Fonterra reports first interim profit; sticks with forecast for record milk payout, but warns markets could correct; 2010/11 output may beat 09/10

By Bernard Hickey

Fonterra has announced its first ever net profit for the half year to January 31 and reiterated its recently upgraded forecast for a payout of NZ$7.75-7.80/kg in the current 2010/11 season.

This would beat the previous record high cash payout of NZ$7.66/kg in the 2007/08 season and be up from the NZ$6.37/kg payout from last season.

Fonterra said it expected production for the full 2010/11 season would be in line with or slightly ahead of the 1.286 billion kg of milk solids collected in 2009/10 despite an early Summer drought in Northland and the Waikato. This implies a total payout for Fonterra's 10,500 farmers of around NZ$10 billion, up around NZ$1.84 billion from the previous year.

See our February 22 article on the 60 cent increase in the forecast.

However, Fonterra chairman Henry van der Heyden warned that there could be a downward correction in prices and farmers should always be prepared for a drop on global commodity markets, particularly if recent steep rises eat into demand.

Last week prices at Fonterra's fortnightly auction of milk powder fell 8.2%. See our March 16 article here on the auction results.

Fonterra reported a net profit of NZ$293 million or 21 cents per share for the first six months and is forecasting a distributable profit of NZ$550-690 million for the full year.

Fonterra is forecasting a milk price for the year of NZ$7.50/kg and distributable profits of 40-50 cents a share. However, Fonterra is planning to retain between 15-20 cents a share, leaving a dividend of around 25-30 cents.

Van der Heyden said current dairy prices appeared to reflect a change in supply and demand for food internationally.

“We are benefiting from a combination of demand growth from China and other Asian markets, and tighter international supply due to adverse weather conditions in many parts of the world," he said.

"To date, these higher prices have more than offset the negative effects of a stronger New Zealand dollar against the US dollar, in which most international dairy sales are denominated. We must be mindful of the impact that dairy prices can have on demand in some markets, as well as on supply growth around the world. As prices continue to climb, the possibility of a downward correction can increase and farmers should always need to be prepared for a potential global price drop.”

Fonterra's departing CEO Andrew Ferrier said the rising milk price was putting some pressure on Fonterra’s operating earnings, which were primarily driven by the ability to make and sell a range of dairy products at a margin above the cost of milk collected from farmers. See our March 1 article article on Andrew Ferrier signaling plans to leave later this year. A search is on for a replacement.

“This margin squeeze is particularly significant in our ingredients businesses where the cost of raw milk represents a substantial proportion of total operating costs. Thanks to our strategy of building leading brand positions in key categories, our consumer businesses are better placed to withstand price increases – but they are not immune.”

Tax and TPP

Later in media briefing, Van der Heyden said the current outlook was for a 1% increase in production in the current year from last year. In future years he saw no change to the current outlook for average production growth of 2-3% a year. Although he noted that the surge of conversions to dairy seen 4 to 5 years ago was unlikely to be repeated as financing was harder for farmers to find.

He said farmers were being careful with their windfall record payout this year, with many repaying debt.

Asked if Fonterra thought the Trans Pacific Partnership would allow it to export more into America, Ferrier said Fonterra was looking elsewhere for growth. Prices in Asia were higher than in the United States.

Fonterra paid NZ$7 million tax on operating profits in the first half.

Van der Heyden said he expected most farmers, including himself, would pay tax this year.

See more detail below on the results from Fonterra:

Half Year Financial Highlights

Revenue of $9.4 billion, 21 per cent higher than the corresponding period in FY 2010, primarily reflecting the impact of higher international dairy prices which were partly offset by a slight decline in sales volumes.

Net Profit After Tax of $293 million, of which 21 cents per share is attributable to shareholders. This is the first time Fonterra has reported a half year profit.

Interim Dividend of 8 cents per share will be paid to shareholders on 20 April 2011, out of a full year target dividend of 25-30 cents per share. The interim dividend in FY10 was also 8 cents per share.

Gearing ratio(economic debt to debt plus equity, which takes account of the carrying value of debt hedges) was 48.5 per cent at 31 January 2011, a substantial improvement from 54.3 per cent a year earlier. The key contributors to this were increased equity contributions from shareholders, increased retentions as a result of adoption of the Group’s dividend policy, and recording an interim profit for the first time. Although the gearing ratio at 31 July 2010 was lower at 44.9 per cent, the seasonal nature of Fonterra’s business means the more meaningful comparison is with the position at the previous half year.

Milksolids production in New Zealand for the season to 31 January 2011 was marginally ahead of the same period last season, reflecting difficult climatic conditions across much of the country. Assuming normal rainfall in the March-May period, overall production across the entire 2010/11 season is expected to be broadly in line with, or slightly ahead of, last season.

Commodities & Ingredients segment revenue for the half year was 24 per cent higher at $6.3 billion, with higher selling prices for dairy products, partly offset by a 2.6 per cent decrease in sales volumes. Normalised segment earnings before net finance costs and tax were $194 million. As in the previous year, a rising Milk Price placed pressure on Fonterra’s ability to make and sell a range of dairy products at a satisfactory margin above the cost of milk collected from farmers.

Australia/New Zealand revenue was up 18 per cent to $1.8 billion, mainly because higher commodity prices flowed through to consumer pricing and partly from the effect of a higher Australian dollar against the New Zealand dollar. Normalised segment earnings before net finance costs and tax were $153 million. ANZ’s businesses continued to perform well despite sustained competition across many categories.

Asia/Africa, Middle East revenue increased 13 per cent to $832 million. This was almost entirely due to price increases across all categories, with volumes year to date in line with the previous half year. Normalised segment earnings before net finance costs and tax were $93 million. Asia/AME’s continued focus on higher value brands and a strong nutritional focus in South East Asia has given its brand portfolio greater resilience despite the impact of near-record milk prices.

Latin America revenue, which reflects our Soprole business in Chile, increased 14 per cent to $403 million. While more than half this increase was price related, overall volumes increased slightly due to growth in the yoghurts, desserts, milk, cheese and butter categories. Normalised segment earnings before net finance costs and tax, which includes Fonterra’s share of its DPA joint venture earnings, were $64 million.

(Updated with detail, comments on tax paid, production outlook and Trans Pacific Partnership)