It has had a strong start to the year but still faces challenges, including the rising milk price squeezing its margins, it said.
“The higher price reflects a global dairy market that is tipped slightly in favour of demand,” chairman John Monaghan said.
“Our New Zealand milk production is forecast to be up 0.5% on last year. Annual milk production in the other key global supply regions of the United States and European Union are both growing at less than 1%.
“On the demand side, Global Dairy Trade prices have increased by about 6% since our previous forecast. Whole milk powder prices, a key driver of our milk price, have hit their highest level since December 2016
“At this stage of the year, we have contracted a good proportion of our sales book and that gives us the confidence to increase the mid-point of our forecast.
“Farmers will welcome what would be the fourth-highest milk price in our history.
“It represents a $11.2b cash injection into our communities.”
Chief executive Miles Hurrell said the co-op has made good progress moving to its new strategy and has had a strong first quarter.
“From a Healthy Business perspective we are clear on the steps we need to take this year to hit our medium and long-term targets.
“A focus is still reducing our debt so it is no more than 3.75 times our earnings. This will require us to achieve a gross margin of $3b, further reduce operating expenditure, lower capital expenditure by $100 million to $500m and also divest some more assets.
So far this year it has:
• Improved the underlying financial performance of the business, delivering a gross margin of $740m, up from $646m;
• Continued the focus on financial discipline, reducing operating expenditure by $104m and managing capital expenditure carefully;
• Generated a normalised earnings before interest and tax of $171m, up $145m, and a reported EBIT of $259m, up $233m and;
• Improved its free cash flow (cash generated from the business available to reduce debt and pay interest and dividends) by $595m compared to last year.
“I’m pleased to see this level of improvement. Our people are doing a great job at putting our strategy into action. There’s more to do but the wheels are definitely in motion.
“When we look out across the year at our financial performance the biggest pressure on our earnings is going to be the rising milk price.
“Stronger than forecasted performance from our food service business has helped offset the higher milk price to date and we will need to be very focused around making improvements in other areas too.
“There will also be some markets that have difficult trading conditions over the course of the year.”
They include Chile and Hong Kong where we Fonterra is starting to see ongoing civil unrest affect sales.
Fonterra’s normalised earnings guidance for the 2020 financial year remains at 15-25 cents a share. That reflects the underlying business performance.
It expects several one-off adjustments such as selling assets that will impact reported earning.
The focus on value and continued financial discipline drove the good results across the business in the first quarter, Hurrell said.
“Our teams have worked hard and this is reflected in both our normalised and reported EBIT.”
Fonterra’s reported EBIT in the first quarter included positive one-off items such as the proceeds from the sale of its interest in foodspring and the revaluation of Beingmate shares.
The ingredients business increased its EBIT by $32m to $139m.
The New Zealand ingredients business continued to contribute a large proportion of the co-op’s earnings and most of the earnings from the ingredients business, which very much validates the focus on NZ milk in the new strategy, he said.
“We achieved strong gross margins from our NZ manufactured ingredients. We are also making good progress in addressing the significant challenges in our Australia and Chile ingredients businesses.
“The Australian ungredients team, in particular, has continued to tackle their new norm of drought conditions and related increased competition for milk supply, by manufacturing and selling a more profitable product mix and reducing operating expenses. Their hard work is helping balance out Australia’s lower milk volumes.”
EBIT from the consumer and food service business was $118m in the first quarter, up by $56m compared to the corresponding period last year, with improvements across all regions.
“The Australia consumer business has delivered record market share in the chilled spreads category and we are starting to see early signs of a turnaround in our NZ consumer business.
“The lift in China food service sales in the fourth quarter of last year continued into the first quarter of the year. Sales volumes were up 43% and gross margins were up $23m in the first quarter on a year-on-year basis. We have entered a further 24 cities taking the total to 327, successfully marketed our Anchor Food Professionals range for use in local cuisines and continued to see strong growth in Chinese bakeries and beverages.”
The co-operative’s early priority in the 2020 financial year has been to get itself in shape to best deliver the strategy, Hurrell said.
Fonterra moved to a new, customer-led organisational structure which allows it to be closer to its customers but also to live within its means.
“Like in any restructure, making these changes has been tough on our people – it’s never going to be easy, especially when it means a period of uncertainty and having to lose some great people from the co-op. I acknowledge this and want to thank our people for their patience and understanding as we have gone through this together.
“We’re now set up to take a more customer-centric approach in our business decisions which helps our in-market teams drive demand for our farmers’ milk.
“Our focus from here is to keep building a culture which can deliver consistent results, one that has employees proud to work for Fonterra and farmers proud to supply their milk to the co-op.”
Fonterra also hit a number of important milestones in the first quarter towards a transition to a more sustainable way of dairying, he said.
The most significant was the announcement, alongside other primary sector groups, to work with the Government to plan how to support farmers to make necessary changes to help meet NZ’s international climate change obligations while maintaining profitability.
“We have also launched a new partnership, Plant for Good, to help farmers with on-farm native planting. This will allow farmers to more effectively deliver the riparian planting actions identified in many of their farm environmental plans, which 25% of farms that supply milk to us now have – up from 23% at the end of July.
“To help reduce plastic packaging and waste going to landfill we’ve started offering Fonterra Milk For Schools in a one-litre format. It doesn’t use straws or plastic wrapping like the 200ml format does and it’s not single-serve. It also allows schools to minimise milk wastage by having more control over serving size.”