* Note disclaimer at the foot of this article.
“Baby Elephant my offspring, the untidy one, you unorthodox, please stay near, near with tradition, the cooperative tradition. Oh, please”
“Clarity, oh fair lady I love thee so, please stay beside me forever!”
These two verses of untidy poetry have emphasis for what follows. You take what you can, learn from this reality.
If you haven’t noticed Fonterra is milking it. This goes with the job, but us all thought the spleen was empty, no monies to be made above the proverbial milk solids high water mark. Think again.
So, we are talking about the Fonterra Shareholders Fund (FSF, #44). In simple terms, as private investors we are able to invest side-by-side with Fonterra farmer shareholders, a kind of half-way house, only the voting rights are given up compared to Fonterra normal shares (FCG), those traded between farmers.
A FSF shareholder receives all dividends and potential capital returns equal to any farmer FCG share. In fact, FSF makes up about 6% of the total Fonterra Group share capital base of approximately 1.7 billion shares.
We should not get too stuck under the mud in quantifying the technicalities of this capital structure, but let’s say it is a bit gumboot material typical of a wet winters day, i.e. tricky to navigate, thus much conversation about the subject has been had ever since Fonterra became a listed entity with the two strains of capital.
FSF Earnings per share
The central theme of importance is to define how a FSF shareholder makes an underlying return (earnings per share) cause a heck of a lot, the majority of ‘cost of goods sold’ goes to Joe and or Janet Blow Fonterra farmer (fair enough).
In being a shareholder either way FSF or FCG, the earnings are a reflection of the difference that Fonterra pays farmers for the base basket of whole milk, commodity products (inclusive butter), and the value it receives from selling so called value added products that “can” ` (one would assume…do not assume!) provide the cream (i.e. $$$).
Anyhow, this “cream” of profitability has been a tricky beast achieve. The most pressing issue or determinate is that usually if Fonterra pays farmers too much for their ‘farm gate’ milk, then it is difficult to get much premium, and therefore it suffers meager profits on the value-added side.
Vice versa, when the farmer payout is low, then the opposite occurs with shareholder benefit.
But why am I taking action now and squeezing open the money cabinet (let’s call it the War Chest) and loading up the bucket?
I have been prompted into action given the income and capital gains possible. I sense an earnings windfall. But why?
Clarity
“Tony, its 4.30am, wake up boy, want a cuppa and vanilla biscuit or two?” said the ruff non-shaven Old Boy in sorts, many moons ago. And me, tired as ever at that time of the morning, never ever contemplating the earnings power from the herd (silly, naive me), but understandable as a meager gingerly teen, I only knew that that the cows had to be milked, and mind the back legs may kick!
Clarity I am suggesting (you delve into your own meaning without googling) is some un-scientific, messy, but beautifully intangible concept (she was at first glimpse and still is…sating through the rough in caring for me!!) You know it when you see it. It sticks out like a sore thumb, a heart throb on those occasions of bliss! This is confirmation of clarity.
So, when Fonterra CEO Miles Hurrell announced late last week that earnings guidance for the next year (ending 31 July 2023) will be between 45c and 60c, significantly higher than the previous forecast of 30c to 45c my mind battled for belief. The prospect for higher earnings rattled the intellect. Is this the light before the sun we have been dreaming so long for New Zealand’s agricultural juggernaut?
The statement reverberated down my spine, because we have been all here before, caught up in the glamour to be, but only again to be waylaid in this waste paper basket of defeat? Still I had to get out of bed and have a look, reappraise the spectacle in front of my screen and gather the more rational thoughts to appraise.
First we should glance back to one of the last glamourous presentations that the previous CEO, Theo Spierings, threw investors late 2017.
In my view, his tenure was a text book of how not to do it.
Thankfully Fonterra has moved on.
The introduction of a no-frills, rugby-forward-looking bloke, lieutenant Hurrell (a long serving Fonterra servant) has essentially reversed all Fonterra’s globally dominating ambitions by sticking to the knitting of fulfilling NZ-only farmer’s existential goals.
Although the Fonterra shareholders fund is small in the scheme of things, so not everyone’s cup of tea, we must remember Fonterra is NZs biggest corporate so has outsized relevance for investors.
So, with a flair for a deal here, what are my mathematics in extracting Mr. Consistent's words of encouragement?
I am quite good at math’s but peering into the future requires one to abstract the possible with the probable all the while keeping on the edge of causal determinism and not failing to be somewhat conservative and practical. Custard-in-the-face materialises if you make up too much artificial self-inflicted fiction. So, pure math isn’t a goer as you’ll never be perfectly correct in this judgement, but let’s just note a few of the matters that matter"
- Fonterra will pay a 15c final dividend for the 2022 financial year to be announced on Thursday (22nd Sept). This is Assumption #1,
- Expect next year’s total dividend to be approximately 30c per share, given Hurrell's forecast of earnings midpoint, which at this stage is 52.5c (I am saying almost 60% of earnings payout).
This #2 assumption is a bit out of line from the year-ago "Long Term Aspirations Presentation". Look at the last page.
They are doing better than forecast I reckon because both the combination of the high US dollar, and the fact the Whole Milk Powder price has retreated some 20% over the last six months. That value-add has widened and may widen further says the CEO. All good. Still remember Mr. and Mrs. Farmer are collecting and forecasting to collect record payouts this year and next.
- Fonterra plans to return a billion dollars to shareholders by the end of 2024 financial year, given the impending sale of Soprole, their South American, now non-core operation. This represents about a 60c per share return of capital.
Therefore, if we assume points 1, 2, and 3, by the end of September next year we will have received 45c in dividends, which represents here about a 13% yield on a FSF share price of say $3.40, plus the expectation of that 60c capital return imminent within a year, plus another increasing dividend payment forthcoming for the 2024 financial year.
