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S&P says Fonterra's restructuring is a 'painful' step toward recovery

Wednesday 11th September 2019

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Fonterra Cooperative Group has taken a painful step toward recovery but any wavering would put immediate pressure on its 'A-' rating, says S&P Global Ratings.

The cooperative has a “reasonable prospect” of building a rating buffer over the next 12-18 months and the suspension of dividends and adjustment of the milk price indicate the group is willing to actively protect the interests of creditors which is “broadly analogous to the long-term sustainability of the cooperative,” the ratings agency said.

Fonterra is in the midst of a cooperative-wide strategic review and in August scrapped its dividend as it slashed the carrying value of assets around the world. 

S&P does not expect structural changes to Fonterra’s vertically integrated, farmer-only cooperative structure at this stage.

“We believe the cooperative’s core function of collecting, processing and selling New Zealand milk remains fundamentally sound.”

According to S&P, the world's largest dairy exporter has maintained its global market leadership, dominance in the purchase of raw milk in New Zealand, and position as the lowest cost, large-scale producer globally.

However, “we are mindful of executive risks and any wavering of the cooperative’s commitments to restoring its financial health would put immediate downward pressure on the 'A-' rating.”

The rating relies on the board and management remaining resolute in restructuring the cooperative and repaying debt. In S&P's opinion “governance factors have contributed to the widespread misallocation of capital.”

S&P said, however, it believes current management have “little attachment to its past strategy.”

It said capital expenditure is expected to have reduced to $650 million in the 12 months to July 31, 2019 and “we believe there is scope for further reduction.” That's down from $861 million in the July 2018 financial year. 

S&P said Fonterra's long-term profitability would be supported by limiting annual capital spending to $500 million between now and the July 2021 year and adopting “a more commercially-orientated research and development function.”

According to S&P, “Fonterra has somewhat lost its way over the past seven years.” The ratings agency lowered the credit rating twice, largely because of "the cooperative’s ambitious capital investment that sought to grow Fonterra beyond its core function of collecting, processing and selling New Zealand milk," it said. 

That was based on a belief that unconstrained demand would surpass New Zealand’s milk supply, S&P said. Fonterra invested in offshore milk pools and processing capacity in New Zealand at a time when it was also investing in higher-value specialised ingredients and consumer and food services.

The result stretched Fonterra’s balance sheet and came at a time when operating costs increased and dividend payments remained high.

“In our opinion, the balance sheet could have absorbed any one of these factors. However, it was the combination of factors that stretched Fonterra’s balance sheet,” it said.

“Asset write-downs, such as those the cooperative announced on Aug. 12, are symptomatic of poor investment decisions or execution.”

S&P also noted that critical mass is necessary for Fonterra’s plant utilisation and to mitigate the risk that assets become stranded. Fonterra needs to remain competitive against independent processors, it said. 

Units in the Fonterra Shareholders' Fund recently traded at $3.28 while farmer-owned Fonterra shares traded at $3.32. 


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