Craigs decided to remove Fonterra and increase the portfolio percentages of A2 Milk, Restaurant Brands and Mainfreight by 2% each.
That means A2 Milk now has an 8% share of the Craigs portfolio to go with its largest market capitalisation on the NZ main board.
Commentary by analysts Mohandeep Singh and Roy Davidson is quite uncomplimentary about the dairy giant’s performance since Fonterra Shareholders’ Fund (FSF) was listed in 2012.
They voiced the disappointment among FSF unitholders who are not dairy farmers with the fundamentals of Fonterra’s earnings and dividends that has seen the share price dip as low as $5 recently.
“Earnings and dividends have been highly volatile, gearing continues to trend higher and major capital investment has not translated into meaningful earnings growth.
“We no longer believe FSF meets our quality threshold (for inclusion in the equities portfolio).”
It no longer ticks enough quality boxes such as earnings growth, capable management team, solid balance sheet and strong corporate governance.
Since 2012 the earnings have fluctuated between 55c/share and 10c while dividends have ranged from 40c to 10c.
Free cashflow generation averaging $100 million annually was disappointing on a revenue base of $19 billion.
Debt continued to increase without much to show for the expenditure.
Fonterra recently increased the milk price for last season to $6.75/kg and reduced the dividend by 12.5c.
“We have some concerns around the alignment of interests between the co-operative and the unitholder,” the analysts said.
Fonterra is now subject to a wide-ranging Government inquiry into the Dairy Industry Restructuring Act and Commerce Commission scrutiny over its risk calculations, which are weighted towards a higher milk price.
Despite spending a total of $3b on growth above capacity needs over seven years from 2010 to 2017, much of it on more added-value, revenue growth has only kept pace with increased milk collections.
Investors want a stable dividend income but dividends had been highly influenced by the farmgate milk price calculation and any changes made to the methodology.
“With gearing at elevated levels, milk supply falling (loss of market share) and a lack of evidence that Fonterra has the ability to materially improve earnings it is difficult to have conviction in a scenario where shareholders begin to see consistent growth in dividend and earnings over time.”
The 80% payout ratio of earnings to dividend showed the strong influence of farmers’ preference for cash and does not bode well for capital-raising as milk supply falls.
As a final kick in the teeth, the Craigs analysts pointed out that Synlait and A2 Milk shares have risen by 60% and 46% in price respectively during this year, compared with minus 18% for FSF.
While FSF looks to be a good buy at the current price ($5.32) Craigs said it is unlikely to be re-rated until Fonterra can demonstrate an ability to grow its earnings sustainably.
That will depend heavily on successful execution of its value-add strategy.
