Fonterra Shareholders' Fund

Transcription

1 NEW ZEALAND FSF NZ Price (at 04:00, 10 Dec 2013 GMT) Neutral NZ$6.10 Valuation NZ$ DCF (WACC 8.8%, beta 0.6, ERP 7.0%, RFR 4.8%, TGR 2.0%) 12-month target NZ$ month TSR % -2.0 Volatility Index Low GICS sector Food, Beverage & Tobacco Market cap NZ$m day avg turnover NZ$m 2.3 Number shares on issue m Investment fundamentals Year end 31 Jul 2013A 2014E 2015E 2016E Revenue m 18,953 21,013 20,237 19,429 EBIT m 1, ,270 Reported profit m Adjusted profit m Gross cashflow m 1, ,043 1,381 CFPS CFPS growth % PGCFPS x PGCFPS rel x EPS adj EPS adj growth % PER adj x PER rel x Total DPS Total div yield % Franking 1 % ROA % ROE % EV/EBITDA x Net debt/equity % P/BV x NZ imputation credits are only able to be used by shareholders to offset NZ income tax liability. FSF NZ vs NZSE50, & rec history Note: Recommendation timeline - if not a continuous line, then there was no Macquarie coverage at the time or there was an embargo period. Source: FactSet, Macquarie Research, December 2013 (all figures in NZD unless noted) 11 December 2013 Macquarie Securities (NZ) Limited The Great Concession Event Fonterra provided a market update with an FY14 EBIT forecast of $ m (Consensus $750m) and reduced dividend guidance to 10cps. Impact The downgrade appears to be driven primarily by the ongoing divergence between milk powder prices (which essentially drive the Farmgate Milk Price) and non-powder prices (products produced by Fonterra but not in Milk Price). Four months into FY14, the gap between powder prices (driven by increasing demand from China and other EM countries) and non-powder dairy prices (mostly cheese and casein prices) is at a record level. The resulting cost to Fonterra (steam returns) has been estimated in the release at -$800m versus a long term average stream return of approximately $30m and the lowest return (prior to this guidance) of approximately -$200m. In such abnormal circumstances, the Board has elected to maintain the Milk Price at $8.30/kgMS, 70c/kgMS below the theoretical milk price. It has further determined to cut the dividend to 10cps from the prior 32cps guidance given at the start of FY14. Without this concession, we estimate that EBIT guidance for FY14 would have been approximately -$450m to -$550m (i.e. using a $9.00/kgMS) or a pre-stream EBIT of $ m (again using $9.00/kgMS). There appear to be three obvious options to mitigate this volatility: 1) change the Milk Price calculation, 2) add capacity headroom to give optionality and 3) shut down non-rcp capacity. We think Fonterra is likely to review its capacity and location and look to migrate non-rcp production overseas. Note, the Fund can be terminated by Fonterra without cause (unlikely), when there has been a breach of obligations (very narrow circumstances) and finally by Extraordinary Resolution from unitholders. However, even if a vote is successful, Fonterra is not ultimately obliged to purchase back the Fund. Earnings and target price revision Reduced FY14E EPS by 54% and FY15E by 37% due to stream returns. TP reduced to $5.86 from $7.12. Price catalyst 12-month price target: NZ$5.86 based on a DCF methodology. Catalyst: bi-weekly GlobalDairyTrade auctions Action and recommendation We assume that the stream return will normalise over two years coinciding. Also, we think our existing forecasts capture the investment required to supplant legacy assets and create increased flexibility by building out more capacity. The stock is trading at an 8% discount to our equity valuation. This valuation excludes an approximate $1ps uplift from FON's China infant formula launch. We downgrade to Neutral on the basis that the market is likely to factor in a material discount to reflect higher stream volatility than expected and we have applied a 15% discount to our TP of $5.86ps. Please refer to the important disclosures and analyst certification on inside back cover of this document, or on our website

