Fonterra 'walks fine line' supporting farmers via dividend while protecting balance sheet

Wednesday 23rd March 2016

Fonterra Cooperative Group, the world's largest dairy exporter, has avoided weakening its balance sheet by providing support to farmers via a higher first-half dividend while shifting production to higher-margin goods to lift profit as sales fell.

Auckland-based Fonterra doubled its first-half dividend to 20 cents and will make early payment of the final 20 cent payment, in two increments in May and August. It didn't extend the interest-free loan package that's been taken up by 76 percent of farmer-shareholders at a cost of $390 million.

Total volumes increased by 8 percent to 12.6 billion LME (liquid milk equivalent) in the first half, including 235 million LME converted into higher-value products in consumer and food service. In the company's biggest business, New Zealand ingredients, the gross margin on reference products used to calculate the milk price - whole and skim milk powder, buttermilk powder, butter and anhydrous milk fat - dropped 20 percent to $331 per metric ton, while the margin on non-reference products jumped 121 percent to $1,412 a metric ton.

That helped drive a 27 percent gain in first-half normalised earnings before interest and tax for ingredients to $617 million. Ebit for higher-value consumer and food service products jumped 108 percent to $241 million. Group net profit rose 123 percent to $409 million.

Both Standard & Poor's and Fitch Ratings cut Fonterra's credit ratings last October, saying its balance sheet had been weakened by the support package for farmers and debt taken on to fund the $755 million purchase of 18.8 percent of Shenzen-listed Beingmate Baby & Child Food Co. That left the company with little capacity to undertake more debt-funded support for farmers. In the first half, though, Fonterra's gearing fell to 49.2 percent from 50.7 percent a year earlier, and today the company affirmed it's on track for a year-end gearing ratio of 40-45 percent.

"Farmers may have been hoping for a little more in terms of support but that's weighed up by how much Fonterra can manage in terms of its balance sheet," said Nathan Penny, rural economist at ASB Bank. "They have dual considerations of supporting farmers while also looking after the credit rating and balance sheet considerations and managed to walk that fine line."

Units of the Fonterra Shareholders' Fund, which are entitled to the dividends from Fonterra's farmer-owned shares, rose 0.2 percent to $5.94 and have fallen about 1.2 percent in the past 12 months while the S&P/NZX 50 Index gained 13 percent.

With dividends for the full-year forecast at 40 cents a share, the annual cash payout is projected at $4.30 per kilogram of milk solids, while the total available for payout, or farmgate milk price plus forecast earnings per share, is projected at $4.35-$4.45/kgMS.

Revenue in the first half ended Jan. 31 fell 9.3 percent to $8.8 billion even as volumes rose 8 percent, while the gross margin widened to 21 percent from 16 percent.

“The low prices have placed a great deal of pressure on incomes, farm budgets, and our farming families," said chairman John Wilson. "Our priority is to generate more value out of every drop of our farmers’ milk by focusing on the areas within our control. We aim to efficiently convert as much milk as possible into the highest-returning products."

The timing of this year's dividends was "a specific response to the current, very challenging, financial conditions farmers are facing" and didn't signal a permanent change away from twice yearly payments, he said.

Fonterra's international farming business gross margin slipped to 21 percent even as volumes rose 54 percent and it reported an ebit loss of $29 million.

The company said it expects a revival in the price of whole milk powder through 2016 as dairy output from the European Union reverts "to normal growth of 1 percent per annum" after last year's spike. Imports of WMP by China are seen growing a steady 4-5 percent a year.

BusinessDesk.co.nz

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