Fonterra faces a simpler, but probably less profitable future as its transformation takes place in markets that are growing increasingly uncertain. It may be becoming a dulled beast

With the last Global Dairy Trade auction completed no great surprises occurred. The small drop (-1.2%) following small compounding increases in the past six months has put the average GDT price back to somewhere near the average for the last ten years.

I still have concerns over the WMP price continuing to decline (–2.1%) and while still above the US$3,000 level it is the one to watch. At its current level it is still slightly ahead of its five-year average although the lean 2015 period had a major influence upon this figure.

There seems to be wide and general agreement that next season will have a $7 in front of at least the opening gambit. This will be welcomed by all and while most developed countries are experiencing low inflation farm costs still seem to keep ahead reducing some of the benefits.

The biggest risk to dairy prices as usual is China’s appetite for milk among other food products. Fortunately, although China’s growth is grinding down, largely due to the US vs Beijing trade war New Zealand may be one who benefits as consumer demand for food continues to grow although apparently not form that sourced from the US. China does not have the ability to wind up US tariffs to the same degree as the US can do to China.

But China does have far greater control on what and how the Chinese spend their money and tariffs aside China has the ability to cut off spending on money US products even if it means making sacrifices within China. This has been shown with pork where even though China is grossly short of pork through African swine fever with up to a third of its herd needing to be culled and the US able to export large amounts, Chinese imports of US pork have been cut by US$6.5 billion.

While here meat schedules are not responding to an increased demand yet there are rumours that mutton prices are due for a lift on the back of Chinese demand. I can recall a similar situation (different drivers) when Japan stopped commercial whaling in the late 1980’s and New Zealand took the opportunity to supply mutton into their schools program from memory to replace the whale meat. Even the All Blacks went over on a promotional tour. I think this was the beginning of ANZCO, different owners back then.

Yet another dairy company has got the green light to go ahead, with the Happy Valley Dairy Company in Otorohanga now having the bulk of its required consents approved and construction due to start in September. With the Waikato having multiple processing plants setting or set up the long awaited DIRA review recommendations which must be getting closer will make interesting reading. Listening to Dominick Stephens (Wespac Chief Economist) the other morning discussing the New Zealand economy and what he was saying that he believed for NZ Inc to make some real progress it needs a real market leader to compete on the world stage. When pressed he said that the only real potential he could see was with Fonterra which is where we have a competitive advantage or a hi-tech company, no doubt still to be revealed.

To my mind Fonterra has a way to go before it can even contemplate being in such a position especially with its current mind set and financial structure.

Fonterra have released their latest market update and prices for the current and next season are generally lower than what most pundits were picking. The current season is looking like it will be between $6.30 - $6.40 a more narrow range than previous ($6.30 - $6.60) and next season the range is $6.25 - $7.25 which is almost no range given the breath of the numbers but perhaps reflects just how much can go wrong rather than what they expect to get.

With rumbles of impeaching Trump getting louder the potential for major disruptions to international markets are great, and can go both ways.

The Aussie drought seems to have claimed another victim with the impending closure of Fonterra's Dennington plant in Victoria. Over capacity (especially in light of climatic conditions) and “other significant changes” are given as reasons.

Further sales in the pipeline with the selling of their share of Dairy Partners Americas in Brazil (DPA), which is a joint venture with Nestle, and a strategic review of its two wholly-owned farm-hubs in China with the likely outcome of them being sold off.

Financially things still look tight for the big Coop and while volumes were up +4%, revenue was (only) up +1%.

However, normalised earnings before interest and tax fell 9% to $522 million. Hurrell said that there are some heightened risks in the fourth quarter to Fonterra's previous forecast normalised earnings and it lowered guidance to 10-15 cents per share from 15-25 cents. That implies a forecast range of $161.2-241.8 million, compared to $241.8-403 million.

For the consumer and food service division, it lowered its forecast normalised EBIT to $400-$430 million from its prior forecast of $475-$525 million. For its ingredients business, Fonterra lowered the forecast to $645-$725 million from the previous $750-$850 million range.

Given these results it can hardly be said that the Coop has managed to turn itself around. However with all the trimming going on it does look as though it will be a simpler business to manage. Whether that will pay the bills in the future remains to be seen.