Downward pressure on dairy

Global dairy prices are waning while interest rates rise and the New Zealand dollar remains...
Global dairy prices are waning while interest rates rise and the New Zealand dollar remains stubbornly high. Pictured: Dairy cattle near Balclutha. Photo by Craig Baxter.

Speculation is mounting Fonterra will cut its forecast milk solids payout further as the New Zealand dollar remains high and global dairy prices continue to wane.

A decline from the recently forecast $7 per kg of milk solids to $6.25 would strip about $3 billion from the dairy sector and economy.

Brokers Craigs Investment Partners and economists at the ANZ and Westpac have all raised concerns, ranging from imminent price reviews to downgrading their respective forecasts.

Craigs broker Peter McIntyre said dairy prices had unexpectedly fallen another 4.9% at last week's global dairy auction.

''Speculation is mounting that we'll see another cut to Fonterra's milk price forecast for the 2014-15 season,'' he said.

Following eight consecutive price declines, one auction made a gain before last week's 4.9% decline was posted.

Mr McIntyre said dairy prices were now back at levels of early last year and negative risks were ''starting to creep in''.

''That's especially with the currency largely unmoved over the period of prices weakness this year,'' Mr McIntyre said.

The ANZ last week downgraded its forecast to $6.25, due to the strong kiwi currency, falling international prices and the recent auction price action, he said.

The Reserve Bank assumed a 27% fall in dairy prices during 2014. Prices were now down 28% since the December 17 auction and whole milk powder prices were down 30%, the bank said.

''While production is expected to increase again in 2014-15, costs have also risen,'' the ANZ said.

''This [$6.25] would represent a $3 billion fall in dairy incomes compared with the record 2013-14 season, according to ANZ estimates,'' Mr McIntyre said.

Dairying debt makes up the largest component of the country's almost $53 billion lent to the rural sector.

The ANZ said with interest rates rising and approximately 65% of debt on short terms, combined with such a drop in the milk price, ''this quickly starts to see discretionary spending evaporate''.

Mr McIntyre also noted economists at Westpac had also suggested there could be some significant cuts. Their forecast of $7.10 per kg for 2014-15 was under review, and likely to be revised down to below $7, Mr McIntyre said.

Those developments were probably not enough to change the mind of the Reserve Bank, with regard to its adding another 0.25% rate hike to the official cash rate (OCR) later this month, he said.

''But with some of the heat coming out of the dairy sector, the [kiwi] currency is looking more and more overvalued at current levels,'' Mr McIntyre said.

ASB chief economist Nick Tuffley said yesterday the OCR's 0.25% lift last month to 3.25% was expected, and there were few signs of an imminent pause coming in the Reserve Bank's tightening cycle.

''We now expect the Reserve Bank to lift the OCR again in July, before pausing until December,'' Mr Tuffley said yesterday.

Units in the tradeable Fonterra shareholder fund could benefit from the global price decline, Mr McIntyre said.

The lower the milk solids payout, the larger the likely profit margin in branded products.

During the past year, shareholder units were down 22% after a high of $7.54 and low of $5.48.

They traded yesterday at $5.74.

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