Fonterra fund units drop to 3-year low as investors grow dark on capital structure

Friday 10th August 2018

Fonterra Shareholders' Fund units, which gives outside investors exposure to Fonterra Cooperative Group, fell to a three-year low after the latest dividend downgrade added to scepticism about the efficacy of the cooperative's structure.

The units dropped 2.7 percent to $4.97, adding to a 20 percent slide so far this year, and fell as low as $4.95, a level not seen since September 2015 when Fonterra was hit by a slump in global dairy prices and offered interest-free loans to its farmer shareholders to tide them through the downturn.

Fonterra today trimmed its forecast milk price for the 2017/18 season by 5 cents to $6.70 per kilogram of milk solids and said it was unlikely to declare a final dividend having paid 10 cents per share in the first half, warning earnings would probably be at the bottom end or slightly below guidance for 25-30 cents per share, implying earnings of $403 million to $484 million.

The world's biggest dairy exporter cited the 105 million euros settlement with Danone and a $405 million impairment charge on Beingmate as warranting a stronger balance sheet, and noting skinnier margins from its global ingredients and consumer and foodservice businesses.

"We've come to expect this sort of thing from Fonterra, sadly," said Mark Lister, head of private research at Craigs Investment Partners. "It's already been a pretty poor performer for the last 12 months anyway and we've had no shortage of bad news out of the Fonterra camp for a while now, and people aren't particularly surprised."

Lister said one of Fonterra's problems is that "it's just poorly structured and poorly governed", giving preference to farmer supplier-shareholders over investors in the fund. He said he doesn't rank the Fonterra Fund as a blue-chip stock with Auckland International Airport, Ryman Healthcare or Mainfreight, and is in no rush to buy units at a depressed price.

"That's one of the problems with this company, it's just poorly structured and poorly governed, they don't know who they answer to, they don't make commercial decisions like another business - they are a cooperative and are run as such," Lister said. "If you buy shares in this company you stand to be treated poorly."

Four analysts cover the stock, two of whom rate it 'underperform' and two who are neutral. The median target price among them is $5.25.

An issue for investors in the fund is Fonterra's capital structure, First NZ Capital analyst Arie Dekker noted in a May review, saying an inconsistency between the growth strategy and capital structure made it hard to raise equity and led to a poor track record of adding value from investments, with earnings showing little movement over the past decade.

Lister said the government's review of the Dairy Industry Restructuring Act offers potential to get things back on track, however, it "still takes a while to implement them and execute them with a company of that size".

Oyvinn Rimer, a senior research analyst at Harbour Asset Management, said today's statement by Fonterra and the decision to depart from the formal calculation under the Milk Price Manual will probably spark more debate about the dairy exporter's structure.

"The deviation from the milk price manual is also a significant event for equity investors and could potentially change how investors evaluate risk," he said.

Fonterra's announcement is the first under the new chairmanship of John Monaghan, who led his first board meeting yesterday after John Wilson stepped down over ill-health. Monaghan has been a director since 2008, and defended the cooperative at the New Zealand Shareholders' Association annual meeting during the 2015 lull, saying at the time that the local dairy sector had weaned itself off subsidies unlike its rivals, and was "in the best position to weather the storm and come out the other side".

(BusinessDesk)

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