The supplier shareholders will want Fonterra to maintain a strong balance sheet, restricting debt-funded growth, because milk payments to farmers have been given lower priority than payments to all creditors as part of the process involved in achieving a strong credit rating. They will want to keep those non-milk payments to a minimum.
With the farmer-owners limiting the level of outside capital, most new equity will have to come from farmers themselves, and the Craigs report notes capacity barriers to this.
With these constraints adding to the challenge of competing with big value-add dairy product manufacturers in world markets, Craigs is one of at least three analyst groups suggesting the unit price for the Fonterra Shareholders Fund (FSF) on the NZX has exceeded fair value.
The capital-intensive NZ Milk Products subsidiary could also act as a constraint on growth in the regional export businesses that Fonterra is relying on for growing revenue and products, Craigs says.
NZ Milk Products produces more than half of Fonterra’s earnings, but its processing arm is capital hungry because the business has to keep developing capacity to be able to accept all the milk offered to it.
Craigs described Fonterra as having attractive earnings growth, but with some risk around achieving its targets. There will also be areas of natural divergence of interest between farmers and unit-holders and the farmers’ view will take precedence.
These issues will have some impact on the FSF, the listed entity set up as part of the Trading Among Farmers (TAF) concept to protect the co-operative from the redemption risk of loss of capital as departing dairy farmers cash in their shares.
So far, the level of outside capital allowed for the FSF is limited to the amount needed to provide liquidity to support TAF.
FSF units have traded well above their $5.50 issue price in late November, reaching a high of $7.53 on January 17, but settling around $7.22 in latest trading.
FSF is now part of the NZX50 index. This should support the price as institutions buy in to maintain index weightings.
Craigs has a 12-month price target of $6.43 and suggests the units are a hold rather than a buy at current levels.
Forsyth Barr, the biggest fully NZ-owned broking house, has a price target slightly higher at $6.50, but suggests investors take profits at the current price levels. Analysts at Morningstar have a valuation of $5.50 (the issue price), saying Fonterra has no competitive advantage against the likes of Nestlé and Danone in world markets.
In its research note, Forsyth Barr has a higher 2013 net profit forecast than the FSF prospectus – allowing for cost savings and strong milk flows – but still says the unit price is expensive.
It notes the farm gate milk price is the single biggest cost for the group and has a direct impact on earnings.
Like Craigs, its expects some execution risk on Fonterra achieving the required higher returns on value-added products.
- At $7.22 a unit, the FSF market capitalisation is about $690 million. This provides an indicative value for the Fonterra group of about $12 billion. Some data lists this as its market capitalisation (which would be the highest for a NZ business), but this is misleading because Fonterra’s voting shares are not listed on the NZX.
The FSF shareholders
The new fund has been strongly supported by overseas investors.
It isn’t clear from NZX data, but the level of overseas shareholding could be about 45% of the 95.5 million units on issue.
Australia’s Commonwealth Bank (CBA) has disclosed a stake of 7.43% to be the biggest single unit-holder. Most of the stake is held through Citicorp Nominees Pty Ltd, with shares also owned through BNP Paribas Securities, JP Morgan Chase, and HSBC.
About 30% of the FSF units are held through the New Zealand Central Securities Depository Ltd. In this group are the 12.14% JP Morgan Chase Bank (New Zealand) holding (an American-controlled entity), 3.7% for Cogent Nominees (BNP Paribas of France), 2.67% for HSBC Bank, and $1.8% for Citibank Nominees (US).
Also in this group are large domestic entities Accident Compensation Corporation (1.9%), NZ Guardian Trust (1.8%), and NZ Superannuation Fund (1.52%).
Nominee and custodial holders are also listed individually among the top 100 unit-holders outside NZCSD. Among these holders, just over 25% are marked as being overseas-based.
Funds associated with Forsyth Barr are shown to hold just more than 5% of the units, though this was before the recent research note advising investors to take profits.
