Fonterra Shareholders’ Fund Unit (FSF.NZ)

IRG

Friday 23rd August 2013

Fonterra Shareholders’ Fund Unit (FSF.NZ) is a unit trust established to invest in the economic rights of shares in Fonterra Co-operative Group Limited. The unit holder can receive dividends but does not have any voting rights or any control over governance of Fonterra. Fonterra Co-operative Group Limited is owned by 10,600 New Zealand farmers and is the world’s largest global milk processor and dairy exporter. Fonterra is ranked fourth (by dairy product turnover) with a turnover of US$15.7 billion – behind Nestlé at US$25.9 billion, Danone at US$19.5 billion and Lactalis at US$18.8 billion. The fund units were sold in an initial public offering in November 2012 at $5.50 per unit.

Performance

The Co-operative’s interim result reflected a strong half year, with a 33% increase in net profit after tax of $459 million. Record New Zealand milk flows in the first half, up 6%, were matched by strong growth in sales volume, up 8% across Fonterra’s business globally.
Revenue of $9.3 billion was 7 per cent lower than the comparable period, with lower dairy prices and the strength of the New Zealand dollar against the US dollar more than offsetting higher volumes sold.

The Board declared an interim dividend of 16 cents per share, 4 cents per share higher than the comparable period. These 16 cents represents 50% of the forecast dividend for the current financial year, and the maximum available under the 40-50% range in Fonterra’s dividend policy.

Outlook

In spite of a positive outlook Fonterra’s board pointed out that the drought in the third quarter meant total milk collection volumes to finish close to what was achieved last season. Hence, Fonterra’s strong first half earnings are unlikely to be repeated in the second half. The on-going volatility in commodity markets could have a negative impact on product mix profitability. In many of Fonterra’s consumer markets, we are expecting intensified competition in the second half – particularly in Australia – and in Asia we are seeing signs of demand slowing.

Fonterra announced on 3rd August, 2013 that three batches of its whey protein concentrate (WPC80) have been found to contain a strain of Clostridium, which has the potential to cause botulism. Although contamination affects only a proportion of Fonterra's product range, it is likely to cause reputational damage that could reduce the sales of other products. Fonterra is working closely with New Zealand's Ministry of Primary Industries in relation to the contamination in an effort to limit potential international damage to both Fonterra and the New Zealand economy. Despite this, China has placed bans on the import of New Zealand milk powders and we believe a number of other countries, including Russia, have followed suit.

Fonterra Cooperative Group, embroiled in a food contamination scandal, was fined $900,000 for its role in fixing prices for infant formula in China on 7th August, 2013.The Auckland-based cooperative was issued an administrative fine of 4.47 million Chinese yuan after the China National Development and Reform Commission finished its probe into foreign firms' pricing on consumer dairy products. Fonterra has been boosting its exposure to Asian markets and China in particular as it looks to cash in on an increasingly wealthy population with growing demand for protein. The company has been building farm hubs in China with a view to producing one billion litres of milk by 2020.New Zealand is the biggest supplier of infant formula to China, selling 371,000 tons to the world's second-biggest economy, in the first half of the year, according to a People's Daily report.

As of Aug 16, 2013, the consensus forecast amongst 10 polled investment analysts covering Fonterra Shareholders' Fund advises investors to hold their position in the company.

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