An increasing dividend pipeline from here is mouthwatering. I sense conviction for this assumption will be clarified further next week. The ship could be departing so to speak.
Furthermore, if you slip in any valuation measure, say a price-to-earnings ratio, then you can appreciate that a $5 to $6 share price is possible again. Why not? The pessimists will say look at old-Fonterra, or look at Livestock Improvement (LIC) with their farmer only held shareholding structure. I’d say shame on LIC, shame they haven’t worked out how to really open the can of capital valuation. Fonterra on the other hand have this dual structure, be it rather inadequate.
Also, you should not discount the $50 mln buy back Fonterra has only but recently begun on the ordinary shares. They had to stop buying on the 1st August due to the blackout period before earnings announcements this coming week. They have bought back less than a million shares so far, so just image what happens when they start again on Friday 23rd September, only a week away?
We should also keep our eye on total debt next week.
As earnings flourish, the cause of historical angst will become but an afterthought as it becomes less a burden, more a sustainable useful financial tool (within high-grade credit worthiness) and thus unleash the calf into a seemingly teenage eager trot, even a gallop. Watch out.
So, a wager on Fonterra. A two-way bet. There is the prospect of growing dividends as a simple reflection of sustainable earnings growth. And given the current lowly valuation, a ripe launch pad for the Elephant again being prized.
Will Fonterra’s leadership once again be worshipped?
Clarity has spoken.
THIS IS NOT INVESTMENT ADVICE. DO NOT ACT ON THE MUSINGS HERE. This article is intended to suggest how situations like this one can be assessed. It is a general example only. Before you do anything with FSF, FCG, or any intended investment, you should get proper advice from a licensed advisor.
Tony Morgan has run a portfolio management business and an equity brokerage, both of which were purchased by Craig Investment Partners. He now runs a small family office that invests globally. Other articles in this series can be found here. And the profiles of all the NZX50 companies can be found here.
11 Comments
Look at all that beautiful green grass. After all that rain the land is the colour it should always be, right? Emerald Green. Great for growing grass, right? And lots & lots of milk. Which is another word for money down our ways.
But hark! Who goes there? A small army of planters with thousands of seedlings in their bags, marching across the lands. Oh no! The Year of the Tree is finally upon us.
So what will happen to all those beautiful moo'ing animals making all that beautiful milk? And what about all those tasty little white & woolly things? Alas, from where will I fetch my local bottle of sweet creamy milk & my yummy weekly mince, & drippingly tasty lamb chops, if all there is growing... are trees.
I've eaten trees before. They don't taste very good.
Mountie,
Have a look at My Food Bag. I have watched its price fall a long way from the issue price and was unimpressed to see the big shareholders sell out, but now the picture looks more attractive. The financials looks much better with a big reduction in debt and now the gross yield is over 16%-worth a small punt i think.
Mountie,
I suggest their (MFB) past dividend of 7c per shares is unsustainable. Half yr result in Nov will be down from last yr, so
do not keep your hopes up, clarity is not possible, not good in this investment environment. Notwithstanding, MFB is
coming more buyable...I would. wait though, no holding. regards Tony
Not one investor I have spoken too understands the Fonterra milk payout, from commodities sold via GDT. vs the dividend, which is from value add. They never understand how manipulated the farm gate milk price is, which in turn affects the dividend, nor how costs are allocated which again favours the farm gate milk payout.
Dividends are being increased just to make the capital structure more palatable.
Of there is one thing farmers care about, it is the farm gate milk payout. They don't care about the share value being destroyed. And why would you when the payout is 10 bucks and the share price 3.
Unless you understand all this, avoid at all cost.
The price disparity between shares and units will continue because farmers will seek diversification. Mills has brought some consistency to fonterra's results, once the fund managers get over themselves the unit price will take off. I sence a few will have sworn off it.
"THIS IS NOT INVESTMENT ADVICE. DO NOT ACT ON THE MUSINGS HERE."
This is quite sensible advice.
You need to split earnings projections into underlying earnings and exceptional and non-recurring items before you start whacking them with PE rations to get a projected share or unit price.
Basically you need to look at the sustainable earnings of the business, not the one off's from capital returns, capital gains on sale of assets (or reversal of previous book losses), or fx gains.
I can't think of any reason that the increased forecast profits are sustainable. Casein might be all the rage right now, but a couple of years ago so was butter. High cheese prices can't make that much of a difference as the bulk of cheese goes through GDT and is part of the farm gate milk payout. So that extra profit must be coming from sales of cheese into NZ and Australia which could easily meet resistance if the Comcom finds price gouging.
If there is one positive factor, it is that declining production allows Fonterra to optimise product mix better. As peak milk flow is so high, there are constraints as to what can be produced, but lower volumes give some respite and allow more profitable products to be made.
Countering that is that lower production and continued fall in market share will see Fonterra with higher factory overheads due to under-utilisation, and higher overhead costs per kgMS.
So to warrant a $6 unit price, you would expect to see some sign of long term earnings growth. There is little evidence of that yet, but you could take a punt. But the last 20 years Fonterra shares have halved in priced. The next 20 will be worse.
This article and some of the comments reflect yet again the confusion that has plagued the history of Fonterra.
Prior to DIRA and formation of Fonterra, the cooperative structure was what underpinned the development and success of the NZ dairy industry. A fundamental tenet of this was non tradeable nominal shares and a capital structure derived from retained earnings underpinned by prudent and competent governance and management. The raison de etat to be part of a cooperative is to maximise the return for milk supplied, not gaming shares and capital as has happened with the scrapping of the co-op model with the formation of Fonterra.
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