Fonterra faces earnings hit despite dairy boom

Monday, 31 March 2014 00:00 - - {{hitsCtrl.values.hits}}

WELLINGTON (Reuters): New Zealand’s Fonterra, the world’s largest dairy exporter, should be flying high on the back of record prices and a “white gold” rush as Chinese demand for milk powder soars. But the nation’s biggest company is expected to reveal a sharp decline in first-half profit on Wednesday, as higher costs, too much milk and a lack of capacity to process higher-yielding products hit earnings.

The co-operative, which controls about a third of global dairy exports, said in December that it expected full-year earnings to fall by up to half from last year’s NZ$1 billion ($854 million) and has slashed its dividend payout. World dairy prices have hovered near record highs for the past year due to surging demand from China and other emerging countries, where growing middle classes are developing a voracious appetite for milk, infant formula, and other products. Fonterra earns its best returns from milk powder, which it ships to China for the fast-growing infant milk formula market, but has been struggling to meet demand due a lack of factory capacity for the product. At the same time a bumper dairy season in New Zealand has resulted in all-time high volumes, which Fonterra is obliged to buy at historically high milk prices. What can’t be made into milk powder has been used for lower-margin cheese products. The company said in December this was cutting about NZ$800 million from its revenues, and analysts said it was still having an impact. “In the last few months there’s been some normalisation of cheese and whole milk powder prices, so they’re probably losing less money now than what they were before Christmas,” said Harbour Asset Management research analyst Oyvinn Rimer. Fonterra’s financial woes come as it faces legal action from France’s Danone, which is suing for compensation after a contamination scare that sparked the recall of infant milk formula across Asia last year. The profit fall may also may slow the co-op’s expansion plans, which include deepening its presence in China’s branded milk formula market. Despite building the world’s largest milk powder dryer, Fonterra is still struggling to meet demand, particularly in China, which sources up to 90% of its milk powder imports from New Zealand. Analysts have refrained from issuing first-half earnings forecasts after Fonterra said in December it was unable to pay farmers a full farmgate price for raw milk, as the high prices were hurting its operating margins. It has forecast a farmgate milk price of NZ$8.65 per kilogram of milk solids for the year to July, less than its official reference price of NZ$9.35m calculated from global dairy prices set at the co-op’s fortnightly auctions. Because the reference price is used to calculate operating costs, analysts have been unable to gauge the company’s performance. “It’s difficult to give a forecast because of the gap between the theoretical milk price and the actual price they can pay out,” ANZ rural economist Con Williams said. “So it’s hard to predict the performance of different business units, let alone how they might present those results.”