Fonterra is forecast to have a bright future as it moves
into the NZX-50 index. Photo by Fonterra.
The price of Fonterra's units is expected to rise further
next week when it joins the NZX-50, Craigs Investment Partners
broker Chris Timms says.
Fonterra will replace Cavalier Carpets in the index,
requiring some index tracking institutions to buy enough
units to match the place Fonterra will have on the index.
Fonterra is likely to be in the top half of the top 50 shares
in the index.
Mr Timms said yesterday having Fonterra listed in the top 50
would also give other institutions the confidence they needed
to lift their positions in the units.
Craigs had initiated coverage on Fonterra with a
recommendation of ''hold'' on the units. Craigs had a price
target of $6.43 on the units, which were already trading at
Mr Timms said the unit price had risen based on demand and it
would get worse once the company was in the NZX-50.
''Our valuation is based on our model but the demand by
investors to get a stake in the company has prompted the unit
price to run ahead of our model forecast.''
Craigs was optimistic about Fonterra's prospects.
Improvements in operating margins and profitability
underpinned attractive medium-term growth for earnings well
above more recent performance, he said. Viability around base
earnings remained inevitable and an element of trust in the
new management on the execution of the price realisation and
cost-out initiatives was required.
In the financial years from 2009 to 2012, Fonterra's earnings
before income and tax (ebit) went from $1.02 billion to $1.03
Craigs' forecasts for 2013 was for earnings of $1.124 billion
with the uplift over prospect forecasts reflecting the
cost-out initiatives Fonterra had announced but were excluded
from the prospectus guidance.
''This uplift in earnings outlook for 2013 has seen us
increase our dividend forecast to 34c per share from
prospectus guidance of 32cps.''
Craigs was forecasting significant improvements in earnings
from 2013 to 2016, with 2016 earnings likely to be around
$1.6 billion, Mr Timms said.
There was an expectation for significant cost reduction and
stronger disciplines in procurement and the supply chain.
While implementation was in its early stages, management's
plans to exert greater discipline in that area were credible
and could drive sustained improvements.
''We do stress that the ability to realise premiums in this
business is limited by the sheer volume of milk Fonterra must
process, its plant configuration, distance from key export
markets and the resulting commodity nature of much of its
Craigs viewed New Zealand Milk Products (NZMP) as a
''commodity plus'' play rather than a value-added business as
its earnings were largely underpinned by return on capital
employed as opposed to superior returns from value added
operations, Mr Timms said.
Among the regional businesses, the greatest growth was
expected from the Asia and Middle East regions, given the
maturity of the Australian and New Zealand markets.
Opportunities for organic growth from Fonterra's existing
capabilities were ''particularly strong'' in the Asean
economies and China, he said.
''We recognise that with around $2 billion of sales across
this wide region currently - around 10% in China - the
opportunities outlined in Fonterra's strategy to grow beyond
existing positions and markets are significant.''
Fonterra was a world-class dairy co-operative with an
enviable position in commodity ingredients and a good mix of
regional businesses with a value-added food services and
consumer focus, Mr Timms said.
Fonterra's emerging markets exposure was high, particularly
for the ingredients business, while good opportunities
existed to grow emerging markets exposure in value-added
''We expect improvements in margins largely on the back of
greater discipline within NZMP on price realisation and costs
which will provide strong earnings momentum over the next
three to four years,'' he said.