Australia | Sep 30 2019
Fonterra Shareholders' Fund is dealing with a raft of problems and brokers take a cautious stance until there is evidence of traction in the proposed solutions.
-Lower contribution from ingredients business flagged for FY20
-Long-term issues surrounding competitiveness in milk
-Move to a debt-related dividend policy
By Eva Brocklehurst
Better outcomes may be ahead but brokers remain frustrated by the slow pace at which NZ dairy co-operative Fonterra Shareholders' Fund ((FSF)) is dealing with its problems.
Credit Suisse highlights the value destruction that has occurred through a series of poor investments which have forced the company to act, although welcomes the direction being taken. Macquarie asserts Fonterra will need to start delivering on several aspects of its strategy before the market regains confidence.
At this stage, the benefits from asset disposals are limited, as funds are required to strengthen the balance sheet. Substantial structural changes are also a possible outcome, brokers note. A capital structure review, including milk prices, has commenced with no set timeframe.
There are long-term issues surrounding the company's competitiveness in milk, which Credit Suisse hopes the review will focus on, as well as its ability to grow the ingredients business given the benign outlook for milk supply growth and surplus capacity.
The broker acknowledges the company's intention to remediate the situation but lacks confidence in the action so far, although recognises it is a complex task. There is too much debt and the number and trajectory of asset sales being undertaken is uncertain.
Guidance for FY20 signals a lower contribution from ingredients in FY20, which UBS assesses reflects the inability to pass on cost increases in price-sensitive markets and categories, as NZ and Australian milk prices are above those in Europe and the US.
Even against a more depressed market valuation, Credit Suisse believes Fonterra needs to generate higher free cash flow, and sustained discipline around expenditure will be a key element in its success.
Any positives? Export competition out of Europe should moderate, as inventory levels are reduced and milk production flattens. Moreover, food service gross margins recovered in the second half of FY19 amid price increases in China and Asia.
There are also positives, brokers note, regarding the planned five-year path to normalised earnings, on a footprint that will mean businesses that have dragged on Fonterra, such as Beingmate and China Farms, will be excluded, although so will positive contributors such as Tip Top and DFE Pharma.