Fonterra first-half results show ingredients offset gains from higher value products

Wednesday 22nd March 2017

Fonterra Cooperative Group lifted first-half earnings from its consumer and food service businesses by shifting volumes into higher-value products but the gains were more than offset by a decline in earnings from its ingredients platform, where increased sales came with a drop in gross margin.

Ingredients are the core of Fonterra's business and include milk powders, nutritional products used in infant formula, butter, cheese and specialty dairy ingredients sold around the world. In the first half, sales from that business fell 7 percent to 11 billion litres LME (liquid milk equivalent). While sales revenue rose 8 percent to $7.2 billion, the gross margin on those sales fell to about 11 percent from 14.8 percent and normalised earnings before interest and tax dropped 17 percent to $510 million

Its consumer and foodservice platform, which produces branded dairy products sold in supermarkets as well as products for food professionals such as bakery butter and shredded extra-stretch mozzarella, lifted the volume of sales by 9 percent to 2.7 billion litres LME. The value of sales rose 1 percent to $3.2 billion while its gross margin widened to 30 percent from 28 percent, resulting in a 30 percent gain in normalised ebit to $313 million. All of the margin improvement came from consumer products.

Fonterra today cut its forecast for full-year earnings per share while maintaining its projected milk payout, citing volatility in returns from ingredients, tightening margins and potential increased milk supply in the autumn.

Per-share earnings are forecast at 45 cents to 55 cents while the farmgate milk price payout was affirmed at $6 per kilogram of milk solids, giving a forecast available for payout of $6.45 to $6.55 before retentions for a fully shared-up farmer. It had previously projected per-share earnings of 50-to-60 cents for a payout of $6.50 to $6.60 before retentions.

"The impact of more volatility in product stream returns in our ingredients business, some tightening of margins in the coming months, and the potential for extra milk in the autumn could result in some pressure on our earnings in the second half," chairman John Wilson said. "The board considered these factors and, while continuing to have confidence in achieving a target dividend of 40 cents per share, has revised the forecast earnings per share range to 45-55 cents to reflect the additional volatility."

"We remain positive but cautious and this is reflected in our interim dividend of 20 cents per share and our February decision to increase the advance cash rate paid to farmers earlier in the season,” he said.

The dairy exporter downgraded its forecast while releasing first-half results today, which showed revenue climbed 9 percent to $9.2 billion. Normalised earnings before interest and tax fell 9 percent to $607 million in the six months ended Jan. 31. Net profit rose 2 percent to $418 million.

Fonterra faces the perpetual dilemma of being owned by the farmers who supply its milk and who expect the company to give them a good return for their milk while turning as much as possible of the supply into the most profitable products. In the first half, the cost of goods sold - largely the cost of its New Zealand-sourced milk - rose 7.4 percent to $7.48 billion, resulting in a 6 percent decline in gross profit to $1.76 billion.

The payout formula is more complex, adding another layer of opacity because it is based on a basket of so-called reference commodity products - whole milk powder, skim milk powder and their by-products of buttermilk powder, butter and anhydrous milkfat. Last year the company proposed adding UHT dairy products to the basket. Because of the formula, Fonterra has a greater chance to make a profit when non-reference commodities such as cheese and casein are well above prices of reference products.

Fonterra's accounts show it managed to rein in many other costs, including selling and marketing, distribution and administration. But it was lower finance costs, more finance income and a smaller tax bill that turned a weaker gross profit into a higher net profit. It cut interest-bearing debt by $800 million to $6.1 billion in the first half, reducing gearing to 46.6 percent from 49.2 percent and said it was on track to reduce gearing further to 40-45 percent by year-end.

Capital spending dropped 46 percent to $244 million, reflecting the tail-end of investments to bolster capacity.

Driving more milk into higher-value products - 'turning the wheel' as chief executive Theo Spierings calls it - is key to Fonterra's business strategy and today the company said it was on track to convert 400 million litres LME into higher-returning products after pushing 227 million litres LME in that direction in the first half. Its long-term aspirational goal is to generate $35 billion in sales from 30 billion litres of milk.

Wilson confirmed that a poor start to spring had slowed milk collection and prompted the company to forecast a 7 percent decline in total collection for the season. But today he said that with good rainfall in autumn "on-farm conditions are improving, which means we are now expecting New Zealand collections to be down by 3 percent on last season."

That increase in volume had already been accounted for in the volumes Fonterra has forecast to send to the GlobalDairyTrade platform, the company said at a briefing today.

"The market will be pleased to know that volume has already been accounted for," said Susan Kilsby, a dairy analyst at the NZX's AgriHQ unit. Based on the way the current season has been tracking, the revised milk collection estimate implies a 3 percent pickup in the final three months of the season, she said.

BusinessDesk.co.nz

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