As New Zealand moves towards reconnecting with the world, 62% of the business leaders surveyed in the NZ Herald’s “Mood of the Boardroom” say they are not satisfied with the government’s plan for reopening the country. International business is being lost due to border difficulties.
So the NZ economy again looks likely to be propped up by the primary sector. On that front, the news is positive. International markets are exhibiting strong demand for our products, with the result that export prices are even more buoyant than seemed likely just three months ago.
Lamb is fetching record prices and dairy, despite some earlier predictions that global production would push down prices, has moved in the other direction, to the extent that Westpac senior agri-economist Nathan Penny this week raised his forecast for Fonterra’s farmgate milk price this season by 75c to $8.50kg/MS. That would surpass the co-operative’s previous record high of $8.40kg/MS paid in the 2013/14 season.
Fonterra’s own forecast is for a payout between $7.25 and $8.75kg/MS, with a mid-point of $8. That’s ahead of its $7.54 last season.
Penny said he lifted his forecast after downgrading his expectation for milk production. He now expects NZ production to fall 1%, compared with his previous expectation for a lift of 1%.
Fonterra itself is in good shape, after achieving a strong set of results for the 2021 financial year. These are reflected in normalised earnings per share of 34c and a final dividend of 15c, taking the total dividend for the year to 20c per share.
The results come as Fonterra moves through its business reset and into a new phase of growing the value of its business.
The question here is whether Fonterra, after three years of re-setting its business and cutting debt, can find new ways to maximise the value of NZ milk.
Miles Hurrell has gone about the job of shoring up the co-op since he took over as CEO, despite the challenges of operating in a COVID-19 world.
Although the higher milk price and tightening margins put pressure on earnings in the final quarter, this is a strong overall business performance, allowing us to deliver $11.6bn to the NZ economy through the total pay-out to farmers.
Hurrell will be striving to improve this season the group normalised EBIT (which reflects underlying business performance) of $952m, up 8%.
What was significant over the past 12 months has been the outcome of the drive to lower debt: net debt was down $872m to $3.8bn. Cashflow improved again and at 2.7x (improved from 3.3x), Fonterra is now within its long-term target Debt/EBITDA ratio.
While a high milk price is good for farmers and for the NZ economy, it does have the potential to squeeze sales margins and impact earnings.
What Hurrell has to do now is find new ways to achieve value growth. Since its foundation the co-op has talked up how it aims to broaden its product range and produce better returns for its milk, but has never succeeded in doing so.
Now Hurrell and his team plan to spend more on product innovation and science to move its milk into higher value specialty nutrition products as it looks for ways to increase profit in an environment where milk volumes are no longer increasing. They will outlay $1bn to make higher value products, and may look to partner with others to blend and pack them.
The co-op in effect has had to rethink how it grows profits as the rapid expansion of dairy farming comes to an end, with the Climate Change Commission suggesting dairy cattle numbers could fall 13% from 2019 levels by 2030 due to environmental constraints.
The idea of reducing cow numbers is a dubious strategy but given the Ardern government’s apparent indifference to encouraging the farming industries the Climate Commission’s proposal to cut cow numbers may be enforced.
In that context the Hurrell strategy of driving more value from milk makes sense. Hurrell says Fonterra is aiming to increase its total annual R&D investment by over 50% to around $160m a year, with about $60m a year specifically targeted at growth in Active Living, to develop new innovative products
“As we move more milk into Foodservice and Consumer, we will direct less through our Ingredients channel and aim to shift more towards higher value ingredients such as in our Active Living business.”
Hurrell says the co-op aims to play more boldly in nutrition science solutions, which underpin a $500bn slice of the global health and wellness category.
He and the team around him may have more success diversifying the product range than some of his predecessors. The country—and his farmer-shareholders—certainly need it.