Fonterra shifts product mix to reap bigger margins from smaller sales in 2015

See also: Top pay at Fonterra hits $4.9m

Fonterra Cooperative Group's [NZX: FCG] $2.1 billion investment in plant capacity has paid off in 2015, allowing the world's biggest dairy exporter to shift production to higher-margin products, while benefiting from a surge in returns from consumer and food service products in Asia and Greater China.

In a year when the global market was what chief executive Theo Spierings called "one of the most difficult I've known," Fonterra lifted net profit by 18% to $506 million.

Total sales volumes rose 9% to 4.3 million tonnes but revenue dropped 15% to $18.8 billion. Still, the company managed to squeeze more profit from less revenue. Gross margin for the year ended July 31 rose to $3.28 billion, or 17.4%, from $2.46 billion, or 11.1% a year earlier.

Chairman John Wilson said a stronger performance in the second half was continuing into the current year and the cooperative raised its forecast farmgate milk price to $4.60 a kilogram of milk solids from a decade-low $3.85/kgMS, projecting a total payout including per-share earnings of $5-5.10/kgMS.

"It has given more clarity around where it's going and its long-term vision and the core metrics such as gross margins, return on capital and its balance sheet that will allow shareholders to more easily benchmark its performance," said Con Williams, economist at ANZ Bank New Zealand, adding that full-year profit met expectations.

The impact of a change in product mix was most notable in Fonterra's ingredients business. While overall volume fell 2% to 2.98 million tonnes and revenue dropped 27% to $14.3 billion, total gross margin from ingredients climbed 18% to $1.56 billion. The margin on the milk powder reference products Fonterra uses to calculate its milk payout fell 32% to $729 million, while the margin on non-reference products such as cheese and casein soared to $614 million from just $12 million a year earlier.

The company said its three-year investment in plant capacity "is now delivering tangible benefits" in terms of efficiency and flexibility.

"In the second half we made the most of this flexibility, favouring production of products where we could secure higher prices and changing production from powders to cheese and casein to capture shifts in customer demand," it said.

Although Fonterra had to change its mix to squeeze better returns from ingredients, its consumer and food service businesses benefited from weak prices for dairy ingredients, a raw material cost. Total volumes rose 27% to 1.69 million tonnes and sales rose 26% to $6.7 billion.

The return on capital from ingredients was 9.3%, while for consumer and food services, it was 25.5%.

Normalised earnings before interest and tax from consumer and food service surged 216% to $408 million, driven by a gain of almost 300% to $202 million for Asia, a 463% rise to $45 million for Greater China and a 17% gain to $110 million for Latin America. Oceania earnings contributed $51 million, compared to a year-earlier ebit loss of $24 million.

Fonterra still faces challenges in the Australian market and took a $108 million writedown of its yoghurt and dairy desserts assets across the Tasman.

Net finance costs for the company rose to $557 million from $379 million in the previous year.

The kiwi dollar gained a third of a US cent on the announcement and units of the Fonterra Shareholders' Fund rose 2.9% to $5.39.

Federated Farmers dairy spokesman Andrew Hoggard said Fonterra's increased forecast for the 2015 and 2016 seasons will bring some relief to farmers facing tough economic conditions.

The cooperative is making a final cash payout of $4.65 for the 2015 season, comprising $4.40 per kilogram of milk solids and a dividend of 25c a share. Farmers had already been paid $4.37/kgMS so the extra money in October will have an immediate impact, Mr Hoggard said from the World Dairy Summit in Lithuania.

Of the increase in payout for the current season, Mr Hoggard said: "Hopefully things won't go backwards again. We're hoping we've hit the bottom and are now coming out the other side."

(BusinessDesk)