2 FY14 EBIT guidance cut to $ m due to stream returns Fonterra has come out with a forecast FY14 EBIT of $ m (Consensus $750m). We see quantitative guidance as necessary in times of such volatility in earnings and, self-evidently, where consensus becomes out of step with internal company earnings forecasts. The downgrade appears to be driven primarily by the ongoing divergence between milk powder prices (which essentially drive the Farmgate Milk Price) and non-powder prices (products which are actually produced by Fonterra but which are not captured in the milk price cost formula). The resulting cost to Fonterra (steam returns) has been estimated in the release at -$800m versus a long term average stream return of approximately $30-40m and the lowest return (prior to this guidance) of approximately -$200m. Fonterra maintained its forecast Farmgate Milk Price of $8.30/kgMS because of the abnormal circumstances, below the theoretical price of $9.00/kgMS. We see this as positive in some respects as the Board has used its discretion to pay a lower Farmgate Milk Price, which is balancing the interest of both unitholders and farmers. The CEO highlighted that the company would not want to pay the Milk Price out of borrowings, which implies earnings could have been zero or even negative if the Board had not held the Milk Price at $8.30/kgMS. Without this temporary concession however, the downgrade would have been worse and we will have to consider whether management are effectively resiling from their comment that the large negative stream return will normalise soon. However, we expect there would have been a further negative impact if Fonterra had maintained the $9.00/kgMS Milk Price due to the higher costs for the consumer businesses, which would have been likely borne by Fonterra. The flow on impact of paying a Milk Price lower than the Farmgate Milk Price means that other independent processors (which tend to have powder based revenues) would be able to pay a higher milk price (and hence capture suppliers from Fonterra) or take the extra ~$0.70/kgMS in margin. The FY14 dividend guidance has also been cut to 10cps (previously 32cps). We understand that when Fonterra originally forecast its DPS for FY14 (one month into the year), it was forecasting a stream return scenario which resulted in an EPS higher than 32cps. Fig 1 EBIT reconciliation and pre milk price concession EBIT estimate $m FY14 - Low FY14 - High Previous Macquarie EBIT forecast 853 Announced inventory write down -157 Previous forecast adjusted for write down 696 Current EBIT guidance (@ milk price $8.30/kgMS) Implied milk price concession (1,500m $0.70/kgMS) 1,050 1,050 Estimated EBIT (@ milk price $9.00/kgMS) Negative stream returns (per presentation) Pre-stream return EBIT (@ milk price $9.00/kgMS) Source: Company data, Macquarie Research, December 2013 We estimate the milk price concession is worth ~$1,050m based on the $0.70/kgMS savings and 1,500m kgms of milk collected in New Zealand. Removing this concession gives an estimated EBIT of -$450m to -$550m. Fonterra estimates the total size of the negative stream returns is -$800m, so adding this back to our estimated EBIT with a $9.00/kgMS milk price gives us a pre-stream return EBIT of $250m- $350m. 11 December

