Difficult year for Fonterra indicated

Broker Damian Foster said Fonterra had lowered its collection forecast for the 2017-18 season by about 3%.

However, a spate of wet weather had subsequently improved the pasture growth outlook and Forsyth Barr had factored in a drop of just 2%.

Forsyth Barr had downgraded its earnings per share (EPS) forecast by 6%, reflective of lower collections and lower “stream profits” return outlook.

Fonterra faced a tough start to the year, Mr Foster said.

Domestic milk production slowed late last year as a dry December constrained pasture growth and milk output.

Coupled with the continuation of unfavourable global dairy price movements, it had led to a downgrade in earnings expectations.

“We are aware Fonterra continues to lose market share in the milk supply market, falling to an all-time 12-month average low of 82.1% as at November 2017 — 83.3% in November 2016.”

Under the revised Dairy Industry Restructuring Act review, competition would be triggered if Fonterra’s collection market share fell below 70% of total New Zealand collections, or at the end of the 2020-21 season, whichever came first, he said.

The relative pricing of whole milk powder and cheddar had continued to deteriorate since late October, eroding the likelihood of a profitable stream outcome for Fonterra in the 2018 financial year.

The previous expectation of a $30 million stream profit contribution had been removed to reflect the price deterioration.

Global dairy consumer and food service markets remained attractive but competition was intense and earnings uncertainty was commonplace, Mr Foster said.

The ingredients business was showing performance improvements and Fonterra was receiving higher prices for some products. Uncertain returns could materially boost or dampen performance.

The global prices for Fonterra’s reference commodity prices — whole milk powder, skim milk power and butter — dictated the farmgate milk price Fonterra had to pay to its suppliers.

The differential between non-reference prices, like cheese and casein, and reference commodity prices could benefit or hurt Fonterra’s earnings. A positive differential helped drive profits, he said.

Fonterra was trying to drive a value-add strategy to complement its commodity operations, which were driven by offshore markets.

“Fonterra’s ability to obtain market share in infant formula/maternal product lines, as well as the food service market, is key to success.”

Mr Foster said there was a disconnect between farmer shareholder and investor unit holder desires. Farmers preferred the maximisation of the farmgate price and unit holders preferred a low farmgate price and a higher dividend.

Fonterra was also facing competition in key markets. Chinese infant formula was challenging and domestic company incentives were providing a market share buying dynamic among peers. Also, regulatory changes were constraining growth.Biosecurity was a major risk for Fonterra, he said. An outbreak of foot and mouth, or another bovine disease, could have material implications for Fonterra and the dairy industry.

The Mycoplasma bovis discovery in New Zealand presented some risk to milk volumes.


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