Fonterra looks on as Australia, US relations with China worsen

Fonterra chief executive Miles Hurrell. Photo / NZ Herald

Fonterra is watching with concern as diplomatic relationships between Australia, the United States and China continue to deteriorate.

China's relationship with Australia sank to a new low this week when a Chinese government official sent a tweet showing an altered photo of an Australian soldier with a knife to the throat of an Afghan child, creating a diplomatic furore.

Trade relations with the United States have been in freefall during the Donald Trump presidency and the Sino-US relationship went from bad to worse after the outbreak of Covid-19 in Wuhan in December last year.

Fonterra - New Zealand's biggest Kiwi-owned company and the country's largest exporter - today upgraded its milk price forecast, largely based on more robust trading conditions in China.

At $7.00 a kilogram, the milk price is at a level that most farmers would be comfortable with.

The move means an extra $200 million will go into Fonterra farmers' pockets before the year's end. All up, the co-op will contribute $10.5b to a Covid-hit economy this year.

Asked if he feared the diplomatic rift may spill over into New Zealand's relations with the PRC, chief executive Miles Hurrell said the co-op was strongly reliant on China.

"It is a very strong market for us and we have strong partnerships in that market," Hurrell said in a conference call for the first quarter result.

"The geopolitical situation is something that we watch very carefully," he said.

"That said, it's not something that we have got our nose involved with directly, but we watch certainly with interest.

"I'm sure the diplomatic process will play its way out and people will see the right solution in the long term.

"But it's certainly something that we watch and it is a concern if we see things continue to escalate."

Dairy is easily New Zealand's biggest export and the People's Republic is its biggest trading partner.

ANZ said in a report that trade friction remained high, with tensions between Australia and China rising.

"New Zealand politicians and diplomats need to continue to build relationships in China so they can make their concerns heard without putting our trading relationship at risk," it said.

Hurrell said there had been a significant turnaround in trading conditions in China, which had continued into the co-op's first quarter.

However, he said that same turnaround had not been evident in other foodservice markets, with parts of southeast Asia going into their second or third Covid-19 lockdowns.

Hurrell said "all the stars would need to align in all markets" for the co-op to go beyond its current forecast for earnings per share for the 2020-21 year - 20c to 35c.

In today's update, Fonterra lifted the mid-point of a narrowed milk price forecast to $7.00 per kg of milk solids from the previous mid-point of $6.80/kg.

"China is continuing to recover well from Covid-19 and this is reflected in recent Global Dairy Trade auctions with strong demand from Chinese buyers, especially for whole milk powder, which is a key driver of the milk price," Hurrell said.

"The impact of Covid-19 continues to play out globally, and we continue to have a watchful eye on the increasing Northern Hemisphere milk production and the New Zealand dollar."

There had been a solid start to the first quarter, delivering total group normalised earnings before interest and tax (EBIT) of $250 million, up $72m on last year.

Hurrell said the co-operative was confident its performance was on track.

"However, there are still a number of risks we are keeping a close eye on and for this reason we have made the decision to maintain our current forecast earnings range," he said.

"Sales volumes are in line with the same period last year, which was before we felt the impact of Covid-19."

Improvements were seen across the business, except for Europe, which had been impacted by higher costs, and Africa, which had been hit by lower volumes.

The Greater China foodservice business was the stand-out performer.

Fonterra expanded its foodservice business into another 13 cities in China, bringing the total number of Chinese cities where the co-op operates to more than 360.

The co-op is continuing to divest non-core assets. It has agreed to sell its China Farms business for $555m, which will be used to reduce debt.

Fonterra is also in the process of selling down its ill-fated investment in Beingmate, which now sits at 6.36 per cent from its original 18.8 per cent stake.

The co-op said Covid-related challenges remain, including how the global recession and new waves of the virus will affect customer demand.

In the year just past, Fonterra has made inroads into its debt mountain, reducing its debt-to-ebitda ratio to 3.4 times from 4.4 times a year ago.

Hurrell wants to get Fonterra's debt down to three to 3.5 times EBITDA this year and the ultimate goal is to get it down to between 2.5 and three times.

Hurrell noted recent in strenght in the New Zealand dollar to over US70c and forecast that it may rise to to US74c next year.

Fonterra hedges its foreign exchange exposure ahead by 18 months.

There was also continued uncertainty over what could happen to the price difference between the products that determine the milk price - mostly wholemilk and skim milk powder - and the rest of Fonterra's product range in the second half of the year.

Fonterra's NZX-traded units last traded at $4.36, having gained 8 per cent over the last 12 months.