tourism in China and abroad will also suffer," said David Mahon, executive director of Beijing-based Mahon China Investment Management.

David Mahon of Mahon Investment Management

ANZ Bank agri economist Susan Kilsby is hearing of logistics issues around China from a majority of sectors, mainly due to a lack of staff and tepid consumption during the Chinese New Year.

"There are reports that containers are not being picked up from the wharf which also means - in many cases – they are not being paid for either," she said.

A2 Milk and Synlait are also feeling the heat, with shares in both pushing lower.

A2 Milk is working closely with its local partner China State Farm Holding Shanghai Company to monitor the situation but "trade is continuing".

Synlait also said it's not experiencing any disruption, although it is monitoring the situation closely.

Harbour Asset Management research analyst Oyvinn Rimer said there was "no question, there will be disruption" and the dairy sector would be no exception.

Still, he underscored that, historically, disruption tends to be short-lived.

"We've seen that time and time again where there is a disruption short-term for essential goods as soon as people start to get back to their normal lifestyle those goods are back on the menu and often in a greater way."

It may just be a question of riding out the storm.