The ailing giant dairy co-operative Fonterra is set to rack up a massive loss for the financial year just completed (end of July) and says it won't be paying a dividend. The company has also said it did not manage to achieve its targeted debt reduction of $800 million in the financial year.
The company has also instigated at board level initial discussions about its capital structure.
Fonterra said in a statement on Monday that it had been necessary to further write-down the value of some of its assets.
This would mean that the company would be reporting a full-year loss, for the year to the end of July, of between $590 million and $675 million.
There would be no dividend paid.
The Fonterra Shareholders Fund units, which are listed on the NZX, fell 19c to $3.57.
Global credit ratings agency S&P described the moves by Fonterra as "painful but necessary" in terms of turning the business around.
"We believe Fonterra's portfolio and strategic reviews will result in a more disciplined approach to capital allocation and more versatile operational performance. In our opinion, this should result in a more stable earnings profile.
"That said, we are mindful of execution risks and any wavering of the cooperative's commitment to restoring its financial health would put the [co-op's credit] rating under immediate downward pressure."
Capital structure discussions - debt target not reached
Fonterra indicated it had "kicked off" discussions about its capital structure at board level, but said whatever was decided would not involve asking farmers to contribute more money "at this point".
Chief executive Miles Hurrell said Fonterra would remain a co-operative and farmer- owned but outside of that the board had been open to further discussion on what is right for the ongoing business in the long term.
The company confirmed on Monday that it had not managed to make its targeted debt reduction of $800 million for the July financial year. Earlier the company had expressed confidence it would make that target.
Chief financial officer Marc Rivers said the company had made good progress, but "we're not all the way there".
He said Fonterra was "absolutely" compliant with all its financial covenants and it had kept the ratings agencies fully informed as to its progress on debt reduction.
Cashflow is strong and "there's no issues at all in that regard", Rivers said.
The asset moves announced on Monday include chunky writedowns on investments in Brazil, China (the China farms investment), Australia and Venezuela.
Big write-down on Kiwi consumer business
Perhaps more surprisingly there is a $200 million write-down on the value of the NZ consumer business, with Fonterra saying that "the compounding effect of operational challenges, along with a slower than planned recovery in our market share has resulted in us reassessing its future earnings".
This write-down has come even though Fonterra had sold its Tip Top ice cream business for about $100 million more than the book value of that business.
This implies that the write-downs in the existing NZ businesses are in the region of $300 million.
Outside of New Zealand Fonterra has taken write-downs of hundreds of millions of dollars.
“Our accounting valuation for DPA Brazil will be impaired by approximately $200 million. This change is mainly due to the economic conditions in Brazil. While they are improving, consumer confidence and employment rates are not at the level required to support the sales volumes and price points our forecast cash flows were based on," Hurrell said.
“As a result of the previously announced sale of our Venezuelan consumer business, and the closing of our small Venezuelan Ingredients business, due to the country’s economic and political instability, we have made an accounting adjustment of approximately $135 million relating primarily to the release of the adverse accumulated foreign currency translation reserve.
“Our carrying value for China Farms will be impaired by approximately $200 million due to the slower than expected operating performance. While the extent in which we participate is under strategic review, the fresh milk category in China continues to look promising and is growing.
"Our Australian Ingredients business is adapting to the new norm of continued drought, reduced domestic milk supply and aggressive competition in the Australian dairy industry. This includes closing our Dennington factory, which combined with writing off the goodwill in Australia Ingredients, results in a one-off impact of approximately $70 million (this includes the $50 million previously announced as part of the Dennington announcement)."
This is the full statement from Fonterra:
Fonterra Co-operative Group Limited today reconfirmed its underlying earnings guidance for the 2019 financial year that ended on 31 July 2019 (FY19), announced a final decision on its full-year dividend for FY19, and provided further information on some significant adverse one-off accounting adjustments.
Chief Executive Officer Miles Hurrell said that as a result of the full review of the business which has taken place across the year, as well as the work done so far to prepare its financial statements for FY19, it has become clear that Fonterra needs to reduce the carrying value of several of its assets and take account of other one-off accounting adjustments, which total approximately $820-860 million.
“Since September 2018 we’ve been re-evaluating all investments, major assets and partnerships to ensure they still meet the Co-operative’s needs. We are leaving no stone unturned in the work to turn our performance around. We have taken a hard look at our end-to-end business, including selling and reviewing the future of a number of assets that are no longer core to our strategy. The review process has also identified a small number of assets that we believe are overvalued, based on the outlook for their expected future returns.
“While the Co-op’s FY19 underlying earnings range is within the current guidance of 10-15 cents per share, when you take into consideration these likely write-downs, we expect to make a reported loss of $590-675 million this year, which is a 37 to 42 cent loss per share.
“We made a commitment to provide information to update farmers and unit holders as it comes available. The numbers still need to be finalised and audited but we now have enough certainty overall to come out in advance of our annual results announcement in September.”
