Fonterra: 'A lot to do to get basics right'

A tanker leaves the Fonterra Edendale plant in Southland. Photo / Stephen Jaquiery

China poses several challenges for Fonterra and a2Milk, and both organisations face the likelihood of short term volatility in sales and earnings.

Fonterra's woes stem from its poor full year result and rising milk prices pressuring profit margins, but it also has to make a decision on its much criticised 18.8 per cent stake in Chinese infant milk formula company Beingmate, which it bought for $755 million in 2015.

And a2 Milk could face some short term volatility with recent changes to Chinese law impacting on the thousands of informal "daigou" traders selling on numerous e-commerce and social media platforms in China.

Fonterra posted a $196 million loss this month, attributed to a $183 million settlement with French dairy giant Danone and a $405million writedown in the asset value of its share in Beingmate.

Forsyth Barr broker Damian Foster said Fonterra's result was below expectations, from the rising milk price pressuring its margins, higher operating expenditure growth and also rising corporate costs.

He noted Fonterra also announced a full review of Fonterra Shareholder Fund's portfolio as part of its new strategy to lift performance, starting with its investment in Beingmate.

"Guidance indicates a modest recovery is expected in full year 2019. However, given historic earnings volatility it remains difficult to have confidence in Fonterra Shareholder Fund's near-term earnings outlook," Mr Foster said.

He described market competition as "intense" and earnings uncertainty was commonplace, given the volatility of commodity prices and production costs.

Craigs Investment Partners broker Peter McIntyre said of Fonterra's poor result, "there's a lot to do to get the basics right".

He said some of the key issues were the magnitude of unallocated overheads, increased debt and profit margin issues.

Fonterra had outlined new plans to improve performance, focusing on greater financial discipline, more realistic forecasting and was re-evaluating all investments, major assets and partnerships, Mr Foster said.

"The wide scope of the review adds to the uncertainty around Fonterra Shareholder Fund's near-term earnings profile."

Fonterra had begun its review of its Beingmate investment, and a near term market update was expected, he said.

"At this stage details remain limited and we await evidence of execution before incorporating any material change into our forecasts," Mr Foster said.

For its year to June a2 Milk posted a 68 per cent increase in revenue to $922.7 million and after-tax profit grew 116 per cent to $195.7 million.

On the outlook for a2Milk, Mr Foster said recent legislative changes in China governing e-commerce - affecting the daigou traders and resellers - would likely be a net positive for the company in the medium to long term.

The informal daigou sales channels are where shopping agents from China operating in New Zealand or Australia bought products to send to clients in China.

Mr Foster said the law change "may create some near-term volatility".

"We expect the new law's impact will be felt primarily by smaller daigou/resellers, through the requirement to now obtain a business licence and pay taxes," he said.

He said daigou traders using official e-commerce platforms would be hardest hit. Those selling on social media platforms would face a "limited impact" due to the difficulty in monitoring and regulating those channels.

Mr McIntyre said the daigou sales appeared to be stabilising after a post-label transition, moving from Chinese labelling to English.

"On a positive note, Australia and New Zealand reported English-label sales were ahead of our expectation and looks like having been driven by stronger growth in the daigou-sales channel," he said.