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Turbulence ahead in dairy sector

Turbulence ahead in dairy sector

The current season milk solids payout was down 30c on original forecasts – an unpleasant end to a highly productive season. Can the dairy sector look forward to better times ahead?

To those who were watching closely, all the warning signs that milk payout forecasts were headed in the wrong direction were there. 

Specifically, in the middle of April, Fonterra’s Trade Weighted Index in its GlobalDairyTrade online auction fell almost 10 per cent, leading ANZ chief economist Cameron Bagrie to assert that as a result “Fonterra is going to flag a 2012/2013 payout with a five in front of it.” 

And so it did, with the 2012/13 forecast milk price forecast at $5.50, plus 45 – 55c in after tax profit, leading to a total payout of between $5.95 - $6.05. 

Fonterra Henry van dr Heyden

But while that figure wasn’t quite as bad as some had been led to expect, it was a late re-writing of the current (2011/12) season’s payout that has plunged rural sentiment into gloom. From May last year, when it was forecast at between $7.15 - $7.25 (the milk price component coming in at $6.75), the reality is as much as 30c lower, at around $6.45 - $6.55. 

It’s news that should not only upset dairy farmers, but indeed anyone who wants to live in a prosperous country. In austere times, when our Minister of Finance has got little in the way of good news to report as he present’s the country’s budget, the nation can ill-afford to have as much as $500 million less sloshing around the economy.

Figures of how much individual farmers will be out of pocket vary between regions – Taranaki farmers will suffer a loss of about $38,000 this year on average, Waikato famers will see around $42,000 less in their bank accounts as a result, and in Canterbury, the average farmer will be as much as $90,000 worse off. The reasons for the downgrades are almost entirely international in scope.

Primarily, there is a lot of supply to global markets at the moment, not only from New Zealand, where a bumper season produced as much as eight per cent more milk, but also the US and Europe. That, coupled with slowing demand in the key Asian markets, has put a dampener on commodity prices.

Unrest in the Euro zone is hardly likely to improve the global outlook anytime soon, while the caps coming off European production quotas in 2014 are a near-future nail in the coffin.

Fonterra Chairman Sir Henry van der Heyden said the opening forecast for 2012/13 reflected a realistic outlook by the Board towards global dairy markets over the coming season. “There’s a lot of milk out there and prices have softened,” he said in the aftermath of the payout announcement.

While supply and demand would even out later in 2012, “there is no consensus among outside experts on how soon we can expect to see prices recover” and farmers had to plan accordingly – presumably, conservatively.

A key problem for local farmers however is that they have already incurred costs for the current season and may have been working on an assumption of a higher payout – many thought $6.35 was a surety.

“The sector has already spent the money, so there will definitely be some that are really hurting,” says Richard Cookson, who, with his brother Robert, manages four farms in Te Aroha, Morrinsville and Paeroa.

He’s quick to point out that he and his brother are doing well despite the uncertain outlook, as a result of conservative management combined with a “great season”. The weather gods smiled on Waikato, no maize was fed, plenty of feed was stored meaning next season feed costs will be negligible, and “the cows are in good nick” he says.

“We have seen lots of volatility in the payout and think it will continue to be volatile, and it’s for that reason that we make ourselves into a nimble operation, able to respond quickly to circumstances,” he says. “All of us have basic costs that have to be met and those like fertiliser are going up all the time, so that has to be factored in. But we are lucky that we don’t have large fixed irrigation costs, for example; that everything over a certain level is discretionary, and like many others, we won’t have as much to play around with but it won’t ultimately impact the final product.”

He says that the sector is under pressure from banks and those farms that were only surviving due to a high projected payout will be in jeopardy from the latest payout news.

Others were potentially vulnerable as they had used the good times to pay off debt, or spent large on capital improvements, expecting the high payouts to continue.

Ian Scott, a Tirau-based vet and dairy and deer farmer, agrees discretionary spending will cease, which will see a lot of the good work of abundant times undone.

“In a low payout scenario the cost advantages of extra feed become marginal, for example,” he says. “Already I have clients who are talking about cutting costs and discretionary spending and cutting staff.”

It’s of course the ripple effect of a low payout that strikes at the heart of rural communities. James Lawn, who is an avid industry watcher, Massey Agricultural student of the year 2009, and owns, with his family, a farm in Taranaki, says all the data show dairy farmers do reinvest their payouts into the local community – in goods and services. Roughly 600,000 people are employed on farms and in agricultural support.

The tax take on those people is also significant – meaning if they make less, the government takes less.

“Margins are pretty low in dairy farming and getting lower as a result of not just costs going up, but price pressure from domestic consumers for milk to come down,” he says, adding that while food costs have increased 45 per cent in the last 20 years, farmers’ expenses have increased by 60 per cent – and climbing.

Ironically, milk is cheaper now than it has been for many years – in part because Fonterra froze the price of milk in February 2011 while inflation continued to climb. In 1999, for example, two litres of milk cost $2.83 - $3.97 in today’s money, while it is currently possible to buy two, 2L bottles of milk for $6.

That hasn’t stopped consumer outcry over milk prices, and as a result supermarkets continue to exert pressure on suppliers. However, Fonterra, as the dominant provider of export dollars to the dairy industry, continues to earn good money internationally export different value-added products and new markets, keeping the sector’s international income high – despite the current downwards payout revisions.

As long as Fonterra can maintain its position as the lead exporter – and not fall prey to a price war with current and future domestic export competitors – it should be able to maintain solid incomes farmers, especially at a time when quality food supplies are highly sought after, say industry watchers.

James Lawn believes despite this month’s payout slump, over time, prices will rise. “Having said that, there will be lots of volatility and people are probably best advised to keep a close eye on what’s happening on the global stage.”

 This story originally appeared in Primary magazine. Click here to subscribe.