Why New Zealand Cows Are Costing NAB Money

Dairy prices in New Zealand have fallen by more than half in the space of two years. This trend is not limited to NZ. As a whole, global dairy prices have fallen to six-year lows.  At the Global Dairy Trade auction last night, overall prices fell another 1.4%, to US$2,203 a tonne.

Change in Global Dairy Trade Index

Source: Global Dairy Trade

How does this affect NAB?

The decline in NZ’s dairy industry has forced National Australia Bank [ASX:NAB] to take action. NAB has had to add $522 million in new impaired assets. But the bank claims this hasn’t added any bad debt on their books. The security offered by farmers is enough for NAB to expect no losses for the moment. But the Reserve Bank of Australia (RBA) has warned that these losses could soon materialise. According to the RBA’s April review:

Persistently low milk prices as well as a decline in dairy land values over the past year have increased the probability of defaults and likely losses on lending to the sector, especially if the banks’ assessments of borrower viability prove too optimistic.

Almost 19% (NZ$13.6 billion) of all NAB loans in NZ have been made to agribusinesses. Of these loans, 62% (NZ$8.4 billion) are to the dairy industry alone. NAB said 64% of their dairy portfolio is fully secured, while an additional 38% is partially secured.

Milk prices aren’t holding up

NZ commodity export prices have dropped 32% between their February 2014 peak and March 2016. Dairy prices have dipped more than 56% during this period. Westpac Banking Corporation [ASX:WBC] also pointed to a ‘milk price stress’ in their half-yearly results on Monday.

Dairy giant Fonterra [ASX:FSF] recently dropped their forecast for milk prices by 20 cents this year. Previously, at $4.70, Fonterra had put a more realistic price of $4.50 per kilo for the current season. The total return to farmers is expected to be between $4.70 and $4.80. This is compared with $8.50 just a year ago. The recent forecasts suggest an earnings drop of about $6 billion for Fonterra farmers alone.

What does this mean for share prices?

Since Monday, NAB’s share price have been tracking well. It’s climbed 4.7% higher, to $28.06 per share. And they could climb even higher as we trek into May. Yet the move lower in trade today was likely due to their half-yearly results for 2016.

NAB Share Price Dairy Prices

Source: Google Finance

On a positive note, cash earnings were up 6.5%, to $3.31 billion. However, they also announced a statutory loss of $1.74 billion, reflecting discontinued operations. One-off items such as the demerger and initial public offering of Clydesdale and Yorkshire bank contributed to NAB’s losses.

Though small, NZ dairy will remain under the watchful eye of NAB.

Härje Ronngard,

Junior Analyst, Money Morning

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