By David Hargreaves
Dairy prices look set for another substantial rebound at the latest GlobalDairyTrade auction to be held in the early hours of Wednesday morning.
Trading in the NZX's whole milk powder (WMP) futures suggests that the key WMP prices could rise in the region of as much as 20%, taking the average price comfortably back over the US$2000 per metric tonne mark.
It should be stressed that futures trading patterns have not always been a reliable guide to what's actually going to occur at the physical auction this year, but the futures prices did fairly accurately point to the bounce in GDT prices two weeks ago.
Another significant rebound in prices this week would be a further relief to farmers who have been told by Fonterra to expect just $3.85 per kilogram of milksolids in the current season, compared with an actual price of $8.40 paid out only a year ago.
But even a 20% or so surge in dairy prices in the latest auction would need putting into perspective.
In February 2014 WMP prices averaged over US5000/MT. As recently as March this year average WMP prices (after falling very sharply at the back end of last year) had risen to above US$3200/MT on expectations of a shortage of supply due to a drought in New Zealand. In the event the effects of the drought here were overcome much more rapidly than expected and milk production was actually up in the past season.
Between March and the beginning of this month there were then 10 consecutive falls in prices at the GDT, with the last two drops particularly severe. In the period from early March to early August the average price for all dairy products at the auctions dropped from US$3374/MT to US1815/MT - a 45.8% slump, while the average WMP price did even worse, plunging from US3241/MT to US$1590MT, a 50.9% drop.
The recovery in the prices at the last auction and the expected further recovery this week come following drastic action from Fonterra to reduce the amount of product, particularly WMP, it makes available through the GDT. Fonterra's managing director global ingredients, Kelvin Wickham says Fonterra is now selling approximately 70% of its total product via channels other than GDT "and as a result we do not expect a material impact on inventories”.
Economists with the country's largest rural lender ANZ say that "market intelligence" suggests WMP prices have scope to move back to US$2100-$2200/MT "fairly quickly".
"But to go beyond this requires a slowdown in milk supply, especially from New Zealand," they say.
"A slowdown here seems inevitable, but it is unlikely to show up in any substance until the second half of the season.
"Putting aside weather events such as El Nino, we expect the decline could be toward 5% due to a reduction in cow numbers and the use of less supplementary feed.
"However, as yet we are not seeing a decline in supply from the US or Europe.
"In fact both regions continue to grow milk supply strongly, despite grumbles from farmers about low farm-gate prices that are not even close to those in New Zealand," the economists say.
They believe that for prices to move back above US$2500/MT, an improvement in the fundamentals – "and not just sentiment and bargain hunting" – will be required.
State-owned Landcorp Farming has seen annual operating profits plunge over 83.5% to $4.9 million in the face of sharply declining milk prices and lower returns on lamb.
No dividend will be paid.
The company's total revenues in the year to June slipped 9.2% $224.3 million, while within this, income from farm products dropped 11.7% to $213.5 million.
However, total liabilities increased to $361.8 million from $320.2 million, with bank borrowings rising to $210.7 million from $172.4 million in 2013/14.
Total assets have risen by $26.2 million to $1.77 billion.
The actual result compared with a targeted operating profit of $31.7 million for the year.
Under International Financial Reporting Standards (IFRS) Landcorp’s "total comprehensive income" position was actually an $8.4 million loss, compared with a $115.9 million profit in the previous year.
This included an unrealised loss on the market value of Landcorp’s livestock of $21.6 million (2013/14: $36.7million gain), an unrealised gain on land, improvements and other property of $11.7 million (2013/14: $69.4 million gain) an unrealised loss on other assets of $7.8 million (2013/14 $3.9 million loss) and tax income of $4.4 million (2104/15 $16.4 million tax expense).
Landcorp said that "as has been previously outlined", it doesn't consider net profit after tax and total comprehensive income under NZ IFRS as a meaningful indicator of Landcorp’s operating results "as it incorporates a number of unrealised revaluations on livestock, derivatives and land".
Recently Prime Minister John Key, Finance Minister Bill English and State Owned Enterprises Minister Todd McClay raised concerns about Landcorp's ability to finance dairy conversion commitments in the years ahead.
