Wednesday, July 6, 2022

Caution in Fonterra forecasts

Fonterra’s new 170-page prospectus contains a massive amount of detail on the co-operative, its place in world dairy markets and the unique Trading Among Farmers concept. Hugh Stringleman provides some highlights.

Fonterra’s directors have been characteristically cautious in providing forecasts for the current financial year in the Fonterra Shareholders’ Fund (FSF) prospectus and investment statement.

These forecasts will be closely studied by intending investors in the unit fund which is designed to make the market for Trading Among Farmers (TAF).

Investors will receive any annual dividend and movements in share (and unit) price, but not any milk price or voting rights.

The indicative range for the share price is conservative ($4.60 to $5.50), given that the current share price has been artificially pegged at $4.52 for more than four seasons and it went as high as $6.79 back in 2006-07.

That was the most recent year of low commodity prices (when payout was $4.46/kg milksolids) and Fonterra earned a record profit of $862 million on dismal revenue of $13.7 billion.

Fonterra’s value-add and brand businesses tend to do better when dairy commodity prices are lower.

However, the final price of the shares and the investing units will be determined after the book-build process during November and Fonterra reserves the right to set the final price higher than the indicative price range.

Caution is also evident in the trading forecasts for 2012-13, including revenue, profit, earnings per share and dividend.

The directors are not going to be accused of over-promising to their sizeable new group of investors and stakeholders, totalling around 100 million investment units.

Revenue has been forecast at $18.6 billion, down $1b from the 2011-12 financial year, the results of which were only declared a month back.

Nevertheless Fonterra is confident of improving normalised earnings by 5% to $1.08 b and profit by 10% to $690 million.

It is therefore perhaps surprising that the forecasts of earnings per share at 42c/43c and the dividend at 32c are not higher when compared with similar results achieved in 2011-12.

The answer lies in the numbers of new shares – both as a result of the record milk production season (up 11%) in 2011-12 and the probability that Fonterra will need to create new shares to get TAF operating.

In the 2012 annual report the number of shares on issue at May 31 was 1.43 billion, but that was before farmers were required to share up to reflect their record milk production.

The prospectus discloses “shares on issue following the offer” between 1.586b and 1.598b.

A footnote explains the number of shares on issue at present is 1.522b (held by farmers), to which has been added a range of 63 to 76 million “required to be issued by Fonterra to meet the minimum FSF size” and a further 110,000 to be issued for the registered volume provider.

Therefore the new total number of shares approaching 1.6b has a dilution effect on the earnings per share and dividend forecasts for FY2013.

Fonterra chairman Sir Henry van der Heyden left no doubt at the launch of the TAF prospectus that the co-operative would issue as many shares as required to “make TAF operate” from November 30 onwards.

This is because the whole purpose of TAF is to reduce redemption risk for the co-operative and the Dairy Industry Restructuring Amendment Act 2012 (DIRA) requires the TAF market to be a minimum size of $500 million before starting.

After five years of sometimes acrimonious debate, Fonterra directors do not want TAF to be stillborn.

In the prospectus therefore Fonterra has indicated it believes around 70 million new shares will be required to meet the shortfall of farmers not willing to place economic rights of shares into the FSF.

As all shareholders will have seen, the FSF at $500 million is the small cog which enables the large cog to operate – the $7-8 billion Fonterra Shareholders’ Market (FSM).

The opponents of TAF within Fonterra’s ranks have already pointed out that the capital restructuring will fail if farmers are not willing to participate in the FSF, notwithstanding the keenness of investors to get a chunk of New Zealand’s export cornerstone.

Conversely TAF will fail if the small cog is frozen and the market for milk supply shares among farmers is illiquid and those who want and/or are required to buy and sell shares are unable to do so.

If that happens Fonterra will be in breach of its DIRA obligation to maintain open entry and exit to the co-operative for all NZ dairy farmers.

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