FONTERRA'S decision to protect the "financial stability" of its farmer shareholders has come at the "detriment of its own", Fitch Ratings said after it slashed the credit rating of the world's biggest dairy exporter by two notches.
Fitch downgraded the New Zealand co-operative from an AA- to single A rating in late October and on Wednesday, detailed the reasons why.
The ratings agency said Fonterra chose not to cut advance-rate milk payments to its farmer shareholders in New Zealand, despite a collapse in global dairy prices last season.
At the start of each dairy season Fonterra, like other dairy processors, announces what it expects to pay farmers throughout the year.
Typically, by the end of the season it has about 10 per cent of payments outstanding, but in 2014-15 that ratio dived to 2 per cent.
"Fonterra's decision in the 2014-15 season to shore up the financial health of its farmer shareholders when dairy prices fell steeply to the detriment of its financial strength contributed to our decision to downgrade," Fitch said in a statement.
The agency said Fonterra funded these higher payments with debt, and also issued its farmer shareholders loans to ease cash flow strain in the wake of the weaker global dairy prices.
"The actions Fonterra took in FY15...shows it will allow deviations from its financial policy when it is in the best interest of the co-operative.
"This contrasts with Fonterra's previously demonstrated commitment towards maintaining its own financial strength and profitability that is consistent with a AA-rated company, and which Fitch expects to strictly comply with its publicly announced conservative policy."
Fitch said before FY15 Fonterra had "consistently demonstrated its commitment towards maintaining a strong credit profile" by adjusting its forecast milk price.
For example, in FY14 the co-operative cut its payout to farmers to below that determined in its milk price manual, to avoid raising debt during a period of record high dairy prices and production.
Fitch expected volatility in global dairy prices to remain in the medium-term, saying their supply is still outstripping demand, which stems from a trade embargo on the West from Russia. Meanwhile, China has eased back on its dairy buying to reduce inventories.
"Fonterra has reduced its advance-rate milk payments for the 2015-16 season to historic levels," Fitch said.
"However, should dairy price volatility continue to strain farmer-shareholder cash flow, Fonterra may elect to extend or increase the support available to farmer-shareholders, again to the detriment of its financial strength. This risk has been captured by the two-notch downgrade."
Fonterra's overall revenue dived 15 per cent to $NZ18.8 billion ($17.3 billion) for the year ending July 31, but net profit soared 183 per cent to $NZ506 million.
Chief executive Theo Spierings attributed the increase in profitability to the company improving its product mix and taking out costs. In early July, he said 523 roles would be "disestablished" at a one-off cost of $NZ12 million to $NZ15 million.