SOE Minister Todd McClay said he was having an ongoing discussion with the board of Landcorp.
"I want to make sure that with changes some of the pricing around dairy and other things that it doesn't become an issue for them. Landcorp buy and sell farms all the time. It is fair to say a few years ago they purchased a lot more farms and that created some debt," McClay said.
"They are also working through some issues in as far as a contract they entered into in 2004 around land conversions which means that they will have expenditure in the next few years going forward. It's important we get the right balance. It's a sustainable business, we want to make sure the debt doesn't get ahead of them," he said.
Landcorp chief executive Steven Carden said today that record-low dairy prices and tough growing conditions had driven overall financial performance down. However, a "constructive" response to challenging conditions had helped buffer Landcorp from major impact.
“It’s been tough for Landcorp and the entire dairy sector, so our result is solid in that context.
“Things might have proved even more challenging had we not secured a significant volume of supply to Fonterra under their Guaranteed Milk Price scheme at prices that were above the final payout level.”
Lower milk revenue of $88.1 million ($129 million in 2013/14) was partly offset by growth in livestock revenues to $111.3 million ($98.7 million in 2013/14), driven by growth in livestock production and higher beef prices. Lamb production had also increased despite an unusually dry summer.
More than one third of the 430,000 finished new season lambs were supplied on an exclusive fixed price contract to United Kingdom supermarket giant Tesco for its Finest programme of premium meat.
Carden said Landcorp’s drive toward fixed price supply contacts, particularly for higher value niche products, was gaining positive traction.
“For example, our wool revenue increased to $10.7 million for the year ($9.1 million in 2013/14) based on higher demand from overseas. Our partnership with the New Zealand Merino Company in the past 12 months has secured multi-year, fixed-price contracts with brands such as Danish footwear-maker Glerups, and Swanndri.
“Rather than being dictated to by the fluctuations of commodity price cycles, we’re locking in supply deals with partners who can help us maximise the value of what we produce.
“In the medium and long term we intend to expand our portfolio into new, high-value products. Sheep milk, for example, is a premium product opportunity for Asian markets and last week, with our Joint Venture partners SLC group, we opened our first sheep milking facility on the Central Plateau,” he said.
Carden believed that Landcorp had run a conservative balance sheet, with low levels of debt relative to its assets.
“We have purposely taken a long-term outlook on our operating environment, rather than seek riskier, short-term gains.
“We’ve worked hard to remove risk from the business and the diversified nature of our operations and income from dairy, red meat, wool and forestry further reduces risk. Our solid results in very challenging conditions reflect this.
“We’re very comfortable with our level of debt. It has moderately increased over the past few years to fund dairy conversions on the Central Plateau and complete conversions in Canterbury, based on long-term views of dairy payout levels.
“We’ve kept costs flat while continuing to work on initiatives across the five core areas of our strategy. Tight cost controls, precision application of fertiliser and aligning our farming systems to a lower milk price have all yielded savings. A flat cost structure is a pleasing result, given we had an additional five farms come into production during this period. ”
Rabobank NZ, which says loans to dairy farmers comprise more than half its total loan portfolio, is warning "very low" dairy prices for an extended time would see its loan defaults rise and potentially lead to higher loan loss provisions.
The specialist rural lender outlines this in its latest General Disclosure Statement.
"Since 30 June 2015 dairy commodity prices have fallen sharply from already low levels. Farm gate milk prices are now at their lowest levels since 2002. Loans to dairy farmers make up more than 50% of the Bank's overall ($9.314 billion) loan portfolio. Very low prices for an extended period would increase dairy farm loan defaults and the potential for higher loan loss provisions in the Bank's dairy portfolio," Rabobank says.
This comment comes after Fonterra recently cut its farmgate milk price forecast for the current season by $1.40 to $3.85 per kilogram of milksolids. Fonterra is also offering farmers interest free loans with Dairy NZ estimating the average farmer needs a milk price of $5.40, which is $1.55 higher than Fonterra's forecast, to breakeven.
Ironically, Rabobank also says during July it received repayments from a number of individually impaired clients that will "significantly" reduce its impaired asset balance.
