Fonterra moves to protect cash and cut debt (Updated)

Fonterra has announced it will stop its farmer owners who want to become contract suppliers from selling shares back to the dairy cooperative because it wants to preserve cash amid the global Credit Crunch. (Updated to include comments from CEO Andrew Ferrier) Fonterra Chairman Henry van der Heyden said the changes to the terms of contract milk supply for next season were "necessary and recognise the absolute priority the Fonterra Board places on protecting the interests of our farmer-shareholders, who make up 96% of our supply base". Contract milk will be available only to 'growth milk' from existing farmers or new milk from conversions. "Shareholders will not be able to surrender, or cash-up, shares to supply on contract," van der Heyden said, adding that the contract milk price would be set at 10 cents below the regular milk price in 2009/10. Fonterra said it would require all milk to be fully share-backed within three seasons, which require farmers to hold shares equivalent to their milk supply and for any increases in their production over time. The contract price for the current season is 2 cents below the Milk Price. "In a tightening credit market, this is about protecting our shareholders from the risk of a significant expansion of contract supply and the resulting surrender of shares," van der Heyden said. "While we need to encourage new milk into the Co-operative and growth from our existing farmers, in the current environment too much milk not backed by share capital will, over time, weaken our balance sheet and place an unnecessary financial burden on Fonterra's capital structure." Fonterra had been refinancing portions of its debt "and was looking at other prudent avenues to make sure Fonterra's balance sheet is suitably protected." Later CEO Andrew Ferrier told interest.co.nz in an interview Fonterra was "simply being extremely cautious in such tumultuous times," referring to problems that companies such as GE Capital had seen in recent weeks accessing the markets. Fonterra would also look to defer capital expenditure and tighten its belt to preserve cash, he said. Its gearing was currently around 57%, partly because of high inventories during the peak of the season. That would drop back into the 45-55% range later in the season as those inventories cleared, but Fonterra still wanted to be more conservative in its gearing. Fonterra was also looking to sell non-strategic assets, but this was often the case, he said. Fonterra had been able to refinance its shorter term debt facilities in recent weeks and its banks were comfortable with its position. It had also moved to extend some maturing debt in recent months. Fonterra has various consortiums of banks, including many of the big Australasian banks. Standard and Poor's had also affirmed Fonterra's A plus rating a couple of weeks ago and was comfortable with its position, he said. "There's nothing showing on our radar screen sending danger signals."  What I think it means. The announcement effectively ends the experiment allowing Fonterra owners to cash out to become contract milk suppliers and puts up the shutters for farmers looking to cash out of Fonterra, which was one of the driving forces behind the move to contract supply. It also suggests Fonterra is having some refinancing stress and may well be acting now to preserve its credit rating.  Ferrier's comments on rolling over short term and S&P's recent affirmation rule out the rollover risk or credit rating downgrade as issues. Fonterra is being prudent by getting ahead of the curve and being should the financial world melt down again. I still think, though, there is likely to be further payout retention in the current season.  Fonterra is currently forecasting NZ$6.60 a kg for the current 08/09 season, down from an actual payout of NZ$7.66 last season. The quoted payout of NZ$7.90 a kg included the 24 cent retention. Given recent further sharp fall in dairy commodity prices (offset somewhat by the NZ dollar's fall), the payout could be cut to below NZ$6 if there is a further 20-30 cent cash retention by Fonterra..