Pressure mounts on dairy, as prices fall and dollar stays high

Pressure is mounting on the dairy sector as commodity prices fall and the New Zealand dollar sits north of US60c.

Average prices for whole milk powder at Fonterra's monthly online auction yesterday were down 3 per cent on June, to US$1829 a tonne of whole milk powder.

Kelvin Wickham, managing director of Fonterra GlobalTrade, said milk powder prices were "going sideways".

He said the past six months had seen the price bounce around in a band between US$1800 and US$2100.

Westpac economist Doug Steel said if prices remained at current levels and the dollar stuck around the US65c mark, the 2009/10 forecast $4.55 per kilo of milksolids payout would be tough to meet for Fonterra.

But Steel said the volatility of the current environment meant it was risky to extrapolate the current data point for 12 months forward.

Wickham said his expectation was that in the short term the pricing trend would continue, on the assumption that there was no significant subsidy intervention by the EU and US aimed at propping up returns for their own farmers.

In the longer term, Wickham said declining global milk supply and renewed consumer demand would lift the auction prices.

"Right now our customers are attempting to predict exactly when decreasing supply or increasing demand will result in an inevitable firming of prices."

Wickham said there was more bidding action in the latest auction but demand dropped once a certain price point was reached. He conceded that current prices were unsustainable in the face of rising farm costs and said that was unlikely to change until later this year or 2010.

But he cautioned against reading too much into the sale figures, saying they reflected sales for one product made once a month. "We are making sales all the time," said Wickham. "It's a spot once-in-a-month flashlight."

He said the lower auction prices were unlikely to have a material impact on the payout for the 2009/10 season, due to be reviewed in August.

Steel said he was mildly surprised the prices paid were not worse, but a further fall on a 12 per cent drop last month signalled international prices were still going backwards. "It has the feeling of being at the low end of the range at US$1800 a tonne."

Steel said that until demand chewed away at US Government milk powder stockpiles aimed at stabilising farmgate prices there was unlikely to be a price recovery.

National Bank economist Kevin Wilson said that while increased inventory levels were disconcerting, they were still at historic lows. Demand would kick in when the effects of government economic stimulus packages were felt globally.

Overall he said the outlook was "quite positive" but there would need to be some belt-tightening.

At a forecast payout of $4.55 the average dairy hectare would lose $222 this year, according to Macquarie Private Wealth.

Blue Read, chairman of Fonterra's shareholders' council, told Radio New Zealand there were "a fair number" of the co-operative's 10,500 farmers exposed to losses at the $4.55 payout level.

If the forecast payout fell further, "I don't think there's much insulation left".

Federated Farmers dairy chairman Lachlan McKenzie said subsidised milk products coming out of the US and EU were a dark cloud over the commodities market.

He said there was "quiet optimism" among dairy farmers meeting this week at the organisation's annual conference.

Dairy farmers had to accept the volatility in the payout and focus hard on cash flow, said McKenzie.

The research note released by Macquarie last month highlighted the rural sector's highly leveraged position in the tightening credit environment saying it was at high risk of its own credit crunch.

"Over the past 12 months, total rural sector credit has expanded a further $8 billion (21 per cent year-on-year)," Macquarie said.

"However, moving into the 2010 financial year we believe this credit growth will prove increasingly unsustainable and will buckle under the weight of falling dairy farmer returns, declining asset values and what is becoming an increasingly unsustainable interest-servicing burden."

Macquarie said the dairy sector was particularly vulnerable - according to the Reserve Bank dairy farmers have borrowed 61.5 per cent of the $45 billion loaned to the rural sector - as it confronted a declining Fonterra payout and sky-high leverage.

Westpac's Steel cautioned against reading too much into dairy sector debt levels saying it was not distributed evenly across all farmers. But he said those who entered dairying at the top of the cycle would definitely be feeling the squeeze.

THE NUMBERS

* $27.7b on loan to New Zealand dairy farmers.
* $8b borrowed in the last 12 months by dairy farmers.
* $4.55 Fonterra forecast payout per kilo of milksolids.
* $222 the average loss per hectare predicted at the current payout.