Fonterra's advance payment for farmers 'right thing to do'

Fonterra says advance payment support for farmers 'right thing to do' despite interest costs

By Fiona Rotherham

Sept. 24 (BusinessDesk) - Fonterra Cooperative Group chairman John Wilson said supporting the cash flows of farmer suppliers hard-hit by slumping global dairy prices was "the right thing to do" even though it was one of the factors which added 6 cents a share in interest costs in the 2015 financial year.

The cooperative’s cash interest costs on funding rose $95 million to $427 million in the year ended July 31, reflecting advance payments to farmers, funding for the $755 million purchase of 18.8 percent of Shenzen-listed Beingmate Baby & Child Food Co, and its three-year, $2.1 billion investment programme to increase and update production capacity.

Fonterra still achieved a strong overall result with net profit up 183 percent to $506 million after the dairy company shifted production to higher-margin products in a challenging year.

The company managed to squeeze more profit from less revenue with the gross margin for the year rising to $3.28 billion or 17.4 percent, from $2.46 billion, or 11.1 percent a year earlier. Return on capital was an overall 8.9 percent, which chief executive Theo Spierings said reflected a strong second-half performance in a difficult market around the globe.

Wilson said it was critical to get the benefit of the group’s “game-changing transformation” to more value-add products through to “farmers as quickly as we can” with payout levels still at unsustainable levels despite a 75 cent increase in the 2016 farmgate milk price forecast to $4.60 per kilogram of milk solids announced today, with a dividend forecast unchanged at 40 to 50 cents per share. Pay-out levels need to be starting with a $6 number for farmers to be making money, he said.

That’s why the interest-free loan Fonterra is offering its farmer shareholders doesn’t have to be repaid until the farmgate milk price or advance rate rises above the $6/kgMS mark.

So far more than 7,000 loan applications have been received, amounting to 70 percent of farmer shareholders, for the loan offer of an additional 50 cents per share-backed kilogram of milk solids for production through to December. The anticipated cost of the support programme, which starts in October, is as much as $430 million.

Wilson said the loan package would be reviewed in December, depending on the number of farmers involved, the success of the review of the business in releasing working capital on the balance sheet, and what level is sustainable for farmers.

Some 750 Fonterra workers, half within New Zealand, have lost their jobs in two ranches as a result of the operational review but Spierings said there would be no “third wave” and it was back to business as usual on that front. Staff numbers have risen to 22,000 from 18,500 this year, although that includes some of those since laid off.

The increase came mainly on the back of an extra 2,633 headcount picked up due to shareholding changes in Fonterra and Nestle’s Dairy Partners America joint venture last year which shifted Brazilian workers onto its books.

There is concern over Fonterra’s increased leverage, with the debt-to-equity ratio rising to 49.7 percent, from 42.3 percent last year.

ANZ economist Con Williams said the jump in gearing followed a big uplift in capital expenditure in recent times which has now been reined in and "this will need to start to pay for itself quickly over coming years," he said.

Spierings said there was a danger of over-capacity now given milk production in New Zealand is forecast to fall 5 percent this season.

"If we don't keep a close eye on that and look at phasing investments going forward then yes, there is a danger, what's why we're making sure that will not happen." Most of the investment has gone in value add production or adding optionality to existing plants so they can more easily be switched from producing reference products such as whole milk powder to more value-add production.

Chief financial officer Lukas Paravacini said the debt-to-equity ratio was set as at July 31, at which time Fonterra had made an advanced payment amounting to 97 percent of the season's total payout, compared with a typical level of advanced payment of 84 percent. That difference was a $900 million increase in advance payments to farmer suppliers to help tide them through a second season of low returns.

That added 3.3 percent to the debt gearing ratio which by October would be adjusted back to 46.4 percent with a long-term goal of returning it to the 40-to-45 percent range, he said. Debt to equity was just one measure and he was more focused on maintaining a stable credit rating for the cooperative which has an AA- rating (stable outlook) from Fitch and an A rating (credit watch with negative implications) from Standard & Poor's, Paravacini said .

There was a strong performance from the ingredients business, which took advantage of the change in relative commodity prices to adjust its product mix away from whole milk powder to cheese and casein in the second half, lifting normalised earnings before interest and taxation by 43 percent to $973 million.

The cooperative is still facing challenges in Australia, where it took a $108 million writedown of its yoghurt and dairy desserts assets. Ingredients manufactured across the Tasman returned a gross margin loss of $27 million as a result of lower sales of nutritionals and a fire at the Stanhope cheese factory in December.

Paravacini said they’re about half-way through a turnaround in Australia with food services showing good growth of 10 percent by volume and new relationships with Coles and Woolworths. It has also attracted new customers to its formerly loss-making Darnum plant which went into the Beingmate joint venture and he said the company had a “clear view on bringing the Australia business towards the type of profitability it would expect it to have.”

He also said the company had not written down its investment in Beingmate despite the shares now trading at 11 yuan compared to the 18 yuan it paid for them.

An impairment assessment was made at the end of the financial year but Paravacini said the value hasn’t changed in what is a long-term investment despite short-term share price movements. “It still has the same strategic value.”

(BusinessDesk)

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