*This is an abridged version of this story. The full version was published in our email for paying subscribers on Wednesday morning. See here for more details and how to subscribe.
Pasture growth forecasts are inching upwards as soil moisture levels and sunshine hours improve, but temperatures still sit below average due to the occurrence of many heavy frosts and wet conditions.
Managers are adapting as best they can, as they cope with the rigors of calving and the new financial climate, but were buoyed by last weeks auction result which suggested we have finally reached the bottom of the dairy price decline.
While no-one is predicting the crisis is anywhere near over, the price lifts even with the restricted volumes, were welcome, and if these gains continue in the dairy futures market, a small seed of optimism will emerge about future prospects.
The Chinese sharemarket crash threatens to undo the feather of optimism from the auction price upturn, with the dairy future markets turning back again overnight, and Fonterra's investment in Chinese dairy company Beingmate losing over $200 million dollars in value from this market adjustment.
Evidence is emerging of some of the tough decisions operators are making, which have included job losses, non renewal of sharefarming contracts, owners back milking, and most commonly, a big cull of poor producing and late calving cows that reduces the stocking rate and lowers the reliance on the use of supplementary feed.
Fortunately they have been able to sell these animals into a buoyant beef market minimizing the capital loss, as meat processors welcome this late flow at a traditionally quiet time of year.
There will be big negative spinoffs for the rural economy as this retrenchment will affect the rural towns and businesses that service the sector, and sheep, beef, and cropping farmers will be looking how to fill the gap this downturn has caused.
The small lifts in lamb schedules continue but pessimism remains for this season’s frozen prospects as our global competitors’ production remains high in our important export markets.
Shoulder season chilled production is still strong and underpinning present price levels, and prime lambs sold at saleyards have begun the traditional spring price rise, albeit much later than normal.
Early spring weather has been reasonable for lambing with no cold storms, but many areas are complaining of wet conditions and colder than normal temperatures slowing pasture growth.
The dairy downturn will have an impact on sheep and beef farmers with reduced income from dairy support, and with store beef prices at record highs and cereal grain demand and prices easing, some may find some options in more sheep.
Co-ops are keen to force these companies to look at amalgamation and have joined forces, but the success of this action is delayed, waiting first to see what comes of the Silver Fern Farms capital raising operation.
There is a concern that overseas ownership could return to the processing industry as a result of this capital raising exercise, and processing giant JBS's interest in Scott Technology who are a world leader in technology for livestock processing, shows the strength of global interest in our red meat sector.
Changes at the top of the reform group Meat Industry Excellence, with John McCarthy being replaced by Southland farmer Peter McDonald.
McCarthy plans to focus on selling the NewCo proposal to both Co-Op shareholders, and they will be looking for funding to put this proposal to farmers.
Last weeks South Island wool auction saw a bigger supply and slight easing of prices on the back of subdued demand for crossbred wool types although half bred and merino wools attracted good support.
A big lift in volumes of wool passed indicated the market maybe under price pressure and news that the Chinese economy is faltering is a worry for our biggest market.
A surprise drop in bull and manufacturing cow schedules this week has created some uncertainty that the big volumes of this type of beef may have over supplied the US market, already under quota pressure.
Saleyard prime steers at the local saleyards continue to sell well, as supply shortages affect volumes and local trade prices reach record levels.
The TB-free strategy in New Zealand is now becoming reality as this successful campaign beats its targets for the elimination of this costly disease from cattle and deer herds.
Ravensdown has capped the price of superphosphate fertiliser to $320/tonne until 30 November, to encourage farmers to put this basic fertiliser on early, and reap the rewards of clover growth in the late spring early summer period.
More big lifts in venison schedules this week and returns at the farm gate are now $40/animal ahead of last year.
The Deer Industry funded Deer Progeny Test is now showing, after three years of measurements, that there is big potential for genetic gain in growth rates, size of eye muscle, and bigger tails, to improve producers return from venison production.
With buttons dropping on stags, the velvet sector looks forward to another stable season, where New Zealand volumes are expected to rise on the back of demand from the healthy food market, and reduced global supplies of our competitors.