3 Options to reduce the volatility in NZMP earnings likely a slow process The volatility of earnings is driven by the underlying commodity prices, which can change over the course of the season. We think that Fonterra needs to take some action to help reduce the volatility within this business and we feel there are a number of options: 1. Change the Milk Price calculation: Fonterra could amend the RCP basket to include the key non-rcp products including cheese and casein as well as milk protein concentrate and nutritionals (mainly infant formula). We estimate that casein is ~40% of non-rcp and cheese is ~10%. Historically Fonterra has delivered positive stream returns (~$30-40m p.a.) but in the long term Fonterra may be disadvantaged in NZ as the country is a powder based market where competitors Milk Price will be predominantly based around powder returns. 2. Add capacity headroom to give optionality: Fonterra can look to overbuild capacity (adding more powder plants like the new Pahiatua site) which will give the company more product mix flexibility and the ability to minimise production of relatively lower returning products, even in the peaks. However the trade off here is a lower utilisation (and hence lower return on capital employed) in return for a lower volatility of earnings. If Fonterra had two more large milk powder dryers during the peak of the current season, we think the negative impact from product mix would have been much less as the company would have produced a lesser amount of cheese. 3. Shut down non-rcp capacity: Fonterra could look to exit capacity in non-rcp products in New Zealand and migrate this capacity to other milk pools that tend to be more favourable for the production of these products. Fonterra will need to maintain a certain level of production to meet the demand of its foodservice and other businesses. We think Fonterra has somewhat done this with infant formula, with a large chunk of its capacity in Australia now and whey protein in the Netherlands. Historically, Fonterra added cheese capacity as it utilise its milk intake (same with casein). If Fonterra was to reduce this capacity, it would need to add on significant extra capacity in powder products to utilise milk. We think the least likely outcome is that the Milk Price will be changed, as this fix may have a lasting impact on the company and its competitiveness against the other New Zealand powder only producers. We think Fonterra is likely to review its capacity and location and look to migrate non-rcp production to milk pools that favour each product. This would take a few years to execute and in the interim we expect further powder dryers to be added similar to Pahiatua. Pahiatua, Fonterra s recently announced dryer, is set to cost $235m (to be completed by September 2015) and is located in Manawatu, in the North Island of New Zealand. With milk production increasing by ~3%p.a., Fonterra must continue to add capacity to meet this (~$400m p.a. growth capex). The flush of milk during the peak in FY13 meant Fonterra had to spill milk, which was costly for the company. Near term earnings still highly exposed to commodity prices The profitability of the NZMP business (and hence the wider Fonterra co-operative) will be driven by underlying commodity prices at the GlobalDairyTrade auctions. In particular, the restoring of the premium for non-rcp products vs. RCP powder products. The current monthly milk price is estimated to be ~$ /kgMS (as high as ~$9.40/kgMS during the season so far) and the theoretical milk price of $9.00/kgMS (pre concession by the Board) implies some expectation of easing of commodity prices at auction in the remainder of the season. In the last auction, we saw casein increase by 18.9% on the previous auction, which makes up ~10% of Fonterra's annual production and is a key non-rcp product. We await an improvement in cheese prices relative to powder before this negative impact can unwind fully. We will also be interested in seeing if powder capacity addition globally to help meet demand and the possibility of closure of cheese plants help to bolster prices. A material weakening in commodity prices could have a further negative impact on near term earnings if the cost of inventory is higher than the prevailing realisable price, resulting in a write down in value. 11 December

