The company also announced it is looking to sell its share of a joint venture with Dutch company FrieslandCampina, as well as looking to offload other interests.
Fonterra CEO Miles Hurrell said that while it is good to see the cooperative back in the black, its earnings performance is not where it should be and this was the reason for revising the full year earnings guidance down in February.
“The steady performance from New Zealand Ingredients in the first half of FY19 has been offset by challenges in Australia Ingredients and this has seen our total Ingredients EBIT decline by 17% to NZ$461m (US$315m),” Hurrell said.
“Our Australia Ingredients business continues to feel the impact of the drought. We can see it in the decline of Australian milk collections and aggressive price competition for milk, which is resulting in the underutilisation of manufacturing assets and tightening margins.
“Consumer and Foodservice is tracking behind last year with an EBIT of NZ$134m (US$92m). This part of the business has been held back by disruptive political and economic conditions as well as high input costs in Latin America. In addition, in our China Foodservice business, demand slowed due to higher prices and in-market inventory levels growing for butter at the end of FY18. In Sri Lanka, our performance was impacted by price constraints.”
Outlook for second half
Hurrell said the focus is to meet the earnings guidance, deliver the three-point plan, and reset the business so it can deliver sustainable earnings.
“We have a forecast Farmgate Milk Price of NZ$6.30-$6.60 (US$4.31-$4.52) per kgMS but we also have to meet our earnings guidance range of 15-25 cents per share. This range builds in an expectation of a slightly softer second half for our Ingredients business, but a meaningful increase in Consumer and Foodservice earnings,” he said.
“Our forecast increase in our Consumer and Foodservice performance is based on a few key factors. It needs a strong improvement in our Foodservice business in Greater China, stronger consumer demand for Soprole in Chile and chilled dairy in Brazil, and an improvement in our Sri Lankan business.
“Our three-point plan involves taking stock of our business and conducting a portfolio review, getting the basics right and improving our forecasting. We’ve made good progress so far and we will continue to take these steps in the second half to firm up our foundations and strengthen our balance sheet.
“The second half will also see us continuing the work on developing a new strategy to support a much-needed change in direction. We are doing the right things but it’s clear more is needed to lift our performance. We need to simplify and improve the coop so we can grow value.”
As part of taking stock of the business, Fonterra has let its farmer owners and unit holders know today that the third asset it has identified in its portfolio review is DFE Pharma, a 50/50 joint venture established in 2006 between Fonterra and FrieslandCampina.
DFE Pharma is a supplier of pharmaceutical excipients used as a carrier agent in medicines such as tablets and powder inhalers.
Hurrell says Fonterra has let FrieslandCampina know it has started a sales process for its 50% share of DFE Pharma.
“At the same time, we have confirmed that we are committed to maintaining our lactose service and supply agreements from Fonterra’s Kapuni operation in Taranaki and supporting the ongoing operations of the DFE Pharma business.
“Together with our partner, we have grown DFE Pharma from relatively small beginnings into a significant and successful business. While continuing to perform well, ownership of DFE is not core to our strategy.”
In addition to this sales process, the coop said it has received strong interest in Tip Top and is actively considering its options for its shareholding in Beingmate.
“We are well on track to meet our target to reduce end of year debt by NZ$800m (US$548m),” Hurrell noted.
Hurrell also said Fonterra has sold its interest in its Venezuelan consumer joint venture, Corporacion Inlaca, to Mirona, an international food business.
“The decision to sell Inlaca is the result of ongoing instability in Venezuela which has led to challenging operating conditions.
“The economic situation in Venezuela is not expected to improve in the foreseeable future, so we have made the decision to act now to minimise the impact on Fonterra.”
Fonterra received NZ$16m cash for the Inlaca sale. The full impact of this transaction, including the devaluation of the Venezuelan currency which has resulted in a negative FCTR balance of approximately NZ$126m (US$86m), will be reflected in the profit and loss statement.
This sale is not directly included in Fonterra’s half-year results, and the impact of the FCTR on the profit and loss statement has not been reflected in the forecast earnings per share range. Fonterra expects there to be one-off transactions and adjustments over the course of its financial year (some positive and some negative). The sale of Inlaca would have an eight cents per share negative impact on earnings. As Fonterra has other one-off transactions that are under way but not yet completed, such as the potential sale of Tip Top and DFE Pharma, it is too early to assess the overall impact of its divestment program on the coop’s FY19 earnings.
As a result, the announced forecast earnings will continue to reflect only the underlying performance of the business. Fonterra will advise any one-off impacts of a transaction on our FY19 earnings when that transaction is announced, and will provide details of the overall impact of its divestment program on FY19 earnings as part of its full-year financial statements.
Change in direction
Fonterra chairman John Monaghan also gave a progress update on the full review of its business strategy.
“There will be fundamental change. We are taking a hard look at our end-to-end business, where we can win in the world and the products where we have a real competitive advantage,” Monaghan said.
“Our cooperative values of the last 148 years won’t change. Our farmers’ quality, pasture-based milk will always be collected, processed and sold for the highest possible returns. They’ll always be paid on the 20th of the month – every month.
“Outside of that, there are no sacred cows. The business strategies designed to secure the highest possible returns will change, but some underlying principles will remain.”
Monaghan said strategy will focus on sustainability and provenance throughout the value chain.
“We are a New Zealand dairy farmers’ coop. Maximizing the value of our home milk supply will always be our number one priority. We believe there’s a premium to be earned from products backed by our co-operative heritage and provenance.
“Our future will be built on our owners’ farming businesses that use advancements in technology and innovation, including adaptations from other industries, to help protect or enhance the premium qualities and reputation of our milk.”
Shareholders echo need for change
The Fonterra Shareholders’ Council said it supports acknowledgement that fundamental change is needed to improve the performance of the cooperative.
Council chairman Duncan Coull said, “Fonterra’s farmer shareholders will agree that the results announced today are not where they should be. The Shareholders’ Council backs the board and management’s initiative to thoroughly review strategy. A well-defined and executed strategy focused on our farmers’ milk is critical to maintaining sustainable returns and an enduring co-operative for generations to come.
“As farmers and business owners, we accept that some change can take effect over a shorter term, while the more strategic outcomes will take longer to evolve. We encourage shareholders to be patient and empower the board and management with time, to ensure the right decisions are made to support the long-term futures of our farming families."
Coull also said the potential sale of Westland Milk Products has highlighted to how critical a strong Fonterra cooperative is for all New Zealand farmers as it underpins the milk price for the entire industry, which in turn flows through to regional New Zealand.