By John Luxton*
Some of the major players have sought to maintain trade protection rather than to reduce it.
It seems incredible that the US dairy industry has so far convinced the US negotiators that they need to be protected from any increase in New Zealand dairy imports into the US.
The New Zealand dairy industry is the only dairy sector in the TPP which is predominantly export focussed. Around 95% of our production is exported which represents around 25 to 30 percent of New Zealand’s exports by value. The next closest is Australia which exports around 40 percent of their dairy production, but this represents only around 2 percent of Australia’s export earnings. The US dairy sector currently provides much less than 1 percent of the US’s total exports, but by volume the US is still the largest exporter of milk powder, cheese, and dairy proteins in the TPP region. The US dairy industry is four times larger than the New Zealand industry, and exports over 15 percent of its production. The US share of global dairy exports has more than tripled since 2003.
The US dairy sector has stated that access should only be given equivalent to the amount of additional access that they gain from the Japanese and Canadian dairy markets. But this makes no sense given that the US dairy market is significantly larger than the dairy markets of either Japan or Canada, having over 322 million consumers compared to Canada’s 36 million, and Japan’s 126 million. It also consumes nearly 800,000 tonnes of butter and butter related products annually.
The Canadian, Japanese and New Zealand dairy sectors each comprise around 11,500 farms each; however the Canadian and Japanese dairy sectors are heavily protected from imported product with tariffs of up to 300 percent on imports.
Being sheltered from any competition they produce around one third of the milk that New Zealand farms produce and at two to three times the cost.
Dairy consumption is also much lower in these countries because of their high production cost, passed on to their consumers.
There is a parallel in New Zealand. New Zealand used to make cars like Japan does - but at a cost of nearly twice that of Japan. The removal of tariffs on motor vehicles in the 1990s reduced transport costs for all New Zealanders markedly. Free access to our market was given to the Japanese, Canadian and US motor vehicle motor vehicle manufacturers.
To date in TPP Japan has been reported as offering an annual increase in dairy access to New Zealand, equivalent to the production of about three larger New Zealand dairy farms, or .0016 percent of our total production.
Meanwhile in Japan, butter has been rationed and additional emergency imports are regularly being sought. Effectively 11,000 dairy producers are holding 126 million Japanese citizens to ransom in terms of their dairy consumption options.
Canada also appears not to have made a decent offer on dairy. Whilst most sectors of the Canadian agricultural sector want TPP to be successful in order to allow an expansion of cereal, canola and pork exports, the Canadian government still seems to be focussed upon protecting inefficient parts of their farming sector. In this way Canada’s 11,000 dairy farmers are holding 36 million Canadians citizens to ransom both in terms of the dairy products they can access and reducing the export prospects of their more efficient producers.
The US, Canadian, and Japanese trade negotiators need to deliver on the original intent of a comprehensive removal of restrictions on all goods traded amongst the TPP signatories – not just on the exports that matter to them.
The best outcome for dairy would be to enter into a comprehensive approach to opening up these currently closed markets by opening up progressively over 5 to 10 years to allow total access. Then local dairy sectors could then adjust to the changing market.
A comprehensive freeing up of dairy trade in the TPP agreement would also markedly increase the amount of international dairy market open to trade, from currently about 8 percent of all international milk production to around 20 percent. This would markedly reduce the current volatility in world dairy prices resulting from the current thinly traded market buffeted by small surpluses or deficits in global dairy demand.
If Japan and Canada cannot agree with the need for a comprehensive TPP agreement providing duty-free access on all goods then they should leave the talks and come back when they are prepared to honour the promises they made on entering the talks in 2013 and 2012.
John Luxton is currently the Chairman of DairyNZ. He is a former National Party politician and minister. He is also co-chair of the Waikato River Authority, a Crown/iwi co-governance organisation established through Treaty of Waitangi settlement legislation to clean-up the Waikato River.
After the downfall of Solid Energy, we have seen increased scrutiny of Landcorp – another State Owned Enterprise (SOE) that has recently taken on more debt.
This debt has been taken on to fund large scale conversions of pine to pasture.
