UPDATE: Fonterra says more assets under review

By Rebecca Howard

May 23 (BusinessDesk) - Fonterra Cooperative Group narrowed the range for its forecast payout to farmers this season, cut its earnings guidance and says it may sell more assets as it slims down its operations and focuses on its core business.

The cooperative has started a strategic review of its two farm hubs in China, is reviewing options for the future ownership of its Brazil joint venture with Nestle, and is closing its Dennington factory in Australia.

The dairy processor now expects to pay $6.30-6.40 per kilogram of milk solids in the current season - which ends on May 31 - versus its February forecast of $6.30-6.60/kgMS. This reflects slightly weaker than expected pricing for whole milk powder and skim milk powder, offset by a lower kiwi dollar, it said.

ASB Bank senior rural economist Nathan Penny said the downward revision was a surprise as it contradicts the lift in dairy auction prices during the past three months. The change reduces forecast aggregate Fonterra farmer incomes by around $225 million in the current season, he said.

Fonterra's opening forecast for the season beginning June 1 is $6.25-7.25/kgMS, something Penny said is "relatively healthy."

Penny also noted the range reflects the wide range of outcomes that are possible at this stage of the season.

“This is a realistic opening forecast. We are having to look out more than a year into the future which is difficult, but what the information available is continuing to show us is that demand remains strong across key trading partners and this is reflected in GDT prices," said Fonterra chair John Monaghan.

The world's biggest dairy exporter is strengthening its balance sheet as part of its wider strategic review. That's included the divestment of a range of assets no longer deemed central to the cooperative's future, the most recent being the $380 million sale of the Tip Top ice-cream business.

Chief executive Miles Hurrell said the China and Brazil decisions reflect the new strategic direction of the firm.

"In particular, prioritising our New Zealand milk supply and simplifying our global portfolio, which, as we have said previously, requires us to review every part of the business to ensure it meets the needs of the co-op today".

It will review the future of its two wholly-owned dairy hubs that comprise seven farms and around 31,000 dairy cows, said Hurrell. No decision has been made but "a strategic review will look at all options and take our time to ensure that the right decisions are made," he said.

Chief financial officer Marc Rivers said the co-op has spent upwards of $1 billion on the farms through upfront investment, capital investment and livestock, among other things.

He declined to give a book value for the asset but did say Fonterra has "endured losses over the years."

In its latest half-year report, China Farms reported total earnings before interest and tax losses of $21 million, largely flat from the same period a year earlier. That was made up from a $17 million direct loss from China farms, a further $5 million loss in ingredients and a $1 million profit in consumer and foodservice.

Fonterra owns another two farms in a joint-venture but said those are not up for review.

Hurrell said China remains a key market for Fonterra.

“We have contributed to China’s dairy industry by developing high-quality model farms and showing there is a valuable opportunity for fresh milk in China’s consumer market, and this continues to be an attractive prospect.

“However, this does not necessarily mean that we need to continue to have large amounts of capital tied up in farming hubs," he said.

Regarding DPA Brazil, which is a joint venture distributing chilled dairy products throughout Brazil, "the review into future ownership options and whether to sell is expected to be completed by the end of 2019,” Hurrell said. Fonterra holds a 51 percent stake and Nestle 49 percent. In a separate release, Nestle said it operates two plants and employs 1,400 people and was formed in 2003.

Regarding Fonterra's operation in Chile, Hurrell said no decisions had been made "at this point."

Judith Swales, chief operating officer global consumer and foodservice, said the market in Chile has been "pretty soft" this year but there are signs of a turnaround. "We expect that business to get very much back on track in the next six-to-12 months."

The Dennington factory in Victoria has 98 employees.

"The Australian ingredients business continues to feel the impact of the drought and other significant changes that mean there is excess manufacturing capacity in the Australian dairy industry," Hurrell said.

“This is not a one-off for this season, it’s the new norm for the Australian dairy industry and we need to adapt. We need to get the most value from every drop of our farmers’ milk and, with the reduced milk pool in Australia, we must put it into our highest returning products and most efficient assets. Dennington is over 100 years old and not viable in a low-milk pool environment," he said.

Rivers said the cooperative is on track to meet this financial year's $800 million debt reduction target, in particular after the sale of Tip Top. However, "a combination of all those deals we have named" will be needed to achieve it. The company's net debt was $7.35 billion as at Jan. 31, up from $7.06 billion a year earlier.

Fonterra’s revenue for the nine months to April 30 was $15 billion, up 1 percent on the same period last year, while sales volumes were 16.6 billion litres on a liquid milk equivalent basis, up 4 percent. However, normalised earnings before interest and tax fell 9 percent to $522 million.

Hurrell said the New Zealand Ingredients business performed as expected but Australia still faces challenges. Some parts of the cooperative's consumer and foodservice business are also taking longer than planned to improve their performance

Hurrell said that there are some heightened risks in the fourth quarter to the co-op’s previous forecast normalised earnings and it lowered guidance to 10-15 cents per share from 15-25 cents. That implies a forecast range of $161.2-241.8 million, compared to $241.8-403 million.

For the consumer and foodservice division, it lowered its forecast normalised ebit to $400-430 million from its prior forecast of $475-525 million. For its ingredients business, Fonterra lowered the forecast to $645-725 million from the previous $750-850 million range.

Units in the Fonterra Shareholders' Fund increased 0.5 percent to $4.22 on the NZX, while on the ASX, the units were down 0.5 percent at A$3.94. Fonterra's farmer-owned shares increased 0.2 percent to $4.22.

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