Dairy multinational Fonterra is New Zealand's biggest business.
Dairy multinational Fonterra is New Zealand's biggest business.
Fonterra’s strong balance sheet allows room for more growth investment or capital returns to shareholders even before the potential sale of its consumer product businesses, says a new report from investment bank Northington Partners.
Commissioned by Fonterra watchdog, the Fonterra Shareholders’ Council, the independent report saidthe dairy multinational’s significantly reduced debt levels and improving gearing and debt/Ebitda ratios provided “significant financial flexibility for future investment or capital returns”.
Fonterra’s improved debt position also supported its recently announced increased dividend payout target of 60% to 80% of net profit after tax, up from 40% to 60%, Northington said.
It also provided scope to improve advance milk payment rates to Fonterra’s farmer-owners, while still maintaining the company’s ‘A’ band credit rating, a key influence on its ability to access debt at attractive rates.
Northington said Fonterra’s net debt had decreased by a further $602 million or 19% to $2.6b over FY24 due to strong earnings and decreased working capital. Gearing and leverage ratios were now well below target levels.
Key contributors to the net debt change were: operating cash flows of $2.2b were down $543m on $2.74b achieved in FY23 (albeit off a record earnings year); investment in working capital reduced by $112m; capital expenditure increased by only $32m compared to $709m in FY23; dividends paid during FY24 included the FY23 final dividend of $643m and the FY24 interim dividend of $241m; and the $804m capital return paid to shareholders in FY24 was including in the closing FY23 adjusted net debt as a payable.
“Along with the reduced gearing ratio (24%), we consider that the strong balance sheet provides scope for further growth investment or capital returns to shareholders even prior to the potential divestment of the consumer and associated businesses,” Northington said.
“However, we expect that any decision on future capital returns will be deferred until the divestment process has been concluded.”
Fonterra farmer-owners watchdog council partners with the Northington investment bank for independent advice on Fonterra's books and annual results.
Examining total FY24 payout and payout ratio, Northington said despite Fonterra’s current earnings guidance of 40c to 60c a share for FY25 being down on FY24′s 67c, 2025 financial year ordinary dividends may only reduce modestly (The investment bank said the earnings guidance was down largely due to the change in Fonterra’s tax status and its ongoing IT and transformation costs).
“This reflects the updated dividend policy along with Fonterra’s strong capital position. If the higher milk price forecast for the current season is achieved, the total payout for FY25 is likely to increase to levels higher than those achieved over the last two years.”
Fonterra’s opening earnings per share guidance for FY25 of 40c to 60c a share implied an underlying performance broadly consistent with that of FY24, when adjusting for the tax status change and increased IT transformation costs, Northington said.’
While this guidance range was a significant reduction on the 70c/share paid in FY24, the forecast reflected a significant increase in non-operating related costs, its report said.
These included:
— Fonterra had exhausted its New Zealand tax losses and was therefore subject to a change in tax status. This was expected to result in a significant increase in the future level of New Zealand tax paid, with Fonterra’s effective tax rate expected to increase to 25%, compared to 17% in FY24.
— Ongoing investment in IT and digital transformation costs were expected to be materially higher in FY25 relative to the $81m in FY24.
“We understand that these costs may be as high as $250m in FY25 — 10c per share higher than FY24.”
Despite the lower earnings guidance, current expectations for underlying FY25 performance — Ebit before IT and digital transformation costs — appear to be in line with the FY24 outcome.
“Broker consensus estimates are also consistent with this view, with a current average FY25 Ebit forecast of $1,369m (vs $1560m from continuing operations in FY24 before allowing for $170m of additional IT and digital costs).”
Northington said as with previous years, price relativities between Fonterra’s reference (commodity) and non-reference products will continue to have a significant influence on Fonterra’s future performance.
The report said price relativities were estimated to have contributed 12c/share to Fonterra’s FY24 earnings, against 40c/share in FY23 and the company’s estimated long-run average of 0-5c/share.
It said price relativities had a significant influence on profitability, particularly within the ingredients product channel.
“If the price relativities do revert to long-run averages, we expect that the gross margin achieved by the ingredients channel will reduce (subject to the impacts of periodic volatility, Fonterra’s cost reduction initiatives and any further improvement in the relative volume split between reference and non-reference products). We also note that price relativities for FY25 year to date suggest that margins for the ingredients channel may continue to reduce compared to recent years.”
Andrea Fox joined the Herald as a senior business journalist in 2018 and specialises in writing about the $26 billion dairy industry, agribusiness, exporting and the logistics sector and supply chains.