We commented earlier this week on the environmental and treaty implications of these conversions and now other Waikato farmers have joined the calls for the conversions to be halted. In light of the drop in milk prices Landcorp’s plans look increasingly vulnerable, and that may force the SOE to sell some of its land.
But the real question is why does Landcorp exist at all?
Why do we have Landcorp?
Landcorp was set up in the 1980s to manage the commercial interests of the Department of Lands and Survey. In these early days the task was mostly to run the high country leasehold farms that the government owned. One of the original rationale for keeping the land in government hands was that it could be used for Treaty settlements. In the mean time, Landcorp’s job was to use the land productively.
However, over the years the activities of Landcorp have grown and grown into a multi-headed monster.
In addition to this original role it now converts land from pine to pasture, leases land for dairy, sheep, deer and beef farming and develops rural land for ‘higher value uses’.
These are all activities that the private sector is adept at – there is no need for the government to be involved.
According to their website:
Our purpose is clear – to transform New Zealand farming. We understand the privileged nature of what we do and where we farm. Landcorp has long been New Zealand’s largest farmer – but we must also be its best.
We have extraordinary assets in our people, land and resources. We will continue to unlock and develop their potential while demonstrating that improvements in profitability can go hand in hand with sound environmental practices.
Landcorp is highly experienced in large scale farming operations and we’ll continue to utilise our skills and brand to target premium, niche markets around the world. We’ll stay lean and agile with a clear vision and robust strategies – because we know that what we have here is precious, valued and cannot be replicated.
This is mostly waffle – there is nothing here that the private sector can’t and shouldn’t do. In fact as we pointed out in our earlier blog, by the government owning this business it actually acts against them getting tough on environmental issues because it impacts on their own bottom line.
Where is the market failure?
Usually governments get involved with an industry or business for a precise reason. This is usually based on a ‘failure’ in the market – there is some reason we can’t leave it to private businesses to deliver. Healthcare is a good example – often people don’t make rational decisions about what healthcare they need. As we see in the US private model people tend to underinvest in prevention and pay through the nose for excessive treatments they don’t need, just because a doctor tells them they should.
So how does this idea of market failure apply to Landcorp? Short answer is, it doesn’t.
Farming is one of our most competitive industries, one where we can with a lot of confidence say the ‘market works’. Why then is Landcorp – a government-owned Quango out there buying, selling and leasing farms and doing stuff the market can do? It’s actually worse than that – to the extent Landcorp has an impact in the market for farms it’s crowding out the private sector, crowding out the activity of arguably our most entrepreneurial sector. It just doesn’t make sense – the government needs to get rid of it.
I can remember ten years ago asking senior Landcorp executives what on earth the rationale for their empire was. They told me it was a proven exemplar of best farming practice and provided much valued new knowledge for the farming industry. I thought that was a stretch at the time, and sounded more like someone trying to justify their job. But there can be little doubt that Landcorp’s expansion over the years has done little but stolen opportunity from the private sector and the justification for that is pretty well wafer thin. Now it threatens the Crown’s balance sheet and our ability to legislate on environmental bottom lines into the bargain.
How can we get out of it?
With the last of the Treaty settlements now being completed, it is time for Government to work out an exit strategy for Landcorp.
As Fran O’Sullivan points out there are several options, such as doing a partial privatization deal with iwi or the NZ Super Fund. The Government could also transition its exit via the mixed ownership model that it uses on the electricity companies and Air New Zealand.
But whatever the route it needs to stop unnecessary interference in the market.
We have enough instances of market dysfunction to justify government regulatory or ownership interference without doing it for no more than legacy reasons.
That a National government is asleep to economically inefficient nationalisation like this seems particularly lazy – especially when it has conducted some quite questionable part privatisations of businesses where it looks like the market isn’t working properly (such as the electricity generators). What is it with this farming monolith for National? Smacks of some pretty weird double standards.
By Keith Cooper*
The recent announcement by Fonterra of a sub $4/kg milk solids forecast payment for the coming season - which was generally followed by competing milk processors - has given rise to a broad spectrum of implications across the NZ economy, the latest being to the SOE, Landcorp Farming.
