The co-operative has a reasonable prospect of building a rating buffer over the next 12-18 months and the suspension of dividends and adjustment of the milk price indicate the group is willing to actively protect the interests of creditors, which is broadly analogous to the long-term sustainability of the co-operative, the ratings agency said.
Fonterra is in the midst of a strategic review and in August scrapped its dividend as it slashed the carrying value of assets around the world.
S&P does not expect structural changes to Fonterra’s vertically integrated, farmer-only co-operative structure at this stage.
“We believe the co-operative’s core function of collecting, processing and selling New Zealand milk remains fundamentally sound.”
According to S&P, the world’s largest dairy exporter has maintained its global market leadership, dominance in the purchase of raw milk in NZ and position as the lowest cost, large-scale producer globally.
However, it is are mindful of executive risks and any wavering of the co-operative’s commitments to restoring its financial health will put immediate downward pressure on the A- rating.
The rating relies on the board and management remaining resolute in restructuring the co-operative and repaying debt.
In S&P’s opinion governance factors have contributed to the widespread misallocation of capital.
But it believes management has little attachment to past strategy.
It said capital expenditure is expected to have reduced to $650 million in the 12 months to July 31 and believes there is scope for further reduction. That’s down from $861m in the July 2018 financial year.
S&P said Fonterra’s long-term profitability will be supported by limiting annual capital spending to $500m between now and July 2021 and adopting a more commercially-orientated research and development function.
“Fonterra has somewhat lost its way over the past seven years.”
S&P has lowered the credit rating twice, largely because of the co-operative’s ambitious capital investment that sought to grow Fonterra beyond its core function of collecting, processing and selling NZ milk.
That was based on a belief unconstrained demand would surpass NZ’s milk supply so Fonterra invested in offshore milk pools and processing capacity in NZ when it was also investing in higher-value, specialised ingredients and consumer and food services.
The result stretched Fonterra’s balance sheet and came when operating costs increased and dividend payments remained high.
“In our opinion the balance sheet could have absorbed any one of these factors.
“However, it was the combination of factors that stretched Fonterra’s balance sheet,” it said.
“Asset write-downs, such as those the co-operative announced on August 12, are symptomatic of poor investment decisions or execution.”
S&P also noted critical mass is necessary for Fonterra’s plant use and to mitigate the risk assets become stranded. Fonterra needs to remain competitive against independent processors, it said.
Units in the Fonterra Shareholders’ Fund recently traded at $3.28 while farmer-owned Fonterra shares traded at $3.32. – BusinessDesk