Fonterra's 2017 opening forecast below expectations; kiwi falls

Fonterra Cooperative Group [NZX: FSF] raised its forecast farmgate milk payout for next season by less than expected but predicts lower prices will crimp production and supply will pick up. The New Zealand dollar fell.

The Auckland-based company said it expects to pay its farmer suppliers $4.25 per kilogram of milk solids for the 2016/17 season, ahead of the $3.90/kgMS payment for the 2015/16 season. The New Zealand dollar fell to 67.23USc, from 67.63USc before the announcement. A BusinessDesk survey of agricultural economist and dairy market analysts last week predicted an opening forecast payout of at least $4.43/kgMS, rising to as high as $6/kgMS by the end of the season.

Fonterra's forecast for the upcoming season marks the third year the milk processor will pay a price below the level required by most farmers to break even. Dairy products are New Zealand's largest commodity export but a global oversupply and weak demand has suppressed prices, pushed up dairy farm debt causing angst about the industry's future outlook.

"That opening estimate or 'stab' is a bit of a reminder I think that the dairy sector is going through an elongated adjustment," says ANZ Bank New Zealand chief economist Cameron Bagrie.

"The recovery in prices to a more sustainable level keeps on getting pushed out. They have come in on the low side, that might prove to be conservative but it does suggest to me that they're pretty cautious about when we are going to see in a sustained fashion that uplift in prices."

Still, Mr Bagrie says while the dairy sector was weighing on the economy, it was getting an uplift from the construction, migration and tourism sectors along with other export areas.

"New Zealand is a lot more than a bunch of cows but of course we have still got a pretty strong reliance upon dairying so there is an economic issue here that is going to take a little bit of time to work through."

ANZ continues to expect the Reserve Bank will keep interest rates unchanged at its review next month, although Mr Bagrie says at the margin, today's news argues for a rate cut soon.

"I think there's enough in the broader economic story to keep the Reserve Bank standing pat at the moment but the longer we see these dairy prices remain low the greater the prospect that the New Zealand dollar has just got to adjust an awful lot more and the Reserve Bank is back at the table."

Fonterra says its forecast accounted for a strong kiwi dollar, global over-supply, international inventory levels and the economic outlook for major dairy importers. It will keep using its balance sheet to prop up its farmer shareholders as the slump in global milk prices erodes their income and keeps the farmgate forecast below the level needed for many farmers to break even.

"Conditions on-farm are very challenging. The strength of the cooperative's balance sheet is enabling us to increase the advance rate in the first half of the new season," chairman John Wilson said in a statement. "We will also bring forward payments for this season's milk. This will provide some assistance with on-farm cashflows."

Mr Wilson says he expects global prices to gradually improve over the season as international production is reined in response to weak prices. Fonterra will project 2017 earnings per share, which is paid out as a dividend to farmers, in July.

Chief executive Theo Spierings says global demand is likely to increase by an annual pace of 2-to-3% on the world's expanding population and growing Asian middle classes. He expects that will lead to a rebalancing of the international market.

"We will remain focused on securing the best possible returns for our farmers by converting their milk into high-value products for customers around the world," says Mr Spierings.