Small Caps | Jun 08 2017
Dairy co-operative MG Unit Trust will undertake a comprehensive strategic review, acknowledging its recent performance has been unacceptable. This adds another layer of uncertainty to the outlook, brokers suggest.
-MG Unit Trust may not experience benefits of cost reductions until FY19
-Strategic review to also consider the profit sharing mechanism
-And suggests deeper problems may exist
By Eva Brocklehurst
The MG Unit Trust ((MGC)) of Murray Goulburn will undertake a comprehensive strategic review, acknowledging its performance has been unacceptable. This review would look at all aspects of the company's strategy and corporate structure and an update is expected at the FY17 results in August.
The company also announced its opening forecasts for the FY18 full year southern milk farm-gate price at $4.70/kg for milk solids, versus $4.45/kg in the prior corresponding period.
Morgans observes, in the past, it was common practice for the opening price to represent around 92% of a processor's full year forecast, with the price gradually increasing over the year depending on the season, exchange rates and global dairy prices.
The company's full year price for FY18 is expected to be in the range of $5.20-5.40/kg milk solids. This includes the recently-announced loyalty payment. Brokers compare this with Fonterra's forecast of $5.30-5.70/kg milk solids and are concerned competitors are in a stronger position to play suppliers a higher price, and the company could lose more market share.
Alternatively, in order to remain competitive and avert further market share losses the company may need to match competitor pricing by taking on additional debt, as occurred in FY17.
The company stated it conservatively envisages collecting 2.5m litres of milk for FY18. The intake assumption is down from 2.7m litres in FY17, which reveals some annualised impact of farmer loss throughout the season.
Morgans revises down forecasts for underlying net profit in FY18 and FY19 by -7.4% and -14.0%, respectively, because of a lower-than-expected milk intake, believing competitors are likely to pay a higher farm-gate price than MG Unit Trust and further market share losses are likely.
The difference in price between Fonterra and MG Unit Trust may reflect different assumptions but also the cost base. MG Unit Trust will not experience the full benefit of cost reductions and plant rationalisation until FY19. Macquarie suggests this may close the gap but whether it is enough remains to be seen. The broker still queries whether the company may need to undertake a debt-funded step up again in FY18 in to order better manage competitive prices and retain farmers.
Further loss of share implied in the guidance is negative for the company's model, in the broker's view, and its ability to meet market pricing, while farmer interests remain favoured. Macquarie retains a Neutral rating and lowers the target to $0.83 from $1.05. The broker concedes the valuation is cheap for mid-cycle, assuming the company can close the price gap on milk in the medium term.
Strategic Review
The strategic review will look at all aspects of the structure, including the profit sharing mechanism (PSM). The PSM is fundamental to the listed co-operative and the prospect of changes may be a concern for the market, Macquarie believes.
Bell Potter remains positive about dairy as a commodity but finds visibility is limited regarding the possible effect of the strategic review and, therefore, the ultimate earnings model. The broker cautions that the company may not provide investors with the same operating leverage to rising farm-gate milk prices that is currently enjoyed under the PSM.
The broker, not one of the eight monitored daily on the FNArena database, reflects this risk in both its target and rating, introducing a 20% discount to reflect the heightened earnings risk. Rating is downgraded to Hold from Buy and the target to $0.73 from $1.11.
Morgans agrees the company needs to address its PSM and conflicting capital structure but believes, in the meantime, the uncertainty surrounding many aspects of the financials is too great. The decision to undertake a strategic review so soon after re-evaluating its manufacturing footprint suggests to the broker there are deeper problems, and that any turnaround in the business will take time.
The review is nevertheless warranted, given recent announcements that highlighted the inherent disadvantage that unit holder's face when a decision is made to deviate from the PSM and support suppliers. For this reason, the broker suggests, the lack of voting rights for unit holders and a poor track record means the company deserves to trade at a material discount to market multiples. Morgans retains a Hold rating and lowers the target to $0.75 from $1.00.
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