Fonterra raises payout forecast to NZ$6.05/kg (Update 2)

Fonterra has raised its forecast payout for the 2009/10 year to NZ$6.05 per kg of milksolids from its previous forecast of NZ$5.10/kg, citing an improvement in commodity prices globally. (Update 1 includes full Fonterra statement, Update 2 includes comment from Fonterra's Shareholders Council and What I Think it Means) Fonterra raised the milk price component of the payout from NZ$4.60/kg to NZ$5.70/kg, but has cut the value add return (distributable profit) to 35 cents/kg from 50 cents/kg. It increased the advance payout rate for the season by 75 cents to $4.00 kgMS. Fonterra Shareholders Council Chairman Blue Read said farmers would be surprised by the size of the increase. "We look forward to the increase flowing through to farmers' cash flow. Receiving this news should help restore farmers' confidence that the food industry is one of the best to be in especially during depressed global economic times," Read said. Fonterra also said it would declare its profit retention policy and its fair value share valuation in December if farmers voted for Steps 1 and 2 of its capital reforms at its annual meeting on November 18. What I think it means This will be a major boost for the regional economies that are driven by the Fonterra payout, in particular Northland, the Waikato, Taranaki, the Bay of Plenty, Manawatu, South Canterbury and Southland. It may help save some very indebted dairy farmers and their financiers. This is particularly good news for South Canterbury Finance, which is trying to sell as much as NZ$500 million worth of dairy farms over the next year or so. It will also help bolster farm values and, more importantly from a bank point of view, the value of the loans underneath those farms. A key question though for any farmer or banker looking to rely on this forecast is how sustainable it might be. It is dependent on the currency staying off its highs and the global economy continuing to recover. Here is the full statement below from Fonterra.

Fonterra announced today a further increase in the forecast payout to its farmer-shareholders for the current 2009/10 season. The Milk Price increases $1.10 to $5.70 per kilogram of milksolids (kgMS), while the Distributable Profit (Value Return) is 15 cents lower at 35 cents per kgMS. This means the Co-operative's forecast of the total amount Available For Payout increases 95 cents to $6.05 per kgMS. The new forecast compares with an opening forecast for 2009/10 of $4.55 per kgMS and a revised forecast of $5.10 per kgMS announced on 22 September 2009. Fonterra Chairman, Sir Henry van der Heyden, says although the recovery in consumer demand and the global economic situation remain relatively fragile, the higher forecast reflects the Co-operative's increasing confidence around the recent gains in international dairy prices. "The improvement in global dairy markets reinforces that dairying is a business that's in good heart with sound long-term prospects, both for Fonterra shareholders and the broader New Zealand economy. However, Sir Henry cautioned: "A big gain like this in the payout forecast, just shows how much volatility there is in the market. "It's heading in the right direction and we're making the most of the opportunities for our farmers. But, we also know there's a risk of rapidly rising prices potentially bringing on more milk from other countries. We saw this happen in 2007 and we saw how quickly the market can fall as a result." At its meeting to review the payout forecast, the Board also agreed that if farmer shareholders vote in favour of Capital Structure Steps One and Two at the Annual Meeting on November 18, the Board would ensure farmers had all the information they needed to make decisions around the purchase of additional shares. This would include advising farmers of the interim Fair Value Share valuation and any dividend retention policy early in December. Fonterra CEO, Andrew Ferrier, says improving market conditions for dairy commodities have been reflected in recent trading events on Fonterra's globalDairyTrade (gDT) online platform, which in the last financial year accounted for about 10% of Fonterra's sales. Since the September forecast revision, there have been two monthly trading events, the most recent when whole milk powder (WMP) prices rose by an average 13.7 per cent. Over the past four months, average WMP prices on gDT have risen by a total of 88 per cent. Mr Ferrier says there is a tight supply situation globally for many dairy commodities and this is reflected in current pricing. Fonterra has also recently confirmed some key contracts with major customers, further improving confidence about the season's outlook. "Although prices for all dairy products are now increasing, the recovery has been strongest across the range of commodity milk powder streams that are used as the basis for the Milk Price component of payout to Fonterra farmers. This is good for our farmers, as it drives a higher milk price, but it is putting profits under pressure". "Prices for non-powder products such as cheese and casein have not risen at the same rate as powder prices. Under Fonterra's new Milk Price, if Fonterra cannot achieve an equivalent return for these products compared to milk powders, the difference comes off profit. This is the primary reason for our forecast reduction in profit," Mr Ferrier says. Although Fonterra expects the differential in returns to recover over the medium term, returns for non-Milk Price products are forecast to be lower, relative to powders, for the remainder of the current financial year. As a consequence, the Distributable Profit (Value Return) forecast has been reduced by 15 cents to 35 cents. "The other business units that contribute to profit (principally the consumer Brands businesses and global dairy ingredients and foodservices) continue to perform well and their expected earnings for 2009/10 remain unchanged from previous forecasts. "However the high NZ$/US$ exchange rate would impact negatively when the profits were converted back into New Zealand dollars. "The high dollar is certainly hurting earnings, and the level of volatility is making forecasting a challenge. The opening forecast for 2009/10 was based on an exchange rate of US59 cents, and the New Zealand dollar has recently been trading as high as US76 cents. "Although recent exchange rates have been fully factored into the revised forecast, and we have a portion of hedging in place at this stage of the season, there remains significant uncertainty about the medium to longer term exchange rate outlook," Mr Ferrier says.