Fonterra’s earnings in nine channel and geographic divisions in the 2022 financial year differed widely from those in the previous financial year as high milk prices made it more difficult to capture added value.
Also, non-reference, protein-based commodities like cheese and casein sold at steadily increasing premiums over reference products like milk powders and butter, thereby generating profits over the farmgate milk price.
Those two big influences on payout and profitability have been explained by Fonterra chief financial officer Marc Rivers after the annual results were published.
Both reference and non-reference products began the financial year, in August 2021, at or around US$4000/t.
The average contract price for reference products increased by 24% during the year, and that covers about 70% of the volume of Ingredients (or commodities) that Fonterra makes.
Non-reference products also increased in value, about 50% by the end of the financial year, and have kept on increasing beyond $6000 into this dairy season.
Ingredients revenue from NZ-sourced milk was $16 billion, up 10% from the previous financial year.
Price increases during the year for all ingredients generated earnings before interest and tax (EBIT) of $916 million, up an arresting 140% on the year before.
Rivers said the price relativities between reference and non-reference products show up strongly in the earnings in the Ingredients channel.
On the flip side, sale prices for Foodservice and Consumer products did not rise quickly and Fonterra’s gross margins were squeezed.
Foodservice and Consumer volumes and revenues were similar to FY21 but their earnings fell 60% and 55% respectively.
“That is because higher prices are slow to respond in those channels and consumers may resist paying, even stop buying,” Rivers said.
“But when dairy prices come down again the lag effect will benefit Foodservice and Consumer earnings.”
Fonterra reports earnings in three channels – Ingredients, Foodservice and Consumer – for each of three world divisions, Asia/Pacific, Africa/Middle East/Europe/North Asia/Americas (Amena), and China.
The biggest falls were Consumer earnings, down 70% in the Asia/Pacific division and 150% in China, where Foodservice earnings were also down 43%.
Rivers said these big movements in earnings from year to year demonstrated the benefits of the spread of Fonterra’s products and market channels and its ability to change products streams.
Fonterra’s tightly regulated and heavily scrutinised farmgate milk price is based on a most-efficient notional competitor that turns all milk into reference products – milk powders, butter and anhydrous milk fat.
“Returns from non-powder commodities such as cheese and casein have largely been irrelevant in driving investment in the dairy industry over the past 10 years and are therefore not taken into account when determining the farmgate milk price,” Fonterra said in its farmgate milk price statement for 2022.
But last year non-reference protein products out-priced milk powders and fats and Fonterra captured higher margins, which flowed on to EBIT and profits.
Rivers said such price relativities may not be sustainable in future and Fonterra’s 2030 performance targets for earnings and dividends did not rely solely on favourable stream returns.
However, it is true that pricing relativities between reference and non-reference products produced the main structural volatility in earnings, he said.
“We have improved tools to be able to lock in these margins, such as futures markets, fixed milk prices matched to customer contracts, and more production optionality.”
Within the strategy and the 2030 targets is the expectation that Ingredients will take less of the milk pool and added-value products will rise.
“How do we get more value for every drop of NZ milk – to show up in milk price and earnings.”
