Unlike most analysts, Tony Morgan is not jaded on Fonterra and its endless history of under-performance. He sees a corner turned with NZ's largest corporate returning to more normal corporate health. He sees opportunity for investors.
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A new dawn for Fonterra, or just another
A new dawn for Fonterra, or just another?

“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”

1. Fonterra will pay a 15c final dividend for the 2022 financial year to be announced on Thursday (22nd Sept). This is Assumption #1,

2. 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).

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.

3. 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.

Did you know that some chewing gums contain dairy products?

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