No voting rights for unit holders
Company: Fonterra Sector: Dairy processing Overview: If investors in the Fonterra Shareholders Fund (FSF) needed a reminder of their place, they got it last week when the dairy co-operative announced support for share-backed farmers in the form of an interest-free loan of 50 cents per kilogram of milk solids.
This reiterates to FSF unit holders that their lack of any voting rights means they are merely along for the ride. Pros: Although some unit holders may be unhappy that Fonterra are extending credit to farmers (interest-free for two years), the reality is that a strong Fonterra relies on the viability of their farmer shareholders. If Fonterra did not step in to support farmers many could go bust, putting further downward pressure on the share price. Fonterra also surprised the market with an impressive earnings forecast of 40-50c a share for the 2015/16 season. This will flow through to a good jump in the dividend, which will please unit holders. The higher earnings reflect the low farmgate milk price (essentially a cost of production for Fonterra) and a favourable product mix for the company. The product mix caused issues for Fonterra in the 2013/14 season, when cheese prices were far lower than whole milk powder and other price setting products. Fervent buying from the Chinese had pushed up prices on some products and pushed up Fonterra’s cost of production, leading to the board paying $8.40 per kg MS compared to the milk price manual price of $8.95). Ironically, this 45c underpayment mirrors very closely the 50c loan to farmers this season. Both were logical for the long term strength of the company. Cons: Working against Fonterra on the global market at the moment is a removal of quotas in Europe and a ramp-up of production in the US, both adding supply. This has coincided with a Russian ban on imports and lacklustre Chinese demand. Prices have subsequently plummeted. This has led to Standard & Poor’s placing Fonterra on credit watch. Its credit rating remains A, which is still very high. Fonterra’s current gearing is approximately 50 per cent. This could be considered high for some companies, but Fonterra’s set-up and ability to tap equity markets has debt holders feeling comfortable. In fact one debt instrument trades at a yield of just 3.16 per cent on the NZX debt market. Investors should also keep an eye out on the Dairy Industry Restructuring Act review that started in June. Price performance: The share price jumped 5 per cent after the earnings announcement last week. Investment outlook: The forward yield is reasonably attractive, but risks abound for unit holders who are merely along for the ride.