Fonterra's profits tipped to soar

Fonterra's revenue in the year to July 2014 was $22.27 billion, with ebit of $503 million. Photo / Christine Cornege

Dairy co-operative likely to hit $3.5 billion in earnings by 2025, but it must execute its strategy fast, says KPMG.

Fonterra is on track to significantly improve its profits over the next decade, says KPMG.

The co-operative has said it wants to achieve turnover of $35 billion by 2025 and KPMG said Fonterra's earnings before interest and tax (ebit) were likely to hit $3.5 billion by then.

KPMG said Fonterra, which today reports its result for the year ended July, would achieve a record result in the second half.

Fonterra's revenue in the year to July 2014 was $22.27 billion, with ebit of $503 million. The dairy giant, which is in the process of reducing staff levels by 750 positions, has in recent years suffered the distraction of whey protein concentrate and 1080 food safety scares.

KPMG partner Simon Hunter said the co-op was well-positioned for the future but reaching ebit of $3.5 billion would be a challenge.

"It will be hard work but they are well-positioned as long as they can execute [their strategy], and execute fast," Hunter said.

"Events [food safety scares] over the last couple of years have taken the focus away from implementing that strategy, and they can't afford that diversion to happen again," he said. "The approach has become disciplined and ruthless, and I guess that's what we want to see from them." Analysts have questioned whether the co-op has done enough to add value, but Hunter said the company had invested $1 billion to add value last year.

"We should not underestimate the scale of the value-add business, which is worth more than the entire red-meat sector, which has got negligible value-add," he said.

KPMG said Fonterra's key problem to date had been an inability to lift profitability beyond an ebit/sales ratio of 5 per cent, compared with competitors such as Nestle, Abbott and Danone that deliver ratios of 10 to 15 per cent. Reaching 8 per cent was "absolutely achievable" in the next two years, based on the co-op's solid foundation and plans for growth.

Commenting on Fonterra's "volume, value and velocity strategy", KPMG said the co-op was systematically building volume through a truly integrated value chain and transitioning more product into food service, consumer products and high-value ingredients.

By doing so, Fonterra was capitalising on the advantage of its integrated business model and superior access to milk pools to build its position.

"It takes time - as an example, there are 100 globally relevant megacities that Fonterra could look to establish a dominant position in for one of its consumer brands. Building a dominant position in any of these cities is a strategic initiative in its own right and probably requires a minimum of four years' investment."

KPMG said Fonterra had sharpened its focus to a tight-knit stable of three major consumer brands - Anchor, Anlene and Anmum - complemented by its value-add ingredients business, and commodity product.

KPMG's executive chairman, Ross Buckley, said the dairy industry and Fonterra were of vital importance to New Zealand's prosperity. "Putting it bluntly, New Zealand needs Fonterra to succeed."

Read the full KPMG report here: