Drought to claw back gains in Fonterra milk price rise

Fonterra is increasing the forecast milk price payout for the current season by 40c to $6.10 per kilogram of milk solids, and says farmers are set to receive a similar amount next season.

The increase to the second-best payout on recoord was on the back of continued strength in global dairy prices, and growth in demand beginning to outstrip supply, chairman Sir Henry van der Heyden said.

The increase is the first since the forecast milk price was raised by $1.10 last November.

But it comes at a time when many farmers, especially those north of Taupo in Fonterra's key milk catchment, are suffering from worsening drought conditions.

Many of them were being forced to dry off their herds early this season, meaning that gains in farm income through the higher milk price may be lost through lower production.

The combination of milk price, dividends and retentions meant Fonterra's forecast total return of between $6.40 to $6.70/kg of milksolids would be well ahead of the combined payout and retention of $5.70/kg of milksolids for the 2008/09 year.

Goldman Sachs JBWere economist Philip Borkin said the payout increase would boost farm incomes by about $500 million, or 0.3 percent of GDP, reflecting the effects of drought on milk production and higher costs such as winter.

Many would use the windfall to pay down debt and reinvest in their farms, Mr Borkin said.

With current conditions, farmers were unlikely to receive a higher payout next year, the dairy giant warned.

"Although a more formal forecast will be done at the end of May, our view is that farmers should budget for a milk price around this year's level," Fonterra chief executive Andrew Ferrier said.

The co-operative maintained its forecast range for the season's distributable profit of 40-50c per share, and kept its target dividend range at 20-30c per share indicating that 10-30c per share of distributable profit would be retained by Fonterra.

Since the last milk price forecast, dairy prices had remained relatively high and more stable than expected for several months, and had recently increased further.

Global demand for dairy products was also outstripping supply. Demand from Middle East/North Africa and Asian markets continued to grow, while milk production had contracted in the key markets of Europe, North America and Australia.

In New Zealand, the effects of drought mean Fonterra's production was now projected to be similar to last season, compared to the modest increase the company forecasted at the beginning of the season, Mr Ferrier said.