Fonterra Increases 2007/08 Payout Forecast
30 May 2008
2007/08 Payout Forecast
Fair Value Share And Payout Forecast Announced For Next Season
Fonterra today announced a 60 cent increase in the Co-operative’s 2007/08 forecast payout to $7.90 per kg of milksolids (kgMS), and a record opening forecast of $7.00 for next season.
Fonterra signalled in April the potential for further upside in this year’s payout, and Chairman, Henry van der Heyden said it was satisfying to be able to confirm a further increase in payout – particularly given the current volatile trading environment and unstable financial markets increasing Fonterra’s cost of capital.
Mr van der Heyden said this season’s record payout and the strong forecast for 2008/09 gave “every reason to be confident about the outlook for dairying”. The new forecast for the current season is made up of a milk price of $7.55 and a value component of 35 cents.
“This is good news for our farmers to have the extra cash flow at a time when they are facing sharply rising input costs, which DairyNZ confirms are up by 32% over the past year. It will also go some way to make up for the production lost this season due to the drought.”
Mr van der Heyden said, at a time of slowing economic growth, this season’s Fonterra payout would inject around $9 billion into the economy on top of 10,000 local jobs and the broader stimulus of dairying, stretching across rural and urban New Zealand.
Key factors in the latest increase in payout were the continued strength of international dairy commodity prices – underpinned by a shortage of New Zealand production due to the drought – a weakening New Zealand dollar, along with performance gains within the company.
Fonterra’s final payout for 2007/08 will be announced in September. Given the instability in the financial markets the Board has signalled the likelihood of retained earnings of around 30 cents/kgMS but this would not be finalised until September, Mr van der Heyden said.
While the demand outlook was positive and there were tangible performance gains across Fonterra’s businesses, he said uncertainties in the external environment required the Fonterra Board to take a prudent approach.
Fonterra Chief Executive Andrew Ferrier said: “There is an unprecedented level of volatility in all agricultural commodities, forecasting prices is more difficult, and there have been fundamental changes in equity markets – all of which we need to take into account in running the business.
“In recent seasons, there has always been a higher probability that the forecast would go up. Next season the volatility in prices means there is an equal possibility of it going up or down,” Mr Ferrier said.
FAIR VALUE SHARE
Fonterra’s Fair Value Share price for 2008/09 has been set at $5.57, a fall of $1.22 on this season’s price of $6.79, partly because of the high commodity prices driving payout. This fall is broadly comparable with the drop in share prices in New Zealand over the past 12 months.
“We can’t have our cake and eat it too,” said Mr van der Heyden. “The credit crunch in global financial markets, ongoing high commodity prices cutting into our Ingredients margins and a higher milk price has hit our share price.”
Fonterra’s Fair Value Share process takes into account all available and material information at the time the valuation is carried out, twice yearly, as opposed to listed shares that fluctuate throughout the year on their earnings and outlook.
“While the fall in the Fair Value Share is disappointing, the Board has confidence in the business, its outlook and that the impact of changes in the external environment has been fully taken into account,” Mr van der Heyden said.
The independent valuer, Duff and Phelps, determined a range of $5.26 to $6.11 for the Fair Value Share with a mid-point of $5.68.
Mr van der Heyden said the lower valuation was driven by three major factors. Fonterra’s cost of capital had increased significantly reflecting the credit crunch and falls in world share markets in the past year.
He said the general rise in global commodity prices had also compressed the difference between international and domestic commodity and ingredient prices in markets such as the US, Europe and Japan – where prices are traditionally higher.
And, Mr van der Heyden said the valuer had also updated cost assumptions which resulted in a higher milk price. “These factors have resulted in a decline in the value of our core ingredients and global trading business.”
“So our farmers are enjoying record returns as suppliers, but unstable global financial markets, high commodity prices squeezing ingredients margins, and a higher milk price have impacted negatively on farmers’ investment in the Co-operative.” On the positive side, the valuer also took into account stronger profitability in Fonterra’s consumer businesses and gains in the performance of overseas investments and joint ventures.
“The value of these businesses has increased materially over the past 12 months,” Mr van der Heyden said. “Good examples include Fonterra Brands’ businesses in Asia, Soprole and our overseas investments.” Corporate cost savings and other cost reductions also partially offset the external factors.
“But this has not been enough to compensate,” he said.
Mr van der Heyden said the Fonterra Board set the Fair Value Share 11 cents below the mid-point of the valuation to reflect a one-off net cost to the Co-operative of redeeming ‘dry’ shares (shares not backed by milk supply this season) due to the drought. This was a matter that the valuer was not in a position to consider at the time of the valuation.
Mr van der Heyden said, as in previous years, the Board continued to have a different view to the valuer on technical tax matters relating to the valuation. The Board had taken this into consideration in setting the Fair Value Share price, he said.
“A fall in the Fair Value Share is a new dynamic and one that affects everyone in different ways depending on their situation. For the vast majority of farmers, there’s a positive – the lower share price means they have the opportunity to get some of the fall in value back in their hands.”
As a result of the drought, the majority of Fonterra’s farmer-shareholders will hold excess shares (above their season’s milk production) that they can surrender at the current share price of $6.79.
Usually, when there are fewer dry shares, they are entitled to redeem these shares at this season’s share price of $6.79 and buy back in at next season’s share price of $5.57 at the end of the season.
Mr van der Heyden said the Board would be encouraging shareholders to take advantage of this opportunity to surrender excess shares.
But to protect the Co-operative from an excessive number of redemptions, farmer-shareholders surrendering shares who are going to return to previous production levels, will be issued with more Co-operative shares at the beginning of next season, rather than at the end. In other words they will be paid out the $1.22 differential between the two share prices for each share they choose to surrender. Payments at the end of the season will be made in cash, capital notes or a combination of the two.
With the fall in the Fair Value Share, Mr van der Heyden said the Board had also made a provision to allow shareholders to increase milk production by up to 20% without buying more shares. The lifting of the Co-operative’s ‘Unshared Supply’ threshold will reduce the extent to which suppliers growing production have to purchase shares at the 2007/08 share price of $6.79.
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