In a research update this week, First NZ Capital retained a neutral recommendation on the Fonterra Shareholders’ Fund (FSF), but said “it’s approaching a point in which there may be opportunity to invest on an improved outlook for earnings following a difficult period”.
Some of the key things being looked for in the next 18 months are improvement in the Australian and NZ ingredients businesses, and delivery on the potential in food services and consumer.
“In FY16 it looks like some of these factors are being delivered on although the very strong result is likely to be dominated by favourable milk price dynamics and stream returns, and it will not be until those conditions normalise that we can get a better gauge on where FSF is at,” it said.
It forecasts $19.2 billion in operating revenue in the 2016 financial year, from $18.8b this year, and a near 70% rise in net profit after tax in 2016 of $784 million, from $466m in 2015.
Earnings a share is forecast to rise to 49 cents from 29.1 cents in 2015, in the middle of FSF’s guidance range, with a significant earnings lift on the back of another strong year for ingredients, a turnaround in Oceania largely because of NZ foodservices and consumer, and growth in Asia, China and Latin America, First NZ Capital said.
The analysts’ valuation for the fund’s units is $5.88 on a discounted cashflow basis and the 12-month target price is $6.12, up 11% on its previous forecast. The fund’s units are trading at $5.70.
Fonterra has reported its turnaround programme is delivering strong working capital and cost benefits although First NZ said it needed to show how much of this is going through to the milk price as opposed to earnings.
Despite a challenging environment for farmers, the co-operative is investing $900m of capital expenditure in the 2016 financial year, a level management has indicated is likely to remain the annual norm longer term.
First NZ said Fonterra has a track record in struggling to consistently deliver return on invested capital. While there has been a recent improvement, remaining challenges include the transparency of its accounts and a “disconnect” between its aspirational earnings targets and the co-operative stating how much capital is required to execute on them.
Fonterra will need to deliver higher and more consistent earnings to generate the required return on investment capital, but the co-operative has “consistently delivered under this”, First NZ said.
Net debt, which caused concern this year when it ballooned to over $7b, is likely to return to below $6b in 2016 after accounting for the $390m farmer-support loan ending this month, First NZ said.