Mr Hurrell said that the majority of the one-off accounting adjustments related to non-cash impairment charges on four specific assets and the divestments that the Co-op has made this year as part of the portfolio review.
“DPA Brazil, the New Zealand consumer business, China Farms and Australian Ingredients’ performance have been improving, but slower than expected and not at the level we had based our previous carrying values on.”
Commenting on the one-off financial accounting adjustments, Mr Hurrell said:
- “Our accounting valuation for DPA Brazil will be impaired by approximately $200 million. This change is mainly due to the economic conditions in Brazil. While they are improving, consumer confidence and employment rates are not at the level required to support the sales volumes and price points our forecast cash flows were based on.
- “As a result of the previously announced sale of our Venezuelan consumer business, and the closing of our small Venezuelan Ingredients business, due to the country’s economic and political instability, we have made an accounting adjustment of approximately $135 million relating primarily to the release of the adverse accumulated foreign currency translation reserve.
- “Our carrying value for China Farms will be impaired by approximately $200 million due to the slower than expected operating performance. While the extent in which we participate is under strategic review, the fresh milk category in China continues to look promising and is growing.
- “In our New Zealand consumer business, the compounding effect of operational challenges, along with a slower than planned recovery in our market share has resulted in us reassessing its future earnings. We are now rebuilding this business and, as part of this, have sold Tip Top which allows the team to focus on its core business. The combined impact is a write-down of approximately $200 million.
- “Our Australian Ingredients business is adapting to the new norm of continued drought, reduced domestic milk supply and aggressive competition in the Australian dairy industry. This includes closing our Dennington factory, which combined with writing off the goodwill in Australia Ingredients, results in a one-off impact of approximately $70 million (this includes the $50 million previously announced as part of the Dennington announcement).
“These are tough but necessary decisions we need to make to reflect today’s realities.
“We’re in no doubt that farmers and unit holders will be rightly frustrated by these write-downs. I want to reassure them that they do not, in any way, impact our ability to continue to operate. Our cash flow remains strong, our debt has reduced and the underlying performance of the business for FY19 is in-line with our latest earnings guidance of 10-15 cents per share. We remain on track with our other targets relating to reducing capital expenditure and operating expenses.”
Chairman John Monaghan said that in-light of the significant write-downs that reflect important accounting adjustments Fonterra needed to make, the Board had brought forward its decision on the full year dividend for FY19.
“We have made the call not to pay a dividend for FY19. Our owners’ livelihoods were front of mind when making this decision and we are well aware of the challenging environment farmers are operating in at the moment.
“Ultimately, we are charged with acting in the best long-term interests of the Co-op. The underlying performance of the business is in-line with the latest earnings guidance, but we cannot ignore the reported loss of $590 - $675 million once you look at the overall picture.
“Not paying a dividend for the FY19 financial year is part of our stated intention to reduce the Co-op’s debt, which is in everybody’s long-term interests.
“Our Co-op remains strong at its core. Over the last 12 months we have improved our cash flow, reduced our debt and removed significant cost from within the business, but there is still more to do. The business units that are at the heart of our new strategy are delivering for us and we look forward to discussing our new strategy and our performance with our owners in September.
“It’s important that we now implement our new strategy and deliver value back to them,” says Mr Monaghan.
This is the statement from global credit ratings agency S&P:
Bulletin: Fonterra Co-operative Group Ltd.'s Risk Profile Can Withstand Asset Impairments
MELBOURNE (S&P Global Ratings) Aug. 12, 2019--S&P Global Ratings today said that it views Fonterra Co-operative Group Ltd.'s (A-/Stable/A-2) approximately NZ$860 million asset impairments and decision to suspend dividends as a painful but necessary part of the cooperative's turnaround. The impairment charges are noteworthy but noncash and, in our view, do not affect Fonterra's fundamental risk profile.
That said, we forecast the group's underlying earnings for the year ended July 31, 2019, to be materially below the prior year. Credit metrics could also deteriorate, but to a lesser extent given cash proceeds from asset divestments, reduced capital expenditure, suspension of dividends, and an improved working capital position.
The dividend suspension indicates the group is willing to actively protect the interest of creditors. We anticipate additional asset divestments, further reductions in capital expenditure, and some normalization of earnings to restore Fonterra's credit metrics comfortably within our expectations for the 'A-' rating. While the cooperative's leverage will remain above its downward ratings trigger at the July balance date, the deleveraging timetable is still broadly consistent with past expectations.
We believe Fonterra's portfolio and strategic reviews will result in a more disciplined approach to capital allocation and more versatile operational performance. In our opinion, this should result in a more stable earnings profile. That said, we are mindful of execution risks and any wavering of the cooperative's commitment to restoring its financial health would put the rating under immediate downward pressure.
This report does not constitute a rating action.
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