Milk Monitor Fonterra looks to maximise value and retain suppliers

Strategy paints bold future

By Gerald Piddock

Each month the milk monitor delves into the dairy industry and gives us the low-down on the good, the bad, the ugly and everything in between.

Released at Fonterra’s annual result, its areas of focus will be making the most of New Zealand milk, investing in dairy sustainability, innovation science and nutrition.

The logic behind this is pretty simple, as covid has made consumers more conscious of the nutritional qualities of food and that means they want our grass-fed milk

“Putting it simply, the world wants what we have got: sustainably produced, high-quality nutritious milk,” chief executive Miles Hurrell said at the time.

The long-term protection of that milk pool has played a large influence in

Fonterra’s capital restructure proposal.

Fonterra chairman Peter McBride says retaining the status quo could see its milk pool decline by as much as 20% by 2030 in modelled scenarios.

“Our operating environment has changed significantly. When

TAF (Trading Among Farmers) was implemented, milk supply was growing rapidly, now we’re seeing more land go out of dairy than coming in,” McBride says.

This likely land-use change will mean a flatter production curve as environmental regulations prevent intensification.

“Our share of that decline will depend on the actions we take now,” he says.

He went on to say modelling also forecasted a 6-13% lowering of the milk price without those changes.

In a nutshell, Fonterra has proposed to allow a more flexible shareholding structure and allow more kinds of farmers to become shareholders – sharemilkers, contract milkers and lessors.

While this is a response to longstanding criticism of the difficulties for young farmers to purchase Fonterra shares, it is also to help retain these farmers in the co-operative and make it less likely for them to be enticed by other milk companies. The era of large-scale dairy conversions and expansion is well and truly over. What is revealing in the annual result presentations was there was no mention of the C word – competition.

In case you hadn’t noticed, the country’s largest dairy region, Waikato, is becoming increasingly crowded.

The world’s third-largest dairy company Olam confirmed its plans to set up a factory in South Waikato as it seeks a slice of the country’s grass-fed milk pool.

Add to that Happy Valley Milk’s planned factory in Otorohanga, they will join Tatua, Synlait, Open Country Dairy, Fonterra, the Dairy Goat Co-operative, Maui Milk, Miraka, Spring Sheep and Yashili.

Now to be fair, some of these are not actively seeking out new suppliers, but there are a lot more options out there

Fonterra’s capital restructuring proposal is designed to retain suppliers within the co-operative, as it looks to maximise the value of its homegrown milk.

Fonterra chairman Peter McBride says Fonterra’s retention of their share of the milk pool has played a big part in Fonterra’s capital restructure.

now for the region’s 4200 dairy farms.

This all makes the capital restructure proposal understandable as Fonterra strives to retain those suppliers.

The strategy also has an average milk price target of $6.50-$7.50/kg MS over the next decade. That’s not giving a lot of wriggle room given AgFirst’s recent financial survey forecasted a breakeven milk price of just under $7/kg MS for Waikato and Bay of Plenty dairy farmers.

It aims to bring debt gearing down to 33% and reduced interest payments would enable steadily increasing dividends to 40-45c a share by 2030.

“Through planned divestments and improved earnings, we could target an intended return of about $1 billion to shareholders by FY24,” Hurrell says.

It also maintained its midpoint $8/kg MS milk forecast for the current season. The two most recent lifts in GDT auctions cemented prices at healthy levels and have undoubtedly helped with ASB lifting its forecast to $8.20/kg MS.

Rabobank has been more cautious, lowering its forecast to $7.80/kg MS, due to what it believes will be a slowdown in demand from China.

Rabobank senior analyst Emma Higgins described it as “muted” in a recent webinar.

She said in Farmers Weekly that supply was outpacing demand in China, with domestic milk production growth combined with growing inventories of dairy products. “Our overarching view is that we think milk supply is outpacing demand in China,” Higgins says.

The bank’s Dairy Quarterly Report said China’s own milk supply is growing 6-7% annually and its milk powder importing has been up 40% in the first half of 2021.

It forecasts that importing will fall by 18% in the second half to drive some destocking of the excess supply.

What could impact the market further is the potential fallout from the financial difficulties of Chinese real estate developer Evergrande.

The company is one of China’s largest and was caught by tighter borrowing restrictions imposed by Chinese regulators last year, prompting fears it may default, owing $420b in debt.

If this occurred, financial analysts feared it could lead to a property bust in China, sparking comparisons to the 2008 financial collapse of the Lehman Brothers and the subprime mortgage crisis.

This could spill over into the global economy if it triggered a property market collapse in China.

Higgins says they are watching that situation very closely. n

Fonterra chief executive Miles Hurrell says covid-19 has led to people paying closer attention to food and nutrition, putting grass-fed dairy in high demand.