The dairy cooperative also updated its first quarter business performance, with gross margin and revenue both down.
Fonterra chairman John Monaghan said the company is also working to meet its commitment to reducing debt levels by NZ$800m (US$550m) by the end of the financial year, which requires both improved performance from last year and the divestment of assets, with Tip Top ice cream under consideration for sale.
Milk price
Monaghan said the revision in the forecast Farmgate Milk Price range is due to the global milk supply remaining stronger relative to demand, which has driven a downward trend on the GlobalDairyTrade (GDT) index since May.
The most recent GDT prices were, however, mostly positive.
“Since our October milk price update, production from Europe has flattened off the back of dry weather and rising feed costs. US milk volumes are still forecast to be up one per cent for the year,” Monaghan said.
“Here in New Zealand, we are maintaining our forecast collections at 1,550 million kgMS. NIWA is saying its likely we will see an abnormal El Niño weather pattern over summer and this could impact our farmers’ milk production.”
He added demand from China and Asia remains strong, but there was ‘geopolitical disruption’ impacting demand from countries that traditionally buy a lot of fat products from the company.
“There are still a number of unknowns in the global demand and supply picture and we recommend farmers budget with ongoing caution. Fonterra’s Advance Rate has been set off a milk price of $6.15 per kgMS.”
Q1 update
Fonterra’s first quarter gross margin of NZ$646m (US$444m) is down NZ$14m (US$9.6m) compared to the same period last year. Revenue of NZ$3.8bn (US$2.6bn), is down 4% and sales volumes were down 6% to 3.6bn liquid milk equivalent (LME).
The coop’s Ingredients business, despite lower sales volumes, saw a gross margin of NZ$273m (US$188m), up NZ$28m (US$19m) on last year. The Consumer business had a gross margin of NZ$310m (US$213m), up NZ$10m (US$6.9m) on last year, and volumes were up 5%.
Chief Executive Miles Hurrell says the coop generally makes a smaller proportion of its total annual sales in the first quarter due to the seasonal nature of its milk supply.
“This means the results from Q1 do not give much insight into the Co-op’s expected earnings performance for the full year. It does, however, put the spotlight on where we have challenges that we need to address,” Hurrell said.
“In particular, we are seeing challenges in our Australian Ingredients, Greater China Foodservice and Asia Foodservice businesses. I want to be clear with our farmers and unit holders about how we are tackling these issues.
“In our Australian Ingredients business, we have lower milk collections as a result of drought conditions and increased competition for milk supply. We are responding by focusing on the performance levers in our control – the main one being reducing our operating expenses to reflect lower milk collections.
Hurrell said the lower gross margins and sales volumes in Greater China Foodservice and Asia Foodservice in Q1 are mainly due to the high sales volumes of butter and cream cheese at the end of Q4 2018, a slightly slower start to sales of UHT culinary cream and more sales of UHT milk which has a lower margin relative to Fonterra’s other products.
“We are expecting our sales to lift as we are seeing strong sales from our distributors off the back of demand in China for New Zealand made products, particularly our UHT culinary creams. We are also prioritising value and moving away from lower margin contracts.”
Portfolio review
Monaghan said the cooperative has reached an agreement in principle with Beingmate that will see Fonterra return to full ownership of the Darnum plant by December 31, 2018 and enter into a multi-year agreement for Beingmate to purchase ingredients from Fonterra.
“We are also looking at our ongoing ownership of Tip Top and have appointed FNZC as our external advisor to work with us as we consider a range of options. We want to see Tip Top remain a New Zealand based business and this is being factored into our options.
“While performing well, Tip Top is our only ice cream business and has reached maturity as an investment for us. To take it to its next phase successfully will require a level of investment beyond what we are willing to make.
“We are still some months off from completing the full portfolio review of assets, investments and partnerships. We are moving quickly to meet our commitment to reducing our debt levels by NZ$800m by the end of the financial year. This requires both improved performance from last year and the divestment of assets.”
Lifting performance
In respect to the three-point plan to lift the coop’s performance, Hurrell said progress is being made on fixing under-performing businesses.
“Fonterra Brands New Zealand is one of the businesses that is starting to turn around. It’s early days but overall our Consumer and Foodservice business in Oceania delivered higher sales volumes and margins for Q1 compared the same period last year. A significant contributor of this is the improved operational performance in New Zealand.
“We have set our capital expenditure (CAPEX) limit at NZ$650m (US$447m). While we are ahead on the same time last year, this was planned as we completed the final stages of projects from last year. Once these assets are delivered, our focus will turn to ensuring they hit their Return on Capital targets.”
Hurrell said Fonterra remains committed to returning operating expenses (OPEX) to FY17 levels – however, they were up 3% for Q1 compared to the same period last year.
“The majority of these costs were committed to before we agreed our new OPEX target. They relate to higher advertising and promotion and storage costs in our Consumer and Foodservice business, additional costs since taking the management of Anmum back from Beingmate and higher storage and distribution costs for Ingredients as we collected and moved more milk than we budgeted for.”