This week Fonterra announced their final result for the 2009/10. There were no surprises there for farmers - the total cash payment of $6.37 / kg MS was as forecast back in April. The final distributable profit was a slightly higher than expected and Fonterra have taken the opportunity to use this to reduce their debt burden - moving their gearing ratio from 53% in the prior year down to a much healthier 45%.
The news that did take my eye was the reaffirmation of the forecast for 2010/11 at $7.00 - 7.10 / kg MS. I had to put my glasses on and read the press release twice to find out what Fonterra was really saying. That made things a little clearer but it does seem that a little bit of magic dust has been sprinkled on the New Zealand Dairy Industry. Here's a few thoughts on how the trick is done.
First let's get the story straight. In April this year Fonterra made the following statement in their press release.
"Based on these forecasts and targets, Fonterra farmer-shareholders on average would receive a total payout before retentions of $6.90-$7.10 for each kilogram of milksolids backed by a Fonterra share."
This was to be made up of $6.60 in milk price and $0.30 - $0.50 in Distributable Profit. Fonterra also noted in that press release that the target range for the dividend was $0.25 - $0.35 and so that means their cash payment forecast was:
$6.85 - $6.95 / kg MS
In their press release of this week:
"After considering these factors, the Board has firmed up the forecast payout for the 2010/11 season to $7.00-7.10 (before retentions). This includes an unchanged forecast Milk Price of $6.60 per kgMS."
and a little further on:
"As announced, the Fonterra Board is targeting a dividend range for 2010/11 of 25-35 cents per share, consistent with its stated policy of paying 65-75 per cent of adjusted Distributable Profit as an annual dividend."
So the forecast cash payment to farmers is unchanged at:
$6.85 - $6.95 / kg MS
Are you confused - did you think the farmer payout was (and still is) about $7.00? You are not alone. I had to go back to their press release of February 24 this year to find this gem of information:
Note: Changes to Key Terms
The capital structure changes approved at November's annual meeting mean some changes to the terms used by Fonterra to describe farmer payments.
The key terms are as follows:
Milk Price: the price paid to farmer shareholders for milk supplied to Fonterra, on a cents per kilogram of milksolids (kgMS) basis.
Distributable Profit: the total profit from Fonterra's business activities available for distribution to farmer shareholders by way of dividend.
Dividend: the amount of Distributable Profit actually paid to farmer shareholders in respect of any financial year, expressed on a cents per share basis.
Retentions: the amount of Distributable Profit that is not paid to farmer shareholders and is retained within Fonterra's balance sheet.
Value Return was previously used to describe the amount of Distributable Profit paid out to farmer shareholders, on a cents per kgMS basis. This term is no longer relevant as profit is now being distributed via dividend payments.
Similarly, payout is no longer a relevant term because farmer shareholders can now hold both supply-backed and dry shares.
Well done Fonterra! First of all you have deleted the the terminology "payout" from the industry language and then you have immediately reinstated it and defined it as the total amount of money available for distribution as milk price, dividends, and retained profits. Now to my simple mind "payout" in financial markets is normally what is actually paid out but I'm clearly living in the past. I must remember to go and update the Wikipedia entry ... or perhaps that definition should be filed under "Three card trick".
All that aside - I come to praise Caeser, not to bury him.
We are now deep into the 10/11 season and aside from a few speed wobbles the Oceania commodity price has held ground against the gravity of the market. All global dairy farmers should give thanks to the EU Commission for holding their nerve and refusing to sell the SMP intervention stock at a discount to the market. That stock is moving but it is going into a 'deprived persons' scheme - a very convenient way of minimising contamination of the open market. Increased global demand and relative shortage of supply has also pushed butter prices back to the top end of price expectations in the three major markets of the EU, US, and Oceania. It's a far cry from a decade ago when butter was subsidised to death to move stock out of Europe.
Against this background of stronger commodity prices the New Zealand dollar has moved up - rising from a low point of $US 0.66 in June to almost $US 0.74 on yesterday (Friday 24th September). The NZ dollar rose by almost 1c on the strength of Fonterra's press release. The rising NZ dollar dilutes the value of rising dairy commodity markets but here's where I think Fonterra has worked another piece of magic for the coming year.
According to our calcuations the forecast Fonterra total cash payment to farmers (please note careful wording here) is currently running at the top end of the estimate we made in June this year - that is $6.50 / kg MS. Commodity prices are 10 - 20 % higher than we thought they would be but this is offset to some extent by the stronger NZ dollar.
Is $6.90 / kg MS possible - well ... actually ... I'm almost embarrassed to say ... yes.
The average US / NZ daily exchange rate over the past 6 months is just under $US 0.71. That figure, or something like it, is what you would use in a simple model for NZ export sales. An astute currency trader, especially one that had several billion dollars of product to trade, might have looked at an NZD trading in the range $US 0.66 - 0.67 in June and said to themselves "I like that number, and I know more about this market than just about anybody else"... and took a very big forward position.
There is still a long way to go in the 10/11 season but here's something positive for New Zealanders to think about. A foreign exchange rate that is 4 cents better than the daily average would yield a gain of about $0.50 / kg MS in the milk price. You can call this magic or luck if you like but if it is real most Kiwi dairy farmers will be able to gaze in wonder at cash in the bank at the end of the 10/11 year.
We tried to find the link to the Fonterra Annual Result Webcast but kept getting referred to this: