GDT #192

The GDT auctions this calendar year have (relative to the experience of prior years) shown relatively low levels of volatility. In fact, as shown below, only one auction amongst the last 12 has shown a move of +/- 4% and the last 3 auctions have seen the GDT index move less than +/-1%.

At present, going into this week’s GDT auction, WMP is currently pricing another move of less than 1%. SMP is showing some weakness with European prices having weakened markedly from the $2,000/t seen a few weeks ago but other product prices are mixed pointing to another relatively stable outcome in this week’s auction.

This stability is good for farmer confidence and the current dynamics of WMP > $3,000/t and a projected FGMP of $6.50/kgMS (see below) probably represent a “goldilocks” outcome (not too cold, not too hot)!

The chart below shows trading activity on the 2017/18 NZX FGMP contract. The top panel is price, closing Friday at $6.49/kgMS having reached a contract high of $6.52/kgMS intra-week and the bottom panel shows daily volume in kgMS (kg 000’s) with activity picking up through the June quarter.

The stability is mildly surprising, particularly given that world milk supply (sourced from Rice Dairy) has now turned positive although perhaps with less impetus than some expected. This trend is expected to continue through the balance of the year with US output continuing to grow by approximately 2% p.a. and NZ output expected to recover by 3-4% in the current season.

In addition, as can be seen below, dairy prices have proved to be relatively more resilient in recent months than my other “MILO” products and coal.

Having said that, modelling using current spot and futures prices suggests that the current futures market is trading almost inline with the AgriHQ spot calculation of $6.56/kgMS and somewhat below the MyFarm current model projection of $6.90/kgMS (the difference being a result of the exchange rate forecast used and the positive forward curve for WMP).

Chinese Regulatory Risk:
As noted above, the dairy market appears to have taken in its stride the weakness in other commodity prices and the recent strength in the New Zealand dollar (primarily a result of USD weakness).

NZ listed dairy sector prices (Fonterra, Synalit but most particularly A2M) have also shown resilience in the face of continued instability in Australian listed dairy sector stocks. Synlait and A2M continue to be out-performers while Blackmores (management changes), Bega (equity raising to pay down debt after recent acquisitions), Murray Goulburn (management changes, supplier losses and poor contract prices) and Bellamy’s (see below) are all challenged in a variety of ways.

The Bellamy’s story continues to be intriguing. In summary (for those of you who haven’t been following), after listing at $1.00, Bellamy’s share prices surged to almost $16 as Bellamy’s Organic became a favourite product of the daigou. Some marketing mis-steps (leading to channel over-supply and then price cuts which undermined daigou profitability) lead to daigous changing their preferences to A2 Platinum and Bellamy’s had to downgrade their earnings outlook after suspending trading in their stock.

The situation was then made worse when Bega sold their Derrimut infant formula plant (which produced infant formula for Bellamy’s alongside Fonterra) to Mead Johnson.

In recent weeks, Bellamy’s raised $60m of equity capital for a range of purposes but in essence to repay debt, reset the Fonterra contract and to purchase 90% (for $28.5m) of the Braeside canning plant from CDI (Camperdown Dairy International) which held a CNCA license. Bellamy’s further announced that the Braeside plant would manufacture / can for Yashili (the Chinese company). This purchase was something of a surprise as it was thought that Bellamy’s was looking at acquiring another registered facility owned by “Blend and Pack”. Following the Bellamy’s announcement the newly listed Wattle Health (listed in March and with a market cap of just $32m) announced that it had bought a 5% stake in that plant as part of an 80% sale of Blend and Pack to HK’s Mason Food.

Without providing a great deal of history, the Braeside plant has always been something of a curiosity. It was purchased by interests associated with Bill McDonald (a Queensland coal entrepreneur and hence its Brisbane Lions sponsorship!) some years ago (for approximately $5m), was somewhat unexpectedly licensed for export into China and became the basis of a much bigger play to build an integrated export dairy company. For a variety of reasons, that play failed to materialise, the canning plant was sold to Bellamy’s last month and CDI was put into Administration the next day (reportedly because the company could not pay the circa $5m due to settle the purchase of the old CDI manufacturing site in Camperdown despite having received the $10.5m in cash and $18m in Bellamy’s shares for the Braeside sale).

If that wasn’t complex enough, Bellamy’s then went into suspension again and the company announced that the CNCA had suspended the Braeside plant registration. Parties associated with both Bellamy’s and the former owners (CDI) have suggested the issues are technical and will be resolved quickly (the Bellamy’s submission to the authorities was due on Saturday). The challenge is that the reasons for the suspension of the license are not clear and thus are difficult to address. What I can offer is that under prior ownership, Braeside canned for several labels and a range of commercial interests. At the very least, the Bellamy’s purchase (and Yashili relationship), combined with the 1 Jan 2018 change of regulations, will have resulted in some displaced and unhappy parties so complaints to the Chinese authorities could have come from any of a range of parties. [Braeside’s previous arrangement’s would have been disclosed to Bellamy’s during due diligence so it begs the question as to what warranties Bellamy’s sought or whether it took comfort from the Yashili relationship].

Now Bellamy’s are offering to repay funds raised from retail investors through the latest equity offering with the press reporting that a HK private equity firm [Janchor Partners] associated with the new Bellamy’s Chairman is underwriting the previous issue - although this, in itself, raises complex issues of disclosure.

So why is this of interest to the NZ sector?
Bellamy’s, unlike NZ companies, is a “marketing animal” rather than a producer or manufacturer (indeed it traded on its Australian domicile although its organic product was largely sourced from Europe and NZ) and CDI has (as noted) been fraught as a corporate entity, notwithstanding having some valuable components but most notably its CNCA registration and license.

Apart from the fact that Bellamy’s is a client of Fonterra’s, the issue is that it highlights the importance of the Chinese registration process and the opacity associated with the maintenance of licenses and registration. It would be easy to dismiss the Bellamy’s / CDI issues as simply being poor governance by that company. However, there are also reports that an Australian, Parmalat owned, facility has also had its license suspended. The press is reporting that this relates to “overheating” of pasteurised milk (although Parmalat say that they conform to both local and global standards) and also a related labelling issue (ie. heat treated product being labelled as “fresh”). While this may be a “one-off” as well, Parmalat is a large global player and arguably much more accomplished in its management of these issues.

In addition, there continues to be complexity around Fonterra’s own China relationships and specifically its influence at Beingmate. That stock price is last quoted at RMB 11.97 (compared with Fonterra’s RMB 18 investment price). The stock is currently suspended (supposedly pending a related party asset sale announcement expected this week) and follows the recent announcements (19 June) of plans to “scrap a milk powder renovation project due to policy reasons” (no explanation provided and I don’t know whether “policy reasons” is a reference to company or industry policy).

However, curiously while the stock is suspended for the above reasons, on Friday came an announcement of widening losses at Beingmate in H1. Fonterra management are quoted as being “relaxed” at their Beingmate involvement. I would feel more “relaxed” if the bad news was interspersed with the odd bit of good news! It will be interesting to see where the stock trades when it reopens!

The bottom line is that the Chinese market remains important to the sector as a whole and particularly to NZ and its major listed companies including Fonterra, Synlait and A2M. Those companies are all more professional and sophisticated in managing their China relationships than Bellamy’s would have appeared to be but China is never a market to be taken for granted and transparency is not its strongest point!

EU – Japan Trade Deal:
I have been in Europe for the last couple of weeks so I am not sure how much publicity this announcement received in Australasia. It was a bit under the radar in the UK as well, given Brexit. However, Europe and Japan announced what is widely being termed the “cars for cheese deal”. There are some complexities and pre-requisites and some 15 year phase outs for some tariffs but in essence the agreement is aimed at providing duty-free access for almost all agri-food exports (according to the EU). Japan had been reluctant to open up its dairy sector but has conceded full tariff elimination for some (soft) cheeses and other dairy products while in other cases a quota system would apply for duty free access. Hard cheese tariffs will be phased out over 15 years. It is promising to see Japan moving on agricultural imports. However, the prize of removing barriers to Japanese car exports is something worth bargaining for!

Commodity product prices continue to point to some stability in the GDT auction this week. That said, it is unusual to see such an extended period of low price volatility.

The corporate scene (particularly in Australia) is experiencing considerably greater volatility and suggests that “below the surface of calm prices”, the market remains challenging for many participants. At the end of the day, farmers will prosper most when the various elements of the value chain are prospering and that does not appear to currently be the case.