Weak dairy prices raise doubts about Fonterra's forecast payout

Continued weakness in dairy prices is stoking speculation over Fonterra Cooperative Group's [NZX: FCG] ability to meet its current farmgate milk price, which it revised lower as recently as last month.

Prices fell 2.8 percent at the GlobalDairyTrade auction overnight, the fourth straight drop this year. The average price for New Zealand's key product, whole milk powder, sank 3.7 percent, taking its decline this year to 18 percent.

Fonterra, New Zealand's largest dairy company, last month reduced its farmgate milk price forecast for the 2015/16 season to $4.15 per kilogram of milk solids, from $4.60/kgMS, citing a continued global imbalance between supply and demand. Estimates in a BusinessDesk survey for the current season currently range from $3.70/kgMS to $4.15/kgMS, with five of the six estimates below Fonterra's. That's less than the $5.30/kgMS required for the average farmer to break even.

"The dairy price recovery is proving more drawn out than anticipated," ASB Bank rural economist Nathan Penny said in a report where he cut his forecast for the current season by 20 cents to $3.90/kgMS, and his estimate for next season by 50 cents to $6/kgMS. "It seems dairy can't catch a break."

ASB's Penny noted New Zealand milk production was holding up better than expected as fears of dry El Nino weather crimping output recedes. Weak global sharemarkets and commodity markets were reinforcing dairy market weakness as buyers prefer to sit on the sidelines and wait until prices bottom, he said.

Westpac Banking Corp New Zealand senior economist Anne Boniface, who recently reduced her forecast for the current season to $4/kgMS and her estimate for next season to $4.60/kgMS, noted the recent themes of strong growth in supply and lacklustre demand show few signs of reversing anytime soon.

"It still looks like a long tough road ahead for the dairy sector," Boniface said in a note. "If our forecasts are right and many farmers are facing a third consecutive season where revenues are below costs, signs of stress in the sector are likely to increase. And the impact of this won't just be confined to the rural sector."

ASB's Penny said he expects prices to lift over the course of 2016 and he expects a lower New Zealand dollar will boost the 2016/17 milk price by around 70 cents compared with the current season.

The outlook reinforces ASB's view that the Reserve Bank will cut interest rates twice this year, taking the official cash rate to a record low of 2 percent.

Source: GlobalDairyTrade. Click to zoom.

10-year price trend. Source: GlobalDairyTrade. Click to zoom.

(BusinessDesk)