Fonterra To Hold Payout Forecast

Media Release
24 January 2007

Sound Half Year Performance Enables Fonterra To Hold Payout Forecast – Despite High Currency

Fonterra Chairman, Henry van der Heyden today welcomed Fonterra’s strong first half performance but said the good result would do little more than provide a buffer against full-year currency impacts.

“After six months of solid effort and increasing revenue, we are still holding to our $4.05 kg/MS forecast, given we have seen the currency in the 68 to 70 cent (US Dollar) range in the New Year. It is very frustrating to see improved performance eroded by an over-valued currency instead of going into farmers’ pockets.”

Fonterra’s average NZ Dollar / US Dollar conversion rate for the first half of the season was 64 cents, against a budgeted 61 cents, but with the New Zealand dollar once again reaching historical highs, Mr van der Heyden said a full season average conversion rate of at least 67 cents was likely.

Higher first half sales volumes of both commodities and value added products saw Fonterra achieve $6.5 billion in operating revenue in the six months to November 30, 2006. $519 million more than the same period last season.

Fonterra achieved sales volumes that were 228,000 MT ahead of the first half of last season, with 859,000 MT of New Zealand-sourced product sold along with 290,000 MT of product from other origins. The higher volumes offset the lower prices in the first half of the season which were driven by market expectations at that time of strong US production and exports.

Despite a cold, wet winter and spring, Fonterra’s farmers achieved a 2.1% increase in production to 578 million kg/MS, with the bulk of the gain coming from central and lower South Island suppliers.

Fonterra’s total cost of goods sold, including payout to suppliers, increased in the first half of the season by $482 million to $5.4 billion, reflecting higher volumes of product sold ex New Zealand and from other origins.

Operating expenses have decreased by $11 million to $879 million in the six months to November 30, 2006. Whilst the savings from the cost drive and the sale of 50% of RD1 contributed to the lower operating expenses, these decreases were offset by further restructuring costs and the additional investment in advertising and promotion spend.

Fonterra’s operating cash flows were $627 million positive compared to an outflow of $63 million for the half year to 30 November 2005.

Net interest bearing debt is unchanged from May 31, 2006 as the strong operating cash flow of $627 million was used to fund the capital structure transition payments, as well as funding of investments and ongoing fixed asset expenditure. Investments made by Fonterra to grow the business, include the strategic acquisition of 43% of San Lu in June 2006 and payment for the investment in the DMV Fonterra Excipients joint venture with Campina.

Fonterra’s net interest bearing debt at November 30, 2006 was $5.6 billion versus $4.7 billion as at November 30, 2005 and $5.6 billion at May 31, 2006.

While Fonterra’s debt levels in the six months under review remained unchanged, the ratio has increased as a result of the capital structure transition. This reduced the value of shareholders’ equity after $255 million in equity was returned to shareholders. On a like for like basis, excluding the transition, the debt to debt plus equity ratio would have been 51.3%.

The debt to debt plus equity ratio at November 30, 2006 was 53.9% compared to 52.1% at May 31, 2006 and 49.9% at November 30, 2005.

In September, Fonterra announced changes to the way it forecasts payout and pays for milk, with a milk price component and a value add component making up the total payment. Fonterra’s Board today declared an interim value-add component of payout of 23c per kg/MS, payable in February, in line with a 45 cents value add forecast for the season.

Chief Executive Officer Mr Andrew Ferrier said today that strong commodity sales from Fonterra Global Trade, higher revenues in our value added businesses Fonterra Brands and Fonterra Ingredients, and good cost control all contributed to the positive half-year result.

“Our strong commodity sales, which followed on from record volumes achieved in the final quarter of last season had benefited cash flows,” he said. “We forecast that cash flows would rebound when we received payment for product sold late last season and that’s been the case.”

Mr Ferrier said the weaker pricing environment for commodities that began to show last year continued into the early part of this season. However, the tone of the market now is much stronger.

“The supply situation is now constrained with reduced production in Australia and lower volumes out of the US and Europe and we have seen price increases in the second half. These stronger second half prices will help offset the strong currency”.

Mr Ferrier said last season’s drive to reduce costs had continued into the current season. “We remain relentless on operating efficiencies, especially in our high dollar environment.”

Mr van der Heyden said the debt to equity position remained outside the Board’s preferred target range of 45-50%, but with the capital structure transition and additional investment being the main influence, the board remained comfortable with the current position.

Mr van der Heyden said today that the interim value-add payment reflected good progress towards Fonterra’s 45 cent value add target which is 20 cents ahead of the prior season’s value add returns on a like-for-like basis. Value add returns in Fonterra are generated by both Fonterra Brands and by Fonterra Ingredients. The full year payout forecast includes a milk price forecast of $3.60.

“We’re staying with our value add target, even though our value add businesses face higher costs from the higher commodity prices now prevailing and the much stronger New Zealand dollar. It remains a tough goal, but as we said in December, we’re staying with it and we are working hard to achieve it. The milk price forecast is also being sustained because the commodity price improvement we’ve seen as supply has contracted is also helping to offset the climbing currency.”

Mr van der Heyden reiterated comments made at Fonterra’s annual general meeting in October when he criticised New Zealand’s high consumption economy, saying the structural imbalances that supported an over-valued currency made it increasingly hard to make a living out of export businesses.

“It is ironic that as we go into 2007, New Zealand’s Year of Export, we continue to have an uncompetitive exchange rate and high interest rates. These will always act as a drag on the export sector and on Fonterra as the largest single contributor. This is just not sustainable. This is not only serious for farmers who are facing rising costs and falling incomes, but also for all New Zealanders given dairy’s crucial role in the economy.

“The dollar has appreciated by 60 per cent since our inception. If we take the 44 cent average conversion rate that we had in 2001-02, Fonterra’s payout to farmers last season would have been significantly higher and well above our historical average payouts.”

ENDS

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