Fonterra in ‘Extraordinary Situation’ as Milk Demand Surges

Fonterra Cooperative Group Ltd., the world’s largest dairy exporter, refrained from raising its projected payout to farmers even as China drives a surge in demand for milk, saying higher prices are hurting profits.

Fonterra today maintained its forecast milk price at a record NZ$8.30 ($6.90) a kilogram of milk solids for the 2013-14 year, even as it acknowledged it could have raised the price to NZ$9. It also projected full-year earnings will decline and cut its dividend forecast to 10 New Zealand cents per share from 32 cents, citing price volatility.

Fonterra said it can’t increase milk-powder production quickly enough to meet soaring demand from China and other emerging economies. That means 30 percent of its milk is still being used to make products such as cheese and casein, which are currently generating lower returns. Raising the milk-price forecast would make it more costly to produce those items.

“We are in an extraordinary situation,” Fonterra Chairman John Wilson said in a statement. “The gap between prices for milk powders compared to cheese and casein is greater than it has ever been before.”

Earnings before interest and tax in the year ending July 31 are currently estimated at between NZ$500 million and NZ$600 million, the Auckland-based company said. It posted normalized EBIT of NZ$1 billion last financial year.

Dollar, Shares

Economists at banks including Westpac had expected Fonterra to raise its forecast milk price. The New Zealand dollar fell a quarter of a U.S. cent to 82.94 cents after Fonterra’s statement today and traded at 83.07 cents at 12:40 p.m. in Wellington.

Shares in the Fonterra Shareholders Fund, a publicly traded trust that tracks the cooperative’s dividend payout and earnings, slumped as much as 10 percent to NZ$5.48 before recovering to NZ$5.84. The stock is still headed for a record-low close.

Fonterra said while the milk price could still be raised in coming months, it made no sense just four months into the season to forecast a price higher than it could afford.

“We will maintain our financial discipline and not pay the milk price out of borrowings, particularly in a year when we are forecasting a record payout for our farmers,” Chief Executive Officer Theo Spierings said in the statement.

Surging Demand

Spierings said Fonterra has devoted the maximum possible volume of milk to whole milk powder and skim milk powder streams to maximize payments to its farmers. However, it hasn’t been able to use more than 70 percent of milk for powder production because of the nature of its existing facilities in New Zealand, he said.

“We anticipated that the market would likely change and that demand for milk powders would increase, but the demand is increasing at a faster rate than anyone predicted,” Spierings said. “The current strong prices for milk powder are being driven by increasing levels of demand from China, and emerging economies in Asia and North Africa.”

Fonterra is continuing to invest in manufacturing assets to meet changes in global demand and commodity cycles, he said. Fonterra’s Board has approved NZ$235 million for the development of a third powder drier at Pahiatua, in the lower North Island, and last week Fonterra opened the world’s largest powder drier at Darfield in the Canterbury region.

“The new market realities mean new opportunities, and we must go after them now as we have in the past by driving forward with our volume and value strategy,” Spierings said. “Over the next few months we will look at additional measures that will further improve our ability to provide higher volumes of the dairy commodities global customers want -– when they want them.”

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