Commenters have identified a variety of implications from the impact to our GDP, interest rates, FX rates, farm sales to foreign owners, on rural communities, on rural goods and service suppliers and of course the impact on farmers and their families.
However to my mind the ramifications will run deeper and across a bulk of the rural sector in some shape or form:
- Land values may well be negatively impacted, with a potential flow on issue for all farmers in terms of their equity position in the own properties,
- The potential of impairment on bank loan books if land values reposition lower,
- There will likely be an influx of productive land being available as dairy farmers reduce their external grazing requirements, leaving dairy grazing operators looking for alternative land use options,
- Same will apply for those who sold forage matter on a standing basis for cut and carry dairy farming operators,
- This additional land/feed availability will undoubtedly put pressure on the store lamb and cattle markets and likely squeeze the margin available to traditional sheep and beef farmers,
- The diversification by dairy farmers into lamb and beef finishing options again more demand for, and pressure on sheep and beef margins.
I would suggest most sheep farmers have had an average time of late with lamb prices having dipped and look settled at below the $5 kg mark (peak season) although many will have enjoyed the surge and forecast sustained increase in beef values.
However for those in the store beef market, many will find some harsh realities of buying replacement cattle within the new found confidence levels and competitive market. So there will be few silver linings for those in the meat sector from the current forecast dairy sector forecast pricing.
Which leads me to lament the long held notion by many a group in the meat sector that the meat industry needs an entity that has at least 80% ownership of NZ meat production/exports.
One can only ask why and where is the value in such a model, when we now have the benefit of observing the realities of the market place on Fonterra who have in excess of 80% of NZ milk exports plus a considerable volume of the internationally sourced and traded milk products.
Yes, there would be cost savings, perhaps $10 a stock unit, but that alone cannot compete with the tidal pressures of supply and demand which is the ultimate definer of the value of any commodity product.
As many commenters have alluded to over the years NZ producers need to focus on creating value from its primary produce as opposed to just relying on producing a quality commodity product.
The debate then becomes, who carries the costly investment in innovation, brand building, value creation and marketing of products that are targeted to avoid the commodity price cycles?
In Fonterra, farmers have been significant investors, however it now appears they have invested in commodity production facilities as opposed to creating value with less commoditised items as evidenced by the reported proportional decrease in added value production, having been diluted by the growth in overall milk production in recent years.
The Silver Fern Farms recapitalisation evaluation process must be nearing a conclusion. It will be interesting to see if the capital will be requested from farmers (so they retain ownership of the value within the value) and what the purpose of that capital will be.
Will it be to enable the company to continue the Plate-to-Pasture strategy central to which is creating value in products outside of the commodity market? Or will it come from an investor?
More importantly, will that investor be just a financial investor (only seeking a dividend stream ) or will they be a vertically integrated business investor who can assist in creating more value by virtue of being part of that value chain.
Regardless, it must be time for the Meat Industry Excellence group (MIE) to take stock of what they are advocating and reflect on what is occurring in the dairy sector and why, the later a point that is often missed in all the vitriol around the outcome of any strategy- the price to the farmer.
Regrettably, challenging times for sheep/beef/venison and dairy farmers alike. After all, they have so much in common on one hand but produce vastly different products on the other. However all are still hugely reliant on commodity markets and the price outcomes of raw supply and demand.
Keith Cooper is the ex-CEO of Silver Fern Farms. He has been involved in the meat sector for 35 years spanning sales, marketing, leadership and governance. He is building a professional Director career and primary sector advisory based in Dunedin along with his farming interests in Middlemarch, Otago. You can contact him directly here.
By Allan Barber*
MIE has to be given credit for its persistence with its campaign to persuade Silver Fern Farms and Alliance to look seriously at the benefits of merging as opposed to continuing to beat their respective heads against the brick wall of competition.
But the outcome depends on several planets aligning at the same time.
The present state of flux exists because of the uncertainty surrounding the results of SFF’s capital raising exercise, still to be announced at the time of writing, the outcome of two special general meetings called by a minimum of 5% of the shareholders in the cooperatives, and last but not least, the attitude of the majority of those shareholders.
