New UHT plant construction starts
Construction is underway at Fonterra’s new UHT cream plant at Edendale, Southland following a groundbreaking ceremony recently.
Standards and Poors will make a decision on whether its credit ratings are changed after full review of Fonterra financial results for 2015 when they are released in September. "We would expect that if we were to lower the ratings, the downgrade would not exceed one notch," Standards and Poors says in a statement.
S&P analyst Brenda Wardlaw says the CreditWatch placement reflects its concerns regarding potential weakness in Fonterra's key financial metrics given its high debt levels at a low point in the global price cycle.
"This follows Fonterra's announcement of a lower forecast milk price due to weak demand and surplus supply in the global dairy market."
This ongoing weakness in the global dairy market has occurred when Fonterra's debt is at very high levels due to a large acquisition and peak capital expenditure, placing downward pressure on Fonterra's key financial metrics, Standards & Poors says.
"While the lower forecast payout to its supplier shareholders supports our view of the cooperatives' superior financial flexibility, the likely weakness in its key financial metrics in the short term may place downward pressure on the credit ratings on the company."
On August 7 Fonterra announced a revised forecast payout for the year ending July 31, 2016, of NZ$3.85/kgMS down from the opening forecast of NZ$5.25/kgMS announced on May 28.
Standards and Poors says it views the reduction in the forecast payout and advance price as ongoing evidence of Fonterra's superior flexibility in price setting for its key raw material, milk.
"We also viewed favourably the announced sizable reduction in capital expenditure (NZ$500 million-NZ$600 million lower than that in 2015), which should temper the deterioration in Fonterra's key credit metrics during this challenging period.
"However, high debt levels reflecting the sizable acquisition of a shareholding in China-based Beingmate, combined with peak capital expenditure, at this low point in the dairy price cycle will place Fonterra's key credit metrics under pressure in the short term."
Fonterra also announced support for its shareholder farmers, given the difficult market conditions, Standards and Poors says.
"This support for supplier shareholders will be in the form of a loan (up to NZ$0.50/kgMS). The loan will be interest-free for two years and paid back when the farmgate milk price or the advance rate goes above NZ$6kg/MS.
"In our view, the loan to suppliers implies there may be limited headroom to lower the payout at the bottom of the global price cycle. However, we note that loan payments will be phased as savings from the cooperatives' transformation program are delivered. Further, we expect that Fonterra will conservatively manage the level of advance payments, loans to farmers, and dividends during this challenging period."
Wardlaw added: "We expect to resolve the CreditWatch following a review of Fonterra's financial results for fiscal 2015, which will provide further visibility on the level of buffer in its key financial metrics. The CreditWatch negative indicates that we could affirm or lower the ratings on Fonterra following our review. We would expect that if we were to lower the ratings, the downgrade would not exceed one notch."
Fonterra's chief financial officer Lukas Paravicini says: "Fonterra has taken proactive and positive steps to maintain the financial strength of the co-op. We have continued to exercise financial prudence and discipline in challenging times for dairy globally."
Measures that Fonterra has taken include:
- Significantly reducing capital expenditure – Fonterra has reviewed capital expenditure for the next two years and is now targeting a spend $500million - $600million less for 2016 financial year (compared to financial year 2015)
- Setting a prudent advance rate payment to our farmers for the current season given ongoing volatility of global dairy prices
- Progressing well with our business transformation that will deliver significant one-off and recurring savings for the business.
"These measures reinforce our sound financial position and are enabling us to provide support to our farmers during this difficult period of low global dairy prices."
Paravicini says the cooperative's current debt levels were in line with expectations and followed investments in New Zealand processing capacity, higher advance rates to farmers last season and planned investments in Fonterra's number one strategic market, China.
"While current global prices are unsustainably low, we take a longer term view of the cyclical nature of the international dairy market and have confidence in the fundamentals for dairy," says Paravicini.
