They believed the good second-half results in FY2015 and 15c dividend making 25c for the full year added certainty to Fonterra’s own earnings guidance for FY2016 of 40-50c a share.
Analysts agreed Fonterra should be able to pay a dividend of 30-32c in this financial year.
Therefore the price/earnings multiple (P/E) of 12-13x for Fonterra was attractive compared with the utilities-weighted top 10 stocks on the NZX that tended to have higher P/Es.
Craigs senior research analyst Adrian Allbon led the way in re-rating the Fonterra target price from $6.25 to $6.50 a share, which he said was a consequence of the better earnings outlook.
Its P/E was attractive compared with Fonterra’s own long-run average of 15x and was comparable with other dairy multinationals.
Fonterra’s fulfilment of capital expenditure plans, increased product flexibility and slowing NZ milk production were all positive signs for profitability.
The company was also promising more of its milk would be made into consumer and food service products.
Allbon said his higher target price fairly reflected the upswing potential in Fonterra’s very cyclical earnings, in contrast to the discounted cashflow (DCF) approach of the other share brokers.
“Craigs attempts to forecast the real earnings but we admit that the elements are very volatile, such as world dairy prices and the spread between different products.”
First NZ Capital and Credit Suisse lifted their target price by 20c to $5.52, after applying a 10% discount on the DCF of $5.78 because Fonterra was a farmer-controlled co-operative, not a standard listed company.
Forsyth Barr increased its target price 25c to $5.70 and analyst James Bascand said the improvement in consumer and food service product volumes was encouraging, though that was a space with more-established competitors in brands, relationships and balance sheets.
“The opportunity for exciting growth exists, however, execution risk and continued market volatility remain key concerns,” he said.
ANZ Bank rural economist Con Williams said he remained cautious about the milk price outlook because Fonterra had taken the easy price gains on GlobalDairyTrade (GDT) and there were a number of factors weighing against further rises.
They included continued reports of high inventory levels offshore, growth in Europe’s milk supply, particularly in Ireland and the Netherlands, and a fragile global demand picture.
Fonterra chief executive Theo Spierings specifically addressed one of those factors when he spoke at the release of the annual results.
Dairy imports by China year to date were down 21% and therefore he understood inventory levels in the country were about normal.
However, the demand growth recorded between 2009 and 2014 of 8-10% annually had subdued to 2-4% now.
“But inventory levels, even with our customers, are normal.”
Fonterra did not report on its own inventory volumes, except to include a monetary value under assets at balance date in the statement of financial position.
On July 31 this year inventories were valued at $3.025 billion, compared with $3.701b the year before but product values used in making that calculation would have been much lower.
On the plus side, Middle East and African imports were up 3% and Asian imports, excluding China, were up 14% year to date, Spierings said.
Fonterra chairman John Wilson said its hedging position was a nominal 50c/kg milksolids charge against the milk price because the NZ dollar value had fallen to low US60s.
That was the estimated difference between the spot rate, at time of product sale, and the hedged, achieved rate for the season.
In the previous four calendar years when the NZD was up at US 75-80c the effect of hedging had been consistently positive, averaging 27c/kg a year.
Now the NZD had fallen, free on board sales revenue expressed in NZD had benefitted but that was balanced by the 50c opportunity cost of hedging.
The hedged, achieved rate was always smoother than the spot rate for currency exchange and therefore had the effect of reducing some of the volatility in international prices, Wilson said.
To partly offset the negative impact of hedging this year, interest rate reductions over the past four years meant the milk price cost of capital had come down.
In the 2015 financial year there was a saving benefitting the milk price by the equivalent of 15c/kg compared with the 2011 financial year, he said.
In his update on the Turning the Wheel strategy Spierings forecast the share of total milk collected going into consumer and food service products would increase from 18% in FY2014 to 23% of a larger milk pool in FY2018.
That would be a 50% growth in consumer and food service product volumes over five years, he said.
The milk pool size was 22.2b litres in 2013-14 and was predicted to be 25.8b in 2017-18, of which consumer and food service products would account for 5.9b litres, up 2b litres over the five-year period.
The share of output sold by GDT would go down to 23% and ingredients (commodities) sales remain steady around 49-51%.
In the financial year end July 31, food service products accounted for 7% of sales and consumer goods 12%.
“The opportunity for exciting growth exists, however, execution risk and continued market volatility remain key concerns.”
James Bascand
Forsyth Barr
Over the five-year span from FY2014 to FY2018, Spierings said food service volumes would have a compounded annual growth rate of 16.3% and consumer goods 8%, versus 4.9% for ingredient sales and minus 2.4% for GDT sales.
“Most of our growth in NZ milk has flowed through to consumer and food service sales and therefore to added-value,” he said.
Elsewhere in the presentation he disclosed ambitious targets for Fonterra but without a timeframe.
The goal was $1.20/litre of milk equivalent, versus 80c in 2014-15, being a gross revenue of $14/kg MS, not the $10 achieved last season.
That goal, applied to the FY2018 prediction of 26b litres of milk, suggested gross revenue of $30b-plus.
In addition, the gross margin was forecast to rise from 17% to 20% of revenue, which should generate earnings before interest and tax 50% to 100% higher than now and a return on capital in the range 11-13% versus 8.9% now.
