A broker's view: Fonterra
Company: Fonterra Shareholders Fund
Overview: There's no point crying over it, but Fonterra's announcement on Wednesday contained a few surprises for investors and farmers alike.
The milk price was set below expectations, although it was the severe trimming of the dividend and associated drop in earnings that likely led to the initial 10 per cent drop in the unit price.
Pros: Fonterra is New Zealand's largest exporter and is a worldwide leader in the processing and marketing of dairy products.
The announcement on Wednesday notes "extraordinary events are having both a positive and negative impact on Fonterra".
On the positive side, we have record global milk powder prices due to increasing demand from China and the rest of the developing world.
The interesting dynamic here is the milk price is set based on the milk powder price. Milk powder makes up 70 per cent of Fonterra's product mix, meaning the other 30 per cent has to endure the higher cost without the associated higher demand.
Fonterra noted its long term strategic focus is to increase production of milk powder.
Cons: The 30 per cent currently suffering a lag in demand relative to milk powder is the market for cheese and casein, a protein commonly used in processed food.
Unfortunately for Fonterra, it still has to pay the milk price based on the in demand milk powder. This divergence in demand led to the board taking the step of overruling the theoretical price of $9kg of milk solid, setting the price at $8.30kg.
This is a prudent move by management as it means Fonterra won't need to borrow in order to cover its underperforming cheese and casein division, and it will allow the company to fund its expansion in the milk powder market.
Price performance: The unit price hit highs of $8.09 earlier in the year, but has since fallen back to recently trade at $5.75.
Investment outlook: The current situation is described as unique and is not expected to be ongoing. The pull back could be a good opportunity for long term investors. The 2014 dividend yield will be in the range of 2 per cent.
*A Broker's View is written by Grant Davies, NZX Associate Advisor, of Hamilton Hindin Greene Limited. This article represents general information provided by Hamilton Hindin Greene, who may hold an interest in the security. It does not constitute investment advice. Disclosure documents are available by request and free of charge through www.hhg.co.nz.