The latest step in this process is the concept of Newco – the Visionary Meat Cooperative which expands on the Big Red proposal contained originally in MIE’s Pathways to Long-term Sustainability report launched in April. There is more detailed financial analysis in the latest concept plan which implies a net profit of $92.4 million in the fourth year after merger compared with a combined profit of $6.7 million if the companies remain separate.
Murray Taggart, Alliance chairman, questions whether the savings used in the proposal can be justifiably claimed as benefits of a merger, saying MIE’s figures contain savings that are independent of a merger. He reiterates the Alliance board’s stance the board would consider recommending the merger to shareholders, if it is as compelling as stated in the proposal. Adviser Ross Hyland doesn’t accept this position, saying SFF in contrast is broadly in agreement with the quantum if not the individual weighting of the savings.
However the most critical issues are not necessarily whether the figures all stack up, but first, the result of SFF’s capital raising and second, how easy it will be to convince farmers to exercise their democratic rights and vote for a revolutionary new state. This depends on overcoming farmer apathy as well as their appetite for a three year contractual commitment which a major bank, believed to be ANZ, has said would be an essential precondition for providing bank funding for forming Newco and the special purpose vehicle Pasco.
This SPV would be an essential part of the exercise, as the redundant processing facilities would be parked in Pasco to be disposed of over time in an orderly fashion. The third issue will be to obtain the agreement of the companies’ boards.
A serious element of doubt arises from the uncertainty of what might happen with the capital raising. If SFF has a genuine offer of new capital on terms which are acceptable to the banks and the majority of shareholders, the MIE proposal and the outcome sought by the shareholder group at the SGM will presumably be dead in the water. There must be an announcement very soon now to comply with stock exchange rules which impose a maximum time limit after declaration of a trading halt.
If none of the investment proposals is acceptable to the board, the SGM assumes much greater importance, because it may start a bow wave of supplier support for getting SFF to appoint an independent expert to re-examine the benefits of a merger. This would have to take into account MIE’s figures, if only to prove or disprove the supporting methodology and conclusions.
Of course none of this will necessarily have any impact on Alliance’s thinking, but it is safe to assume Alliance shareholders who are supportive of the merger concept or at least neutral, may be encouraged to believe there could be a valid reason for going through the same exercise. It will take longer to gain momentum and persuade the board, but it could lead to a similar outcome.
Questions to be answered focus on the assumptions built into MIE’s numbers which Ross Hyland assures me have deliberately taken a conservative view of such critical factors as gains from combined international market activity, livestock retention by the merged entity, plant closure costs and annual revenue growth rates.
The basis of MIE’s plan which must be absolutely understood by farmers is the need to commit to three year enforceable supply contracts which will serve as security against which the banks would be prepared to lend money.
Suppliers would be required to commit livestock without price guarantees from which a levy would be deducted to repay the bank loan, although Newco intends to pay premiums for quality, yield and shoulder supply.
The levies would contribute up to $115 million, roughly two thirds from sheep and one third from cattle, which would be sufficient to raise $150 million subordinated debt to meet peak funding requirements. It is estimated this would earn interest and either be repaid to shareholders or converted to equity at the end of year 4. Levies applied to funding Pasco and the redundant assets would only be repaid to the extent of the value of assets sold.
There is much for Alliance and SFF shareholders to get their heads round, if this plan is ever going to have much hope of flying.
Therefore, depending on other events such as SFF’s capital raise, it will be essential to get the boards of both cooperatives to accept the logic and promote it to their shareholders.
This may be the hardest task of all.
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Allan Barber is a commentator on agribusiness, especially the meat industry, and lives in the Matakana Wine Country. He is chairman of the Warkworth A&P Show Committee. You can contact him by email at email@example.com or read his blog here ». This article first appeared in Farmers Weekly. It is here with permission.
Fonterra reducing supply to the GlobalDairyTrade (GDT) auction is helping pull prices out of the dumps… just.
The latest fortnightly GDT auction overnight saw the GDT trade weighted index rise an impressive 14.8% to US$1,974 per tonne.
The price increase is the first since the March 3 auction, and breaks a 10-auction falling streak.
