Guest Post: by Simon Louisson
Pundits, most residing in the National Party, just three years ago predicted the economy would surf high on “rivers of white oil” flowing from the dairy industry, but they now have cow pats splattered on their faces as Fonterra today announced another payout downgrade and signalled liquidity pressures.
Fonterra’s move to demand 90-day terms from its 20,000 suppliers indicated the dairy giant is experiencing working capital and or cashflow problems, suppliers and shareholders said today.
“What is going on with their liquidity?” asked investment consultant Will Wilson who owns several dairy farms and is a Fonterra shareholder. “You have to start asking questions – how commercially sound is their business?” he told RNZ today.
He said the announcement that Fonterra has decided unilaterally to change its terms of trade to stretch payments out from the usual 30 days while also requiring suppliers to look for cost reductions of 10-20 percent “indicates there is pressure on liquidity”.
Fonterra Chief Financial Officer Lukas Paravicini told The Standard the price cut “illustrates the challenges facing New Zealand’s dairy sector and the pressure continuing low global dairy prices are having on our farmers’ businesses”.
Paravicini would not comment on whether the company was experiencing cash or liquidity pressures although he said Fonterra was on track to reduce its gearing (debt to equity) to 40-45 percent.
He said the move to the harsh terms of trade was in line with its “global standard” and ‘it is about being efficient as possible and driving as much cash back to our farmer as possible.
Fonterra’s announcement today that it is again slashing its farmgate price for milk by another 6 percent to under $4/kg of milksolids puts the industry into the “severe” scenario outlined in the Reserve Bank’s most recent Financial Stability report.
The cut to the farm payout to $3.90/kg of milksolids, down from the previous already dire forecast of $4.15, will put intense strain on the wider economy because of Fonterra’s position as the dominant exporter.
It also has serious implications for the Government books and places doubt on the National Party’s plan to cut taxes as an election bribe.
It also exposes the paucity of National’s economic policy of reliance on commodities such as dairy powder, logs and oil and its failure to support value-added industries.
One Fonterra supplier said Fonterra’s requirement for them to cut costs by over 10 percent was intolerable.
“It just doesn’t work. We are all struggling at the moment,” he told RNZ. “Loyalty is disappearing. A lot of contractors won’t give them the same loyalty and drop everything to help them out when their plant goes down because they are not good creditors.”
“Because they are paying three months late, that indicates that they have a serious liquidity problem. What guarantees do Fonterra give all their creditors that they are good to pay their bills on time?”
The supplier labelled Fonterra as “corporate bullies” who want to “beat up their little suppliers”, while trying to portray themselves as good employers.
Wilson said Fonterra was using its suppliers to provide working capital, but suppliers still had to pay their own suppliers on the 20th of the month following as everyone else in New Zealand does.
Fonterra made the spurious claim the move in line with overseas practice.
The RBNZ in its November Financial Stability report noted suppliers were already under serious pressure from losses experienced by most dairy farms last year due to the severely curtailed dairy price.
The RBNZ’s baseline scenario had the Fonterra payout at $4.15. Even in November, the RBNZ said 11 percent of farm debt was owed by farms with negative cashflow. Under its severe scenario, nearly half of all dairy farm debt – amounting to over $38 billion (up 26 percent in five years) – will become non-performing loans. Those loans will be concentrated in a quarter of dairy farms.
Prime Minister John Key said banks would be patient.
“They’re very much taking the view that they’re not going to rush to be forcing people off their farms, but inevitably there are a few that are going to be highly indebted.”
History would say that banks seldom exercise patience for long.
Debt soared during the dairy boom when the payout in 2013/14 jumped over $8/kg and people leaped on the bandwagon to buy dairy farms at inflated prices or paid high prices to convert forest and other pastoral land to dairy.
This week, the country’s largest farmer, Landcorp, announced it had abandoned a hugely expensive plan to convert land in the central North Island to dairy due to financial pressures.
The state-owned farmer forecast it would lose between $8-9 million in 2015/16 due to low dairy prices. It runs 17,000 cows on 6400 hectares on its 13-farm Wairakei Estate near Taupo. It had planned to run 43,000 cows on 39 farms by 2021.
Landcorp will also face serious cashflow pressure and will be forced by its banks, ANZ, ASB and Westpac, to sell assets at the bottom of market to repay debt. Last year’s Landcorp annual report showed its contracted capital for conversions would cost $35 million annually until 2019 and it then escalated to $229 million.
Landcorp costs before even debt servicing were up at at $4.82/kg of milk solids which is typical of the kind of poor economics of many of the recent dairy conversions.
At $3.90, the milk price is well below industry body Dairy NZ’s estimate break even at $5.25/kg.
Dairy prices rose marginally in the latest GlobalDairyTrade auction, breaking a run of four previous falls, but analysts see no immediate sharp recovery in prices due to over-supply from the US, EU and New Zealand combined with slacking demand from key consumer markets in China and Russia.
Financial analyst, commentator and Milford Asset Manager Director, Brian Gaynor recently noted Fonterra’s net debt has risen to $7.6 billion from $4.7 billion in 2011. That compared to farmer equity of just $5.8 billion and Fonterra’s own estimation of market value of just $8.9 billion.
Fonterra’s net interest bill in the latest year was $518 million.
Gaynor said that when Standard & Poor’s downgraded Fonterra’s credit rating in October to A-minus, it assumed a milk price payout of $4.60/kg. S&P then said Fonterra’s financial flexibility had diminished due to the speed and magnitude of the drop in global dairy prices relative to the level of advance rate payments to its supplier shareholders.
“This also resulted in a material increase in its working capital at balance date, which added to the already elevated debt levels from capital investment and acquisitions during the year,” S&P said.
It noted Fonterra’s recent offer of interest-free loans to distressed farms, “in our view implies there may be limited headroom to lower the payout at the bottom of the global dairy product price cycle.”
Gaynor commented that Fonterra shelled out $364 million in capital investment on China last year and said it may have too many balls up in the air at once. Certainly, the value of its $615 million investment in Beingmate as a “game changer” in the infant formula market in China would have gone well south and will be just one more pressure loaded onto its books.
Fonterra is due to announce its financial results on March 23. We await with interest.
Simon Louisson formerly worked for The Wall Street Journal, NZPA, Reuters and
was most recently a political and media adviser to the Green Party.
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