Fonterra is at the mercy of global dairy prices. Photo by
Australian-based Morningstar Equities is less
enthusiastic about the prospects of the Fonterra Shareholders
Holder Fund than most of its New Zealand counterparts.
Fonterra's main risks stemmed from the movement in global
dairy prices, exchange rates and the supply of milk in New
Zealand, analyst Nachiket Moghe said.
''A rapid rise in dairy prices could undermine margins on
consumer-branded and out-of-home food-service products,'' he
Also, Fonterra's margins would be affected if the price of
dairy nutrition products - accounting for 20% to 25% of New
Zealand Milk Products revenue - was less than the farmgate
milk price (FMG).
Fonterra was also exposed to foreign exchange risk since its
revenue was derived globally. Fluctuations in the New Zealand
dollar versus other currencies could undermine earnings.
Fonterra collected about 89% of New Zealand's total milk
supply which was processed into commodities such as whole
milk and skim milk powder.
''This over-reliance on New Zealand's milk supply exposes the
firm to supply risks. For instance, farmers might choose to
move away from dairy farming into other farming activities
should they deem dairy farming to be less lucrative.''
Fonterra was required to collect all the milk produced by
farmer shareholders, leaving it with excess production
capacity during periods of weak demand and/or unfavourable
dairy prices, Mr Moghe said.
Morningstar did not believe Fonterra possessed a competitive
''While the company is the world's largest exporter of dairy
products, its business is driven by commodity prices like
whole milk powder and skim milk powder which make up 60% to
65% of its operating earnings.''
Consequently, the majority of the firm's business had no
pricing power and generated mid-single digit operating
That paled in comparison to the mid to high-teens generated
by some of the other multinational food companies.
Fonterra aspired to sell more branded products to move up the
value chain and boost returns.
However, Morningstar believed it would face significant
competition from companies like Nestle and Danone, given
their well-entrenched positions in several key markets and
Morningstar has a fair value estimate of $NZ5.50 on the fund
units. They last traded at $NZ7.31.