4 Termination of the Fund an unlikely option The Trust Deed provided circumstances when the Fund could be terminated. The Fund can be terminated by Fonterra without cause (unlikely), when there has been a breach of obligations (very narrow circumstances) and finally by Extraordinary Resolution from unitholders. If unitholders vote to terminate the fund, we understand the following process comes into motion: Fonterra must efficiently and using reasonable efforts facilitate another party nominated by it to acquire the Economic Rights held for the Fund. This is done at the 6-month VWAP from the date which an announcement is made to the market advising of the expectation or intent to vote in respect to a Fund wind-up. If a purchaser has not been found within 120 business days, Fonterra will have the right but not the obligation to require the sale of the Economic Rights to it. We have little clarity on the pricing under this scenario. Overall, we think it is unlikely the Fund will be wound up unless this is motioned by Fonterra itself. 11 December

5 Mead Johnson Unilever Saputo Robert Wiseman* Nestle Kraft Kerry Danone Glanbia China Mengniu Synlait Milk Dairy Crest FrieslandCampina Arla Foods Fonterra Parmalat Goodman Fielder Bongrain Dean Foods Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 US$/Metric Ton Mead Johnson Nestle Danone Unilever Kraft (post split) China Foods China Mengniu Fonterra Kerry Dairy Crest Goodman Fielder Bongrain Synlait Milk Glanbia Saputo Parmalat Dean Foods Robert Wiseman* Dec/ x 15.9x 13.8x 13.8x 12.5x 15.9x 12.1x 8.4x 8.1x 12.6x 11.7x 9.9x 8.3x 27.5x 25.6x 24.7x 20.9x 20.0x Macquarie Private Wealth (FSF:$5.74) Interim Profit & Loss 1H/13A 2H/13A 1H/14E 2H/14E Annual Profit & Loss 2012A 2013A 2014E 2015E 31 July Year End 31 July Year End Operating revenue $m 9,334 9,619 10,782 10,231 Operating revenue $m 19,769 18,953 21,013 20,237 Gross profit $m 1,730 1,282 1,384 1,410 Gross profit $m 3,048 3,012 2,794 3,187 EBITDA - pre unusual $m EBITDA - pre unusual $m 1,521 1,532 1,131 1,473 Depreciation $m Depreciation $m Amortisation $m Amortisation $m EBIT - pre unusual $m EBIT - pre unusual $m 1,028 1, EBIT $m EBIT $m Net interest expense $m Net interest expense $m Pre-taxation profit $m Pre-taxation profit $m Taxation expense $m 58 (126) (35) 28 Taxation expense $m 53 (68) (7) 101 Profit after taxation $m Profit after taxation $m Minorities $m Minorities $m Reported profit after taxation $m Reported profit after taxation $m Tax-affected non-recurring items $m (17) (30) 0 0 Tax-affected non-recurring items $m (30) (47) 0 0 Pre abnormal profit after tax $m Pre abnormal profit after tax $m ^ EBIT and EBITDA includes equity accounted profit share Divisional EBIT 1H/13A 2H/13A 1H/14E 2H/14E Divisional EBIT 2012A 2013A 2014E 2015E NZ Milk Products (Ingredients) NZ Milk Products (Ingredients) Consumer - A/NZ Consumer - A/NZ Consumer - Asia & AME Consumer - A/A&ME Consumer - Latam Consumer - Latam Eliminations/other Eliminations/other (14) Total Total 1,028 1, NZMP ROCE - ungeared post tax 5.5% 5.3% 1.1% 3.6% Discounted Cashflow Valuation A/NZ ROCE - ungeared post tax 5.1% 3.6% 3.0% 4.0% PV FCFs available to owners $m 14,296 Asia & AME ROCE - ungeared post tax 18.1% 19.5% 15.8% 20.2% Less net debt $m 4,467 Latam ROCE - ungeared post tax 13.8% 14.1% 14.1% 15.5% Other adjustments $m 57 Company - ungeared post tax 6.7% 6.4% 3.5% 5.7% Equity Value (ex Minority equity) $m 9,886 Shares outstanding # 1,598 Ratios 2012A 2013A 2014E 2015E Equity value per share $ p.s EPS (adj) c Last price $ p.s DPS c Effective tax rate % 7.8% -10.2% -2.9% 17.3% DCF Assumptions Payout ratio % 76% 70% 68% 75% Terminal year 2029 EV/EBIT % Perpetuity growth rate 2.0% EV/EBITDA x Risk free rate 4.8% ROE % 9.6% 11.4% 3.5% 6.8% Asset beta 0.58 Net debt (closing) $m 3,833 (330) 4,206 3,748 Post-tax market risk premium 7.0% Economic net debt $m 4,229 4,384 4,990 4,672 Target D/V 40.0% Net Debt/Equity % 57.6% -4.9% 62.9% 53.8% WACC 8.8% Price/NTA x EFPOWA m 1,444 1,589 1,598 1,598 