UPDATE2: Fonterra reaped gains from slow supplier payments

UPDATE2: Fonterra says it reaped $50M-$70M benefit from extending supplier payments

(Recasts to add comment on delayed payments, executive comment)

By Fiona Rotherham

March 23 (BusinessDesk) - Fonterra Cooperative Group, the world's largest dairy exporter, says it gained a $50 million-to-$70 million benefit from extending payment terms by a month to about 1,000 New Zealand suppliers.

The dairy cooperative caused a storm this month after confirming it had asked another 1,000 suppliers in New Zealand to wait up to three months to have their invoices paid.

Fonterra chairman John Wilson said the policy was introduced globally in 2011 but had not been implemented consistently. The New Zealand suppliers were added at the end of last year although the policy affects 15 percent of its 20,000 suppliers worldwide.

He said Fonterra won’t be changing the policy but could have communicated better with affected suppliers.

“While the policy is right we have work to do to ensure no errors occurred and there’s a better understanding of what we have done,” he said.

Chief executive Theo Spierings said the policy was introduced to put Fonterra on a more level playing field with its global competitors because it already had a $150 per tonne disadvantage from route to market and had to wait six months before it got paid for the goods it sells.

The cooperative doubled its interim dividend today to 20 cents today – the highest ever - after shifting more production to higher-margin products following weak prices for its main product, milk powder. It reported a 123 percent jump in first-half profit to $409 million for the six months ended Jan. 31 while revenue fell 9.3 percent to $8.8 billion due to low commodity prices even as volume rose 8 percent.

ASB rural economist Nathan Penny said the improvements in the first-half results were encouraging and roughly in line with analyst expectations. “That said, comparisons with last season’s very weak results tend to gloss over what are still relatively weak absolute profit levels,” he said.

He said the result is a step in the right direction for Fonterra’s performance and its value-add strategy but there is still a long way go.

Fonterra reiterated its forecast 2015/16 milk payout of $3.90 per kilogram of milk solids and Wilson said while it would wait until May to give its farmer suppliers a forecast for the 2016/2017 season advance rate, he expected global milk prices will start improving in the next six months as global supply and demand slowly rebalances.

Fonterra has been considering ways to help support its cash-strapped farmer shareholders including whether to offer another interest-free loan which 76 percent of farmers took up late last year at the cost to the company of $390 million.

That had stretched the balance sheet after Fonterra also took on debt to take a cornerstone stake in China's Beingmate Baby & Child Food Co and incurred the wrath of the ratings agencies. Instead the co-operative is paying its final dividend earlier than usual – 20 cents paid in two 10 cent increments in May and August, to get the money into farmers' hands as quickly as possible.

Wilson said the interest-free loan was the “most appropriate” form of support at the start of the 2015/2016 season but it now had the cash in the bank that allowed it to bring forward the dividend payment. The timing of this year's dividends was "a specific response to the current, very challenging, financial conditions farmers are facing" and didn't signal a permanent change away from twice yearly payments, he said.

ASB's Penny said smoothing farm cash flows will help, however, for now, the low milk price remains the dominant factor impacting farmers. “We do note, in making this decision, Fonterra is likely to have weighed up helping farmers’ cashflow struggles against its own balance sheet health,” he said.

Net debt is currently $6.9 billion and its debt to equity levels fell to 49.2 percent at Jan.31 from 50.7 percent a year earlier. The company said it was on track to drop that further to the promised 40 to 45 percent in the second half when it has less milk to deal with.

The biggest improvement in the first half came from Fonterra's consumer and food service business, which lifted volumes by 10 percent and improved its gross margin to 28 percent, resulting in a 108 percent jump in normalised earnings before interest and tax of $241 million. A further 235 million litres of milk was shifted higher up the value chain into consumer and food service products in the first half.

When asked about criticism Fonterra’s leaders hadn’t moved quickly enough to turn to value-add as global dairy prices dropped, Spierings argued management had moved the company at an “enormous pace” while at the same time having to build new driers to cope with extra volumes of milk as production ramped up.

He said the co-operative had shifted one billion litres of milk over the past 18 months into the value add side of the business – moving from a 4 percent return on the GlobalDairyTrade auction to 25 to 30 percent in the consumer and food service business. In any context, that was moving fast, he said.

Wilson said the cooperative has had to build the right assets to deal with increased milk volumes as efficiently as possible while also making significant investments in the consumer and food services side of the business. “That’s what we have been doing for the last few years and it’s now having an impact.”

He said the long-term fundamentals for global dairy remain positive with demand expected to increase by two to three percent a year.

Fonterra remains committed its China farming operations which booked a $29 million loss in the first half, up $2 million on a year ago due to falling domestic milk prices. It has completed 10 farms in China that are expected to produce around 250 million LMEs (liquid milk equivalent) this financial year and a third hub is planned with its joint venture partner, Abbott.

In the first-half, Fonterra booked a $12 million impairment on its loss-making Australia operations where the rebuilding this year of the Stanhope cheese factory, destroyed by fire, is expected to help turn things around.

(BusinessDesk)

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