Thursday, November 30, 2023

Fonterra units look attractive as plans are executed

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Momentum continues from spectacular annual results.
Jarden’s head of research, Arie Dekker, says Fonterra should consider refining its dividend policy to provide better value for farmers.
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Equities analysts say some of the momentum from Fonterra’s stellar results in the 2023 financial year can be maintained and have lifted their target prices for Fonterra Shareholders Fund units.

Share brokers have rated Fonterra Shareholders Fund (FSF)  “overweight” or “outperform”, which means investors should consider buying more units for possible price gain and for good yields.

Jarden’s head of research, Arie Dekker, who has critically analysed Fonterra for more than a decade, has lifted the 12-month FSF target price by 20% to $4.15.

At the time his note was written the quoted FSF price was $3.46, with a steady upward momentum after the 50c Soprole capital return in mid-August and before the 40c dividend declared on September 21 for payment on October 13.

Craigs Investment Partners senior research analyst Joshua Dale increased the target price for FSF by 30c to $3.80 and maintained the overweight rating.

He has forecast price/earnings ratios around 6x for the next three financial years, certainly among the lowest ratios available on the share market.

Low P/Es signal to investors potentially good dividend yields for the prices paid for shares.

The Craigs forecasts are for 30c, 31c, and 32c dividends over the next three years, with dividend yields around 9%.

Investors in FSF units seem to have latched on to the potential, as those prices exceed the Fonterra Co-operative Group supply shares (FCG) by 30%, currently $3.50 compared with $2.65.

Among the reasons for the disparity is the so-called restricted market discount – farmers can only sell FCG shares to other farmers.

But Dale doesn’t buy that reason entirely, as FCG shares are entitled to the same returns, and thus earn the same yields, as the FSF units.

Previously linked until Fonterra began its recent capital restructure, the units and the shares have diverged, but potentially will return to parity, he said.

Craigs has recommended holding on to FSF units after the 40c dividend is paid because favourable stream returns have continued in the first two months of FY24, plus good prospects for foodservice and consumer products divisions.

Analysts Matt Montgomerie and Benjamin Crozier, Forsyth Barr, also cited continued favourable stream returns, from which they think Fonterra has factored in 15c earnings per share delivered in the first half.

The current earnings guidance for FY24 is 45c to 60c.

“Should stream returns remain favourable for longer, earnings upgrades could occur,” they said.

“Even as stream returns normalise, FSF units trade on approximately 8x earnings expectation and a cash yield of 7.2%.”

The balance sheet is in good shape and management has executed well on its plans to date, Forsyth Barr said.

For Jarden, Dekker said his elevated FSF target price of $4.15 is based on the strength of the free cash flow and balance sheet position and the nearer-term stream returns.

“Fonterra is committed to ongoing capital discipline as it enters a phase where it is signalling potential for an increase in non-core investment.”

Dekker called for greater transparency around the recent decision to hold on to its Fonterra Australia business and assets, where performance has been poor – A$1.5 billion of capital earning only NZ$100 million annually.

“Free cash flow generated on a cumulative basis over a sustained period is very poor.

“If Fonterra were to exit [Australia] and could achieve close to book for this asset, it would allow for a significant return of capital to farmers from a business that has not delivered in the last 10 years and where current returns still look marginal to us.”

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