BMI View : Fonterra 's recent listing on the New Zealand Exchange via a shareholder fund bodes well for the company's expansion in fast-growing Asian dairy markets. With its traditional sources of growth petering out due to New Zealand's dairy sector muted long-term growth, Fonterra will have to increasingly turn to alternative milk producers in order to answer emerging market's robust demand. In the medium term, Fonterra's earnings are likely to recover after 2012 disappointing results, due to improving trading conditions and increased exposure to Asian markets
Fonterra's recent listing on the New Zealand Exchange via a shareholder fund bodes well for the company's expansion in fast-growing Asian dairy markets. Fonterra, a 10,500-member co-operative that collects almost 90% of New Zealand's milk and is the world's largest processor of dairy products, launched a shareholders' fund on November 30 with units starting to trade at NZD5.50 (US$4.5). Although the farmers maintain control over Fonterra as the fund's units do not carry voting rights, investors will be entitled to dividends paid from the fund's profits.
The main goal of this fund is to bolster Fonterra's financial position and relieve pressure on its balance sheet in order to fund overseas opportunities. Indeed, the company lacks capital for expansion on a big scale, mainly because the co-operative's mutual structure requires it to pay most of its earnings to the farmers and to buy farmers' shares when they choose to sell. By letting its farmer-owners trade shares among themselves or with the fund, Fonterra will no longer face what it calls "redemption risk" (referring to the fact that Fonterra is obliged to pay farmers out when they decide to sell their shares in the co-operative, posing strong liquidity risks when milk production falls sharply and Fonterra has to buy back many shares).
|Expanding Into Asia|
|Fonterra - Revenue By Region (as % of total revenues)|
Units in the Fund have surged over 20% on the initial NZD5.5 per share to NZD6.9 as of December 3 2012, two days after the listing. This is despite Fonterra's disappointing 2012 results (year ended July 2012). Fonterra recorded a slight drop in revenues (of 0.5% to NZD19.8bnm, or US$16.2bn) and tumbling net profits, at NZD624mn (US$511.9mn), down 19.1% year-on-year. Performance was dragged by unfavourable trading conditions, in the form of a strong New Zealand dollar, which hampered revenues from exports to Asian and Latin America countries, and of lower international milk prices (we see three-month CME milk prices averaging US$16.75/cwt in 2012, compared to US$18.02/cwt in 2011). The co-operative Asian business performed better than the rest of the world, as revenues from Asian countries grew by 1.2% to NZD7.7bn, while New Zealand, Australia, US, Europe and Latin America sales dropped by 1.6% to NZD12.1bn.
We see Fonterra's listing favourably, as it will allow the company to ramp up its expansion plans at a time when robust demand for dairy in emerging markets show the need of higher milk production volumes. Fonterra's growth in New Zealand will remain hampered by a soft consumer environment and sustained competitive pressure from private-label dairy products. Moreover, Fonterra needs to increase milk production overseas, as the company's traditional sources of growth are slowing. New Zealand already has high productivity standards and its liquid milk production is forecast to showcase mild if not negative growth in the coming years.
|Strong Sales Opportunities|
|Select Countries - Processed Liquid Milk & Cheese Sales (tonnes)|
Fonterra will continue to lean on its higher-growth emerging markets, particularly in Asia, to prop up its overall performance in the near term. Fonterra is aggressively expanding its production and manufacturing plants in Asia and Latin America, as it currently has one plant under construction in China, where it already owns two dairy farms and a packaging plant in Indonesia. Fonterra plans to expand milk production in China by 20% by 2020 to 1bn litres and build four or five dairy hubs. In India, the company recently opened an office and could rapidly start collecting and transform dairy products there. India has a clear potential for dairy domestic sales, with liquid milk consumption forecast to grow by a robust 25.1% from 2012 to 2017 to 62.2mn tonnes, as well as for exports, as the production surplus in India should widen in the coming years, reaching 88.2mn tonnes in 2017. Development plans also involves a shift into higher-margin processed products, especially out-of-home and infant nutrition.
|Improving Trading Conditions In 2013|
|Three-Month CME Class III Milk (US$/cwt, Daily, LHS) & New Zealand Dollar Spot (US$/NZD)|
Increasing investment in emerging markets, along with better market conditions in 2013, should favour Fonterra's performance in the medium term. Domestic demand conditions in Asia are likely to remain healthy in the coming quarters. Moreover, the company's earnings are likely to recover in 2013, driven by the rise in milk prices (we forecast them to average higher in 2013 and 2014 at US$18.00/cwt and US$17.25/cwt, respectively) and our expectations for the New Zealand dollar's appreciation to ease in 2013, as signs of economic weakness continue to pose a threat to the country's extremely vulnerable external accounts, which continue to deteriorate.
|Notes: f BMI forecasts. Sources: 1 China Ministry of Agriculture, FAPRI,BMI; 2 FAPRI, BMI; 3 National Dairy Development Board, FAPRI, BMI; 4 FAPRI, BMI; 5 USDA, BMI.|
|Milk Production, '000 tonnes 1||32,086.9||f||33,737.3||f||35,000.0||f||36,000.0||f||37,500.0||f||39,000.0||f|
|Liquid Milk Consumption, '000 tonnes 2||14,426.8||f||15,471.9||f||16,513.0||f||17,586.9||f||18,642.1||f||19,666.8||f|
|Milk Production, '000 tonnes 3||120,100.0||f||124,137.0||f||130,244.0||f||136,756.2||f||143,594.0||f||150,431.8||f|
|Liquid Milk Consumption, '000 tonnes 4||49,769.5||f||52,095.6||f||54,970.6||f||57,246.1||f||59,665.9||f||62,240.2||f|
|Milk Production, '000 tonnes 5||19,874.0||f||19,107.9||f||19,101.2||f||19,167.6||f||19,225.1||f||19,282.6||f|
|Liquid Milk Consumption, '000 tonnes 2||333.4||f||333.4||f||333.4||f||333.4||f||333.5||f||333.5||f|