Cashflow Analysis 2012A 2013A 2014E 2015E Balance Sheet 2012A 2013A 2014E 2015E EBITDA $m 1,520 1,477 1,131 1,473 Cash $m 1, Net interest expense $m Receivables $m 2,302 2,054 2,185 2,034 Tax (paid)/credit $m 53 (68) (7) 101 Inventories $m 3,078 3,257 2,972 2,886 Other (share of equity accounted profit) $m 100 (121) (18) (18) Investments $m Gross cashflow $m 1,257 1, ,025 Property, Plant & Equipment $m 4,569 4,807 5,015 5,103 Changes in working capital $m (323) (188) Intangibles $m 2,858 2,772 2,686 2,600 Operating cashflow $m 1,015 1,039 1,139 1,212 Other Assets $m , Capital expenditure $m 1, Total Assets $m 15,117 14,373 14,805 14,371 Proceeds from asset sales $m Overdraft $m Other $m Current Payables $m 1,386 1,491 1,578 1,439 Investing cashflow $m (826) (868) (703) (564) Short Term Debt $m 1,204 1,569 1,521 1,368 Net equity raised $m Long Term Debt $m 3,745 3,108 3,014 2,709 Dividends paid $m Other Liabilities $m 2,085 1,456 2,002 1,892 Other $m 107 (917) 0 0 Total Liabilities $m 8,462 7,625 8,115 7,409 Financing cashflow $m 26 (828) (294) (190) Net assets $m 6,655 6,748 6,689 6,961 Net change in cash $m 215 (657) Shareholders' equity $m 6,620 6,708 6,649 6,921 FX adjustment $m 14 (5) 0 0 Minority Interests $m Change in cash (B/S inc o/draft) $m 229 (662) Total Shareholders' Equity $m 6,655 6,748 6,689 6, x 25.0x 20.0x 15.0x 10.0x 5.0x 0.0x FMCG 14.7x Key Comparable Companies Consumer brands and processing 17.5x Processing focussed 15.0x 19.0x 17.0x 15.0x 13.0x 11.0x 9.0x 7.0x Histioric FY13 EV/EBIT for Global Comps FY13 EV/EBIT Time Series - Weekly 60% 50% 40% 30% 20% 10% 0% 51.6% EV/EBIT (FY14) Average Return on Capital Employed Comparison Pre-tax Return on Capital Employed (FY0) 23.4% 21.5%18.2% 16.3% 15.2%15.2%13.8%13.6%13.5%13.3%11.9%10.7%10.5% 8.8% 8.4% 8.3% 8.1% 5.3% FMCG Consumer brands and processing Processing oriented All comps Fonterra GDT Pricing GDT - Fonterra Basket Price vs. RCP Basket Price 6, x 5, x 5, x 4, x 4, x 3, x 3,000 2, x 2, x FY13 Average price (Fonterra basket) FY13 Average price (RCP) Source: Bloomberg, FactSet, GlobalDairyTrade, Macquarie Research, December 2013 Multiples calendarised to 31 July year end * Robert Wiseman was acquired in 2012 and has been excluded from averages. FY13 numbers shown Fonterra/RCP weighted (RHS) FY12 Average multiple (RHS) FY13 Average multiple (RHS) Note: Return on capital employed is EBIT/Capital Employed where capital employed is calculated by taking the total assets and subtracting current liabilities for the last reported financial year Source: Company data, Macquarie Research, December 2013 RCP weighted price (~COGS) Fonterra sales weighted price (~Revenue) 11 December

6 Important disclosures: Recommendation definitions Macquarie - Australia/New Zealand Outperform return >3% in excess of benchmark return Neutral return within 3% of benchmark return Underperform return >3% below benchmark return Benchmark return is determined by long term nominal GDP growth plus 12 month forward market dividend yield Macquarie Asia/Europe Outperform expected return >+10% Neutral expected return from -10% to +10% Underperform expected return <-10% Macquarie First South - South Africa Outperform expected return >+10% Neutral expected return from -10% to +10% Underperform expected return <-10% Macquarie - Canada Outperform return >5% in excess of benchmark return Neutral return within 5% of benchmark return Underperform return >5% below benchmark return Macquarie - USA Outperform (Buy) return >5% in excess of Russell 3000 index return Neutral (Hold) return within 5% of Russell 3000 index return Underperform (Sell) return >5% below Russell 3000 index return Volatility index definition* This is calculated from the volatility of historical price movements. Very high highest risk Stock should be expected to move up or down % in a year investors should be aware this stock is highly speculative. High