Fonterra: What shape is it in?

Fonterra is vital to the New Zealand economy. It represents more than 20 percent of total exports and 7 percent of the country's national output.

So what are the implications of its latest payout announcement?

Fonterra today cut its milk price forecast from $4.15 to $3.90 a kilo of milk solids for the current season, due to continuing declines in dairy prices.

Fonterra said that will knock another $400 million from farmer incomes.

Fonterra has axed jobs, sold assets and cut costs and said in November that its cost cutting programme, which has slashed more than 800 jobs, was expected to deliver $340 million worth of savings a year.

But persistent questions about Fonterra's financial soundness remain, given its high debt levels and credit rating downgrades by some international ratings agencies.

Chief financial officer at Fonterra Lukas Paravicini rejected that saying debt was falling and its finances were in good shape.

"Fonterra is absolutely sound, a very sound business ... we are committed to not increasing our debt. We expect our gearing ratio to go to 40 to 45 percent ... by the end of the year."

Head of private wealth research at Craigs Investment Partners Mark Lister agreed and said while Fonterra's debt was high, the company's belt-tightening plans were working.

"I think it's in quite good financial shape. If you just look at the earnings that have come out of the business for the last couple of years, they're going in the right direction and the company's making some progress. So I think it's not something anyone needs to be overly worried about."

And today's announcement did not upset investors.

The Fonterra Shareholders' Fund rose 3 cents, or 0.5 percent, to $5.90 a unit, while Fonterra Co-operatives stock rose 4 cents to $5.90 each.

While the milk price payout forecast was cut, Fonterra still expects dividends from its commercial activities of between 45 and 55 cents.

Mr Lister said a lower milk price usually meant better returns.

"It's not as material as people may think at first glance for Fonterra, hence the quite limited share price reaction. You've got to remember in some ways the lower input price is actually good for them, and for Fonterra the payout is a cost of production. So not terrible for them. The real pain will be felt by farmers."

Dairy farm debt has reached $38 billion and a recent Federated Farmers poll found more than one in 10 were already under pressure from banks over their mortgage.

Fonterra's chair John Wilson blamed the second payout cut this year on more production from Europe and tepid demand from key markets such as China.

"Clearly, prices are unsustainably low for our farmers here in New Zealand. But also ... globally, farmers generally are starting to come under some pressure."

There is no doubt a third season of low dairy prices will hurt more than just farmers.

Westpac senior economist Michael Gordon said reduced farmer spending will ripple through the economy to the country's main urban centres.

"The impact is not going to be limited to just dairy farmers or even to the more rural areas. I think we're going to see the effects flow out around the country over the course of the next year or two.

Despite the dairy sector's current woes, economists point out that the economy is growing at a respectable 2.3 to 3 percent, led by a surge in immigrants and tourists, as well as a robust construction sector.

Whether that is enough to hold up the economy until dairy prices recover remains to be seen.