Auction #189

It has been 3 weeks since the last auction and there has been a reasonable amount happening in the market:

  • Updated 2016/17 announcements and first indications of 2017/18 payout
  • We have seen the transition from 2016/17 to 2017/18 activity in the milk futures market
  • Fonterra has updated expected auction volumes suggesting more WMP
  • There has been some corporate activity by Synlait and very positive price action
  • The RBNZ Financial Stability report has been published this week with some explicit discussion on the dairy sector

2016/17 Payments and 2017/18 forecast:

  • Fonterra announced a revised 2016/17 FGMP of $6.15/kgMS, no change in dividend guidance at 40 c per share (from expected earnings of 45-55cps)
  • Fonterra also forecast an improved 2017/18 FGMP of $6.50/kgMS
  • Synlait matched this forecast of $6.50/kgMS but said that a revised 2016/17 final payout would be announced on 16 June.
  • OCD announced an opening forecast price of $6.25 - $6.55/kgMS
  • Tatua announced an opening forecast o $6.50 - $6.90/kgMS
  • Westland Dairy continues to be the laggard with an as yet unfinalised price for 2016/17 but seemingly likely to be in $5.40-$5.80kgMS range and getting this price closer to other producers is clearly the task for 2017/18

The 2017/18 Fonterra forecast struck me as relatively optimistic (or perhaps, more accurately, not conservative). However, we shouldn’t place too much store in the opening price. Over the last 6 years, the opening price has proved to conservative on 3 occasions and optimistic on 3 occasions (not much consistent bias there!) and has, on average been wrong by $1.375/kgMS. In fact over the last 3 years the opening price has been wrong by $2.60, $1.35 and then $1.90/kgMS in the current season.

My point is that the opening forecast is a best estimate (at least this year) on what Fonterra (and other companies presumably) know today and on current market pricing. The volatility in the market, however, means that farmers need to be flexible in their thinking and responses as the year moves on.

Milk futures Market activity:
Activity has well and truly shifted in the 2017/18 year although overall activity this last week was relatively light.

After the Fonterra announcement activity in the current contract essentially ceased. In 2017/18 it became apparent quite quickly that there was farmer interest to hedge exposures at $6.50/kgMS. Over the course of the last 10 days the 2017/18 contract has eased from $6.50/kgMS to close on Friday at $6.30/kgMS.

It would seem that another strong auction result on Tuesday night will be needed to see this contract trade at higher levels in the short run.

Fonterra Volumes:
Fonterra announced increased WMP volumes for later in the season (Oct-Jan). FCNZ observed that with the market trading in “backwardation” (ie. June WMP price is $3235/t compared with December at $3075/t), these increases are probably factored in and it is good to get the news in the market.

Near term this seems unlikely to impact this week’s result with specific buying requirements and shortages in some product lines providing some volatility.

Synlait Activity:
Synlait has been a focus of the investor community over the last 3 months.

Since the beginning of March the Synlait share price has risen 33% from $3.05 to a close at $4.00 on Friday.

Interest from the analyst community, ATM activity and investment and, this week, the purchase of 100% of New Zealand Dairy Company which is building a canning and blending plant in Auckland have all created interest.

At an FNZC / CS conference in Sydney in April, that I attended, John Penno suggested that they would invest in canning and blending rather than drying capacity and noted that if they did it would be “offsite” due to the regulations around licensing from plants. The activity this week is consistent with that and Synlait are being rewarded for “doing what they say they are going to do”. This is a stark contrast to what we have seen from some Australian corporate sector participants in recent years.

This week’s Auction: Event #189:
This is the third auction in a row in which the futures and market activity (with a focus on WMP) point to a weaker GDT outcome (-3% - 4%).

WMP prices are generally off $150/t - $190/t across the curve and the curve, as noted above is trading in backwardation (which doesn’t incentivise near term buying other than to meet current contractural obligations). However, SMP prices have improved significantly (circa $200/t) since the last auction and they have improved in Europe as well (although they are trading below Oceania levels).

So while acknowledging a risk of being wrong again, this auction should, on balance show a little weakness but I don’t expect a uniform trend across all the products.

Global Supply:
The first chart below is from this week’s RBNZ Financial Stability Report (more later). It shows global supply turning positive again as we have moved into the northern hemisphere spring.

A Wall Street Journal article on US milk supply (“Got Milk? Too much of it say US dairy farmers!”) has got some air play but is generally seen as a bit simplistic. Nevertheless there is no doubt that the US has surplus milk and lower prices than prevailing in Europe or Oceania so their situation needs monitoring.

Rice dairies are producing high quality analysis of the US situation and click here for a link to a paper by them this week on US exports and imports which deals with some of the complexities but I recommend you talk to them for expert commentary. 


The RBNZ Financial Stability Report:
There was a reasonably direct commentary from the RBNZ in this week’s FSR. Rather than paraphrase I include a section below.

The bottom line is that the RBNZ is saying very directly that the dairy sector is over-indebted and needs to do something about it. They take some comfort, but not much, from the recent rise in dairy prices.

This point is reinforced in the next chart (also from the FSR) which shows a clear move to higher debt per kgMS over the prior three seasons and a sharp increase in the % of farms operating at over $30/kgMS. Some of this will have been addressed his season but clearly there are farms who have sold their shares and who are operating on high debt levels for whom even $6+ payouts are only seeing them tread water.

Terms of trade:
Statistics NZ published the latest terms of trade (the ratio of export prices to import prices) earlier this week. This used to be a very closely watched data release (25 years ago)!

It was notable this week because (ironically) the terms of trade got back to levels last seen in 1973 at the time the UK entered the EU! And, as was noted by some commentators, this has occurred with dairy prices well off their highs!!

Having noted that, I include an up to date chart of the kiwi dollar versus WMP prices. I often show this chart and the relation between the 2 is dependent on the base point I choose (health warning). In this case I have gone back to 2014 when dairy prices were coming off their highs. It does highlight that prices have been quite resilient (notwithstanding the volatility) over the last 12 months. This was also apparent in my chart 3 weeks ago that compared dairy prices with iron ore, coal and oil.

No conclusion other than to say it is relatively easy to come up with charts that urge a little caution!!

In the category of “just an interesting graphic!”
A couple of charts below that just piqued my interest.

The first is on China’s expanding global footprint in land and food. The America’s and Australasia stand out, clearly land acquisition is hard in Canada and Europe and their investment in Russia was something of a surprise.

The second chart is on the largest traded commodity – oil.

This chart is from the International Energy Agency (IEA). It highlights the different views in the market on oil consumption. At present the world is consuming about 94 million barrels of oil per day. The “oil industry” is forecasting demand to continue to increase with no “peak demand” yet in sight. The IEA has charted their base case which also shows demand increasing over the forecast period by a further 10%+. However, they then hypothesize the potential for efficiency gains, electric vehicle roll out and “fuel switching” to impact demand. In a “best case scenario” (as long as you are nnot an oil producer) the IEA is suggesting daily oil demand could fall 23% in the next 25 years compared with the “oil industry” forecast of an 185 increase!!

When forecasting demand is this hard, forecasting prices which are a derivative of deamand and supply is even harder!!

Conclusion:
This week will be another interesting auction.

Dairy company opening forecasts reflect a degree of optimism probably a bit ahead of my own expectations as you can possibly tell from the above commentary.

At the least I probably share the RBNZ view that some discipline within the sector continues to be necessary!