Fonterra rating down but ‘stable’

‘Flexibility can come under pressure, as was shown following the recent sharp decline in global dairy prices.’ Fitch Ratings analyst Kelly Amato

CREDIT rating agency Fitch Ratings has downgraded Fonterra from AA- to A, the second credit drop the dairy giant has received in the last two weeks.

Earlier, Standard & Poor’s dropped Fonterra from A to A-.

ASB Bank economist Nathan Penny said the co-operative had so far escaped being given a B rating, which would have had more serious implications.

For example, as soon as the company is rated B, certain investment funds would no longer be able to hold their bonds.

‘‘There has been a fear they might be placed on a negative watch, but [this rating] rates them as stable,’’ Penny said.

To return to a higher rating demanded three things: a turnaround in dairy markets, better financial performance by Fonterra and less debt.

Between July last year and July this year, Fonterra’s borrowings rose from $4.9 billion to $7.6b.

Chief financial officer Lukas Paravicini said Fitch’s A rating confirmed Fonterra’s underlying financial strength.

‘‘We have maintained an A rating category while progressing with a carefully planned investment strategy. These strategic investments are making the cooperative stronger and positioning us well for the future,’’ he said.

The revised ratings would not have any impact on Fonterra’s strategy or on farmer shareholder payouts. Fitch credit analyst Kelly Amato said the downgrade reflected Fitch’s view that Fonterra’s business profile had weakened, even though it remained in a strong global position.

Fitch’s stable outlook took into account that Fonterra credit metrics would be in line with the A rating in the next few years.

Amato praised Fonterra’s business model because it offered a lot of financial flexibility – by its ability to set the farmgate milk price in advance and the fact that its payments to farmers were subordinated to bondholders.

Fonterra elected not to reduce the level of advance rate milk payments in line with the sharp decline in milk prices in the 2015 financial year.

‘‘We do give them credit for that, but that flexibility can come under pressure, as was shown following the recent sharp decline in global dairy prices,’’ Amato said.

‘‘If farmers are struggling to provide milk that has implications for Fonterra as well. We understand why they took [the] actions they did. But that meant them electing not to continue with historic decisions to preserve their balance sheet.’’

Fonterra had gone into more debt, partly in order to fund a capital expenditure programme. This was positive because in 2014 it had not been able to deal with the increased milk supply. But it had also led to a deterioration in Fonterra’s credit metrics.

Amato said Fonterra’s financial flexibility had also been weakened by its offer of interest-free loans to distressed farmers.

The company expects to pay out up to $430 million, to be funded by one-off working capital savings.

‘‘While these actions support Fonterra’s farmer shareholders’ financial stability, they are to the potential detriment of bondholders and highlight a weakening of Fonterra’s financial flexibility.’’

Fitch expected Fonterra’s leverage to improve in 2016 as it returned to historic levels of advance payments and capital expenditure.

Amato noted Fonterra’s strong business profile, commanding 48 per cent of the international whole milk trade.

The agency had factored number of assumptions.

These included: the farmgate milk price returning to its historical average; consumer and food service growth to be in line with forecast growth; non-New Zealand sourced milk to increase to 15 per cent of the total cost of milk; farmer shareholder milk payables at balance date to be 10 per cent of the annual cost of New Zealand sourced milk; capital expenditure to decline to about $900m; and the dividend payout ratio to be at the higher end of 65 per cent to 75 per cent of net profit after tax guidance.

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