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Fonterra strategy positive but light on detail - Jarden

Friday 27th September 2019

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Dairy giant Fonterra Cooperative Group's intent and direction is good but lacking in detail, says Jarden research analyst Arie Dekker.

Fonterra yesterday unveiled a new strategy that puts greater emphasis on extracting value rather than pursuing volume. Key elements include bringing the focus squarely back to New Zealand and a pull-back from its consumer brands. 

"We are disappointed by the lack of detail accompanying Fonterra’s strategic reveal," Dekker said in a note to clients  

For Dekker, there are still key uncertainties around the base level of earnings that can be sustainably generated from the ingredients business, and how much investment and spending on overheads is needed over the medium-term. He also questions what sort of return Fonterra expects to pocket from selling assets, and what the approach will be on its capital structure. 

"Only as the visibility on some of these issues emerge is it likely that it will be possible for investors to more confidently invest in Fonterra Shareholders' Fund," said Dekker. 

The new strategy came as Fonterra posted a net loss attributable to shareholders of $557 million in the 12 months ended July 31, widening from its maiden loss of $221 million a year earlier.

Among other things, Dekker asked how far Fonterra's intentions go in the shifting away from consumer products, and how it plans to invest and structure the business for a smaller overall focus and in an environment where domestic milk supply is subdued.

He also said it was disappointing that Fonterra did not provide more detail on its intentions around China Farms – an asset that continues to lose money but which is still valued at $550 million in its books. 

Dekker lowered his long-term earnings expectations "ahead of more granularity on what Fonterra might look like in the future."

He now expects normalised earnings per share will be 27 cents in the current financial year, down 12 percent from his prior forecast. Dekker sees earnings rising to 34 cents in FY21, down 20 percent from his prior forecast. Fonterra's own forecast is for earnings per share of 15-25 cents, and it's targeting 50 cents in five years. 

Dekker dropped his 12-month target price to $3.85 from $4.39 and retained a neutral rating.

Units in the Fonterra Shareholders Fund last traded up 1.7 percent at $3.56 while farmer-owned shares were up 1.4 percent at $3.55. 

Dekker said that while Fonterra did not explicitly state it, it would be reasonable for investors to assume it will exit Brazil, which is under review currently. This will largely flow through as a de-consolidation of around $300 million of debt, he said. He also expects it to try to exit its China Farms exposure, something he said would be "very positive."

Regarding other assets, Dekker said he would like Fonterra to be clearer on why it's retaining other assets, such as Australia and Chile, and how value will be maximised and success measured. 

Alternatively, if an exit is on the cards for these businesses, he wanted Fonterra to be clearer on the timeframe and work needed to get them ready for sale. 

Dekker was positive about Fonterra's move to a dividend payout policy of 40–60 percent of net profit, with consideration to be given to the balance sheet in any dividend payout. 

Despite Fonterra's silence on a capital structure review, Dekker said he expects it to be a focus over the next 12 months because it goes to the heart of Fonterra's competitiveness as a cooperative, and puts constraints around what opportunities the group can pursue.

"We believe Fonterra has been closed off to introspection on its capital structure and the tradeoffs around it for too long, and needs to present clear choices to the farmer shareholders around this." 

Overall, "there was not enough visibility from Fonterra at the FY19 strategic reveal to be as clear as we would like it to be on intent or on what the new strategy means for valuation," he said. 


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