Murray Goulburn Co-operative Co Limited has announced that CEO and Managing Director Gary Helou will step down from his role, following a profit downgrade. Chief Financial Officer Brad Hingle has also decided to resign following Mr Helou’s decision.

The company is Australia’s largest dairy foods company with annual revenues of around $2.9 billion. A listed ASX entity, the MG Unit Trust (ASX: MGC) invests in notes and convertible preference shares issued by Murray Goulburn – allowing retail investors to gain exposure to the dairy company – without compromising the co-operative structure of Murray Goulburn (MG).

The main issue appears to be that Murray Goulburn has been paying its suppliers a much higher Farmgate Milk Price (FMP) than the market is paying, and it can no longer sustain that.

The world’s biggest dairy exporter Fonterra, has been paying its farmers NZ$3.90 a kilogram of milk solids – but was until recently paying its Australian farmers $5.60 a kilogram – the same price as MG was paying its farmers.

The problem is that due to a global oversupply of dairy commodities, prices have almost halved over the past 2 years. Slowing demand, particularly from Russia and China, has combined with the rising Australian dollar to crush earnings. Fonterra chairman John Wilson noted last year that current global prices were unsustainable. Fonterra’s CEO Theo Spierings also criticised MG saying, “What you cannot do is pay money that you have not earned.

Murray Goulburn had forecast earnings of around $63 million for the 2016 financial year (FY16) but has lowered that to between $39 and $42 million. In its prospectus, MG had forecast a net profit of $89 million, so this is a significant downgrade.

Lower earnings means MG has been forced to cut the price it pays its farmers to between $4.75 and $5.00 per kilogram – although the company says it is introducing a Milk Supply Support Package giving suppliers a milk support payment so they receive the equivalent of $5.47 per kilogram this financial year.

CEO Helou has previously stated that the company could keep milk prices high because it had converted to more value-added prices (i.e. branded products). Speaking at the Global Food Forum last week, Mr Helou even suggested prices of $6/kg were realistic – when clearly that’s not the case.

Lower milk prices should be good news for the value-added retailers such as Bellamy’s Australia Ltd (ASX: BAL) and Blackmores Limited (ASX: BKL) which has recently entered the infant formula market.

Foolish takeaway

As much as Murray Goulburn wants to support its farmers, suppliers and part owners through paying higher FMP prices, if global prices aren’t at those levels then something has to give and realistically, it’s the FMP price which had to be cut.

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Motley Fool contributor Mike King owns shares of Bellamy's Australia. You can follow Mike on Twitter @TMFKinga

The Motley Fool Australia owns shares of Bellamy's Australia. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.