Fonterra rating cut no cause for alarm

Investors and farmers should not panic over Fonterra’s credit rating being cut, an economist says.

Fonterra had its A+ long-term credit rating cut to A by Standard & Poor’s after its decision to enter into a joint venture with Chinese infant-food maker Beingmate last week.

The outlook on the long-term rating is stable.

S&P left Fonterra’s short-term rating unchanged at A-1, but lowered the rating on Fonterra’s subordinated notes to Afrom A and on its Chinese renminbi notes to A from A+.

Under the deal, Fonterra will spend more than $600 million buying a 20 per cent stake in Beingmate.

‘‘Fonterra’s proposed sizeable shareholding in a commercial company operating in China indicates a financial risk appetite that is more aggressive than what we had factored into the previous A+ rating,’’ Standard & Poor’s credit analyst Brenda Wardlaw said.

A related distribution agreement with Beingmate would boost sales of Fonterra’s New Zealand-made infant formula in the growing Chinese market.

However, the Beingmate deal came at a time when Fonterra was also investing $555m to expand production capacity in New Zealand over the next few years, Wardlaw said.

In addition, global dairy product prices were weak, which had caused Fonterra to reduce its forecast price of milk to $6 per kilogram of milksolids early in the season, from $7 per kg/ms.

Wardlaw said the size of the Beingmate acquisition; a reliance on dividends from the equity holding, rather than having direct control over cashflows; higher leverage in the shortterm from this transaction; and the capital expenditure, worsened Fonterra’s credit quality to the A rating level.

S&P’s view contrasted with that of fellow ratings agency Fitch, which held Fonterra’s long-term credit rating at AAafter the China deal announcement.

‘‘Fonterra’s ratings are underpinned by its scale, the defensive characteristics of its ingredients business, the financial flexibility afforded by the effective subordination of its farmer creditors, and the margin protection offered by its fully integrated business model,’’ Fitch said.

‘‘In a scalable industry, Fonterra is the world’s largest processor and largest exporter of dairy products.’’

ASB rural economist Nathan Penny said the ratings cut by S&P were a natural reflection of Fonterra taking on some more risk.

‘‘With their China investment they are basically taking on more risk and the idea is they are going to get better returns out of that. Fonterra perceive that as a healthy risk to take on given the prospects of the market they are operating in.’’

S&P’s ratings cut could have an impact on Fonterra’s borrowing costs but it would be only a small one, Penny said.

‘‘At the end of the day it will come down to what investors think. The credit rating is one metric they’ll look at. They’ll also look at its strategy and if they think it’s good they’ll be more than happy to invest.’’

Fonterra chief financial officer Lukas Paravicini said in a statement the two agencies’ ratings of AA- and A ‘‘continued to reflect Fonterra’s solid balance sheet position, and strong liquidity and gearing.’’