* Note the disclaimer at the bottom of this article.
“Baby elephant my offspring, the messy, you unorthodox, please stay close, close to tradition, cooperative tradition. Oh please”
“Clarity, oh beautiful lady, I love you so much, please stay by my side forever!”
These two lines of messy poetry have the emphasis for what follows. You take what you can, learn from this reality.
If you haven’t noticed Fonterra is dealing with it. It goes with the job, but we all thought the spleen was empty, that there was no money to be made above the proverbial high water mark of milk solids. Think again.
So we are talking about the Fonterra Shareholders’ Fund (FSF, #44). Simply put, as private investors, we are able to invest side by side with the farmer shareholders of Fonterra, a kind of halfway house, only voting rights are given up compared to normal Fonterra shares ( FCG), those exchanged between farmers .
An FSF shareholder receives all dividends and potential capital returns equal to any FCG farmer share. In fact, FSF represents around 6% of the Fonterra Group’s total share capital, which amounts to around 1.7 billion shares.
We shouldn’t get too bogged down in the mud quantifying the technicalities of this capital structure, but let’s just say it’s a bit of gumboot material typical of a wet winter’s day, that is- i.e. difficult to navigate, so a lot of conversations on the subject have taken place since Fonterra became a listed entity with both strains of capital.
FSF earnings per share
The central theme of importance is defining how an FSF shareholder achieves an underlying return (earnings per share) causes a lot, the majority of the ‘cost of goods sold’ goes to Joe and/or Janet Blow Fonterra farmer (fair enough).
As an FSF or FCG shareholder, revenues reflect the difference Fonterra pays farmers for the basic basket of whole milk, commodities (including butter) and the value it receives from the sale of produce. value-added sayings that “can”` (one would assume…don’t assume!) provide the cream (i.e. $$$).
Either way, this “cream” of profitability has been a tricky beast to achieve. The most pressing or defining problem is that, generally, if Fonterra pays farmers too much for their “on-farm” milk, it is difficult to obtain a large premium and, as a result, it suffers from meager profits on the side added value.
Conversely, when the farmer’s payout is low, the reverse happens with the shareholder’s benefit.
But why am I acting now and opening the coin box (let’s call it the war chest) and filling the bucket?
I was prompted to act given the income and possible capital gains. I sense a windfall of income. But why?
“Tony, it’s 4:30, wake up boy, do you want a cup of tea and a vanilla cookie or two?said the unshaven old boy, sort of, many moons ago. And I, tired as ever at this hour of the morning, never contemplating the earning power of the herd (stupid, naive me), but understandable as a skinny, careful teenager, I only knew that the cows had to be milked, and Be careful, the hind legs can kick!
The clarity I suggest (you delve into your own sense without googling) is an unscientific, messy, yet beautifully intangible concept (it was at first glance and still is…sitting through the tough looking after me! !) You know it when you see it. It comes out like a sore thumb, a crush on these occasions of happiness! It is the confirmation of clarity.
So when Fonterra CEO Miles Hurrell announced late last week that profit forecasts for next year (ending July 31, 2023) would be between 45c and 60c, significantly higher than previous forecast of 30c to 45c my mind struggled to believe. The prospect of higher earnings shook the intellect. Is this the light before the sun we’ve been dreaming of for so long for New Zealand’s agricultural juggernaut?
The statement resonated in my spine, because we’ve all been here before, caught up in the glamor of being, only to be swept up in this wastebasket of defeat again? Still, I had to get out of bed and take a look, reevaluate the show in front of my screen, and gather the most rational thoughts to evaluate.
We should first take a look at one of the latest glamorous presentations which former CEO Theo Spierings pitched to investors in late 2017.
In my opinion, his mandate was a manual on how not to do it.
Fortunately, Fonterra has moved on.
Introducing a no-frills, forward-looking guy, Lt. Hurrell (a long-time Fonterra retainer) essentially overturned all of Fonterra’s dominating global ambitions by sticking to achieving existential goals of New Zealand farmers only.
Although Fonterra’s shareholder fund is small in the scheme of things so it’s not everyone’s cup of tea, we have to remember that Fonterra is the biggest company in New Zealand and has therefore of disproportionate relevance for investors.
So, with a flair for a deal here, what’s my math for extracting Mr. Consistent’s words of encouragement?
I’m pretty good at math but looking into the future requires abstracting the possible with the probable while staying on the edge of causal determinism and not failing to be somewhat conservative and practical. Custard-in-the-face materializes if you invent too much self-inflicted contrived fiction. So pure math is not an amateur because you’ll never be perfectly correct in that judgment, but let’s just note some of the questions that matter”
- Fonterra will pay a final dividend of 15c for the 2022 financial year which will be announced on Thursday September 22. This is hypothesis #1,
- Expect next year’s total dividend to be around 30 cents per share, given Hurrell’s earnings midpoint forecast, which at this point is 52.5 cents (I say close 60% of profit payment).
This hypothesis #2 is a little off from the previous year “Presentation of long-term aspirations“. Look at the last page.
They’re doing better than expected, I think, due to both the high value of the US dollar and the fact that the price of whole milk powder is down about 20% in the last six months. This added value has expanded and could expand further, says the CEO. All good. Remember that Mr. and Mrs. Farmer are collecting and planning to collect record payments this year and next.
- Fonterra plans to return $1 billion to shareholders by the end of fiscal 2024, given the impending sale of Soprole, their now non-core South American operation. This represents approximately 60 cents of return on capital per share.
Therefore, if we assume points 1, 2 and 3, by the end of September next year we will have received 45c of dividends, which here represents a return of around 13% on a FSF share price let’s say $3.40, plus the expectation of that impending 60c return of capital a year from now, plus another growing dividend payment to come for the 2024 financial year.
A growing dividend pipeline from here is enticing. I feel that the conviction of this hypothesis will be further clarified next week. The ship could be leaving so to speak.
Also, if you slide in a valuation metric, say a price/earnings ratio, then you can figure out that a stock price of $5-$6 is possible again. Why not? The pessimists will say look at the old Fonterra, or look at the Amélioration de l’Elevage (LIC) with their shareholders held solely by the farmers. I would say shame on LIC, too bad they haven’t figured out how to really open the capital valuation box. Fonterra, on the other hand, has this dual structure, although quite insufficient.
Also, you shouldn’t ignore the $50 million buyback that Fonterra started recently on common stock. They had to stop buying on August 1 due to the blackout period before the earnings announcement this coming week. They’ve repurchased less than a million shares so far, so imagine what happens when they do it again on Friday, September 23, just a week from now?
We should also keep an eye on total debt next week.
As incomes thrive, the cause of historical angst will only become an afterthought, as it becomes less of a burden, more of a sustainable and useful financial tool (in the context of high creditworthiness) and will thus release the calf in a seemingly adolescent trot, or even a gallop. Be careful.
So a bet on Fonterra. A two-way bet. There is the prospect of dividend growth as a simple reflection of sustainable earnings growth. And given the current low valuation, a ripe launch pad for the elephant is once again in demand.
Will Fonterra’s leadership be worshiped again?
Clarity has spoken.
THIS IS NOT INVESTMENT ADVICE. DO NOT ACT ON DREAMS HERE. This article aims to suggest how situations like this can be assessed. This is just a general example. Before doing anything with FSF, FCG or any planned investment, you should obtain appropriate advice from a licensed adviser.
Tony Morgan ran a portfolio management business and an equity brokerage firm, both of which were purchased by Craig Investment Partners. He now runs a small family office that invests globally. Other articles in this series can be found here. And profiles of all NZX50 companies can be found here.