The price of New Zealand’s key export, whole milk powder (WMP), rose 19.1%, while skim milk powder (SMP) rose 8.5%. Anhydrous milk fat rose most significantly by 26.6%.
A matter of supply/demand
ANZ Agri Economist Con Williams says, “Fonterra’s strategy of changing its product mix and constraining supply sold via GDT seems to have at last found some price traction”.
He says lower supply, as well as increased purchasing from China, are key to driving prices back up.
“Both have shown tentative signs of heading in the right direction in recent weeks, but further movement will be required to provide a sustained rally”, he says.
Fonterra has decrease its total WMP supply for the next 12 months by 19% (91,400 tonnes) over the last two auctions, with much of the recent reduction front-loaded.
“To provide perspective the change is equivalent to nearly twice the US annual exports and one quarter of Europe’s”, says Williams.
Fonterra last week announced it would cut the amount of WMP it sells on the GDT by a third over the next year.
The NZX’s AgriHQ dairy analyst Susan Kilsby recognises this reduction was the trigger required to turn market sentiment, but says global dairy markets remain over supplied.
“Until global milk supply slows the market will remain very volatile”, she says.
What’s really happening with production?
For this reason, ASB rural economist Nathan Penny says we need to see evidence production is heading down, before we can be confident prices will keep inching up.
He says we need to see hard data from Fonterra, affirming it is in fact tracking to reduce production by 2% this season. ASB maintains the drop will realistically be closer to 1%.
“Expectations and forecasts only go so far – we need to see less milk on the ground here in NZ”, Penny says.
“Farmers have culled stock heavily so far this year, and are poised to cull further over the next few months, which 'should' translate into lower milk production particularly from later in spring.”
Agreeing with Kilsby, Penny says we need to see broader production falls globally.
“Often NZ farmers respond faster than their global counterparts. European production is down 0.6% so far this year compared to last, but the recent quota removal means further falls are not guaranteed.”
Where to from here?
Last night’s auction results have sparked economists to change their forecast milk prices for the season.
AgriHQ has increased its 2015-16 Farmgate Milk Price to $3.85/kg of milk solids (MS), in line with Fonterra’s 2015-16 milk price forecast.
Kilsby says, “Fonterra’s milk price forecast is now looking achievable. Dairy commodity prices need to continue to track upwards in line with NZX Dairy Derivatives market projections in order to reach the current forecast price.”
The NZX Dairy Derivatives market indicates whole milk powder prices will increase by a further 45% by the end of the season. This price projection is built into the AgriHQ 2015-16 Farmgate Milk Price of $3.85/kg MS.
ASB has stuck with what it acknowledges is a “relatively optimistic” forecast of $4.50/kg MS.
However Penny notes this doesn’t alter the medium-term picture materially, as ASB now expects a more gradual recovery and has lowered its 2016/17 forecast to $6.50/kg MS.
“We expect the prices to recover much of the preceding three auction’s lost ground. But from there, further lifts become more difficult,” he says.
ANZ says last night’s price rebound reduces the downside risk to Fonterra’s latest milk price forecast.
It has accordingly removed the downside risk to its 2015/16 milk price forecast, moving back to a $3.75-$4.00/kg MS range.
Williams says milk powder prices need to head back toward US$2,200/t to deliver Fonterra’s $3.85/kg MS.
Futures market activity
Westpac senior market strategist, Imre Speizer, notes futures markets in particular, had pre-empted a positive auction result.
“Contracts started rising after the Fonterra volume announcement, and closed yesterday implying gains of between 8% and 34% across the future delivery months”, he says.
“If anything, futures markets appeared to under-predict the nearby months and over-predict the more distant months."
“The futures market is expecting another strong result at the next auction on 1 September.”
One a slightly different note, Speizer also points out there was a material increase in the number of participating buyers in last night’s auction, suggesting low prices have prompted some buyers into action.
“Around 29% of 621 qualified bidders participated – the largest proportion since September 2014. And among this auction’s participants, only 77% were successful bidders for product, suggesting stronger competition than at the previous two auctions where 96% and 93% of bids were filled,” he says.