stock should be expected to move up or down at least 40 60% in a year investors should be aware this stock could be speculative. Medium stock should be expected to move up or down at least 30 40% in a year. Low medium stock should be expected to move up or down at least 25 30% in a year. Low stock should be expected to move up or down at least 15 25% in a year. * Applicable to Asia/Australian/NZ/Canada stocks only Recommendations 12 months Note: Quant recommendations may differ from Fundamental Analyst recommendations Financial definitions All "Adjusted" data items have had the following adjustments made: Added back: goodwill amortisation, provision for catastrophe reserves, IFRS derivatives & hedging, IFRS impairments & IFRS interest expense Excluded: non recurring items, asset revals, property revals, appraisal value uplift, preference dividends & minority interests EPS = adjusted net profit / efpowa* ROA = adjusted ebit / average total assets ROA Banks/Insurance = adjusted net profit /average total assets ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation *equivalent fully paid ordinary weighted average number of shares All Reported numbers for Australian/NZ listed stocks are modelled under IFRS (International Financial Reporting Standards). Recommendation proportions For quarter ending 30 September 2013 AU/NZ Asia RSA USA CA EUR Outperform 50.56% 56.87% 48.78% 41.00% 61.75% 47.10% (for US coverage by MCUSA, 5.85% of stocks followed are investment banking clients) Neutral 38.95% 25.18% 42.68% 54.40% 34.43% 30.89% (for US coverage by MCUSA, 3.90% of stocks followed are investment banking clients) Underperform 10.49% 17.94% 8.54% 4.60% 3.83% 22.01% (for US coverage by MCUSA, 0.00% of stocks followed are investment banking clients) Company Specific Disclosures: Macquarie Capital Advisers acted as a Co-Lead Manager for the initial public offer of the, which listed on 30 November Macquarie Capital Advisers received compensation for investment advisory services from. Important disclosure information regarding the subject companies covered in this report is available at Analyst Certification: The views expressed in this research reflect the personal views of the analyst(s) about the subject securities or issuers and no part of the compensation of the analyst(s) was, is, or will be directly or indirectly related to the inclusion of specific recommendations or views in this research. The analyst principally responsible for the preparation of this research receives compensation based on overall revenues of Macquarie Group Ltd (ABN , AFSL No ) ( MGL ) and its related entities (the Macquarie Group ) and has taken reasonable care to achieve and maintain independence and objectivity in making any recommendations. General Disclosure: This research has been issued by Macquarie Securities (Australia) Limited (ABN , AFSL No ) a Participant of the Australian Securities Exchange (ASX) and Chi-X Australia Pty Limited. This research is distributed in Australia by Macquarie Equities Limited (ABN , AFSL No ) ("MEL"), a Participant of the ASX, and in New Zealand by Macquarie Equities New Zealand Limited ( MENZ ) an NZX Firm. Macquarie Private Wealth s services in New Zealand are provided by MENZ. Macquarie Bank Limited (ABN , AFSL No ) ( MBL ) is a company incorporated in Australia and authorised under the Banking Act 1959 (Australia) to conduct banking business in Australia. None of MBL, MGL or MENZ is registered as a bank in New Zealand by the Reserve Bank of New Zealand under the Reserve Bank of New Zealand Act Any MGL subsidiary noted in this research, apart from MBL, is not an authorised deposit-taking institution for the purposes of the Banking Act 1959 (Australia) and that subsidiary s obligations do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of that subsidiary, unless noted otherwise. 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