Fonterra is paying farmers too much for milk, ComCom says

The Commerce Commission says Fonterra is setting the price it pays farmers for their milk too high because it is estimating too low a cost of capital, or, in other words, underestimating its risks.

“The Commerce Commission has released an emerging view that Fonterra’s estimate of risk in calculating the cost of financing milk processing operations is too low,” the corporate regulator says.

“The impact of this is that Fonterra calculates a higher milk price than would be the case if it used a more feasible allowance for risk in the cost of finance, consistent with other processors,” it says.

The commission is charged with monitoring the price Fonterra pays for milk under the Dairy Industry Restructuring Act because the dairy giant has market power over the purchase of farmers’ milk.

“For several years now, Fonterra has been unable to provide sufficient evidence to convince us” that using a lower cost of capital than comparable processors is justified, the commission’s deputy chairwoman, Sue Begg, says in a statement.

“We acknowledge there are differences between the risks borne by Fonterra and other comparable producers,” Ms Begg says.

“However, based on the evidence we have, we do not consider the differences in the risks are sufficiently material or relevant to justify” Fonterra’s low risk and cost of capital estimates.

The commission is calling for submissions on this by July 4.

The payout

In May, Fonterra announced an opening forecast farmgate milk price of $7/kg of milk solids for the 2018/19 season, one of its highest on record, which chairman John Wilson put down to global demand and supply dynamics. It also increased its 2017/18 forecast farmgate milk price by 20c to $6.75/kg of milk solids.

Although that was good news for farmers still recovering after the two years of lower milk prices in 2015 and 2016, the higher milk price puts pressure on Fonterra’s earnings, which are already suffering from its Danone settlement and Beingmate impairment announced in February. Because of that Fonterra has revised its forecast normalised earnings per share guidance range down to 25-30c a share (from 35-45c) and its forecast dividend range for the full year down to 15-20c a share (from 25-35c).

Political attack

Meanwhile, Fonterra and its chairman have come under fire from Regional Development Minister Shane Jones in yet another attack on a Kiwi corporate.

He said yesterday that it was time for a restructure at Fonterra and that its chairman should stand down.

His comments come just months after he took a swipe at Air NZ over regional airfares.

Mr Jones said he had been disappointed by the dairy co-operative and that in his view, its leadership had not accepted there has been a new government and should focus less on interfering in politics.