Standard & Poor's lowers Fonterra's credit rating because of a new "financial risk appetite that is more aggressive than what we had factored into the previous ... rating"

Standard & Poor's lowers Fonterra's credit rating because of a new "financial risk appetite that is more aggressive than what we had factored into the previous ... rating"

Content supplied by Standard & Poor's

Standard & Poor's Ratings Services said today that it had lowered its long-term rating on Fonterra Co-operative Group Ltd. to 'A' from 'A+', and affirmed the 'A-1' short-term rating.

The outlook on the long-term rating is stable.

At the same time, we lowered the rating on Fonterra's subordinated notes to 'A-' from 'A'.

We also lowered the ratings on its Chinese renminbi notes to 'A' from 'A+' and the Greater China regional scale ratings to 'cnAA+' from 'cnAAA'.

The downgrades follow Fonterra's announcement of a proposed equity holding in Chinese company Beingmate.

"Fonterra's proposed sizable shareholding in a commercial company operating in China indicates a financial risk appetite that is more aggressive than what we had factored into the previous 'A+' rating," Standard & Poor's credit analyst Brenda Wardlaw said.

This is notwithstanding the fact that the proposed transaction does not affect Fonterra's effective subordination of milk payments to suppliers and its resultant discretion in setting the estimated forecast milk price.

The proposal involves Fonterra acquiring a shareholding (via a tender process) of up to 20% in Beingmate. A distribution agreement with Beingmate will facilitate growth in sales of Fonterra's New Zealand-manufactured infant formula in the growing Chinese market.

A joint-venture arrangement for ownership of Fonterra's Darnum manufacturing plant in Australia is also proposed, with Beingmate acquiring a 51% ownership interest.

The net investment cost will exceed NZ$600 million. The proposal is subject to regulatory review in both China and Australia.

This transaction is occurring at a time when Fonterra is also undertaking large investments in plant expansion and optimization in New Zealand, which would cost about NZ$555 million over the next few years.

In addition, global dairy product prices are currently weak, resulting in a reduction in the estimated forecast price of milk to NZ$6.00 per kilogram milk-solids early in this season, from NZ$7.00 per kilogram.

We acknowledge that the sourcing of product for distribution via the partnership from New Zealand milk means the pricing flexibility afforded through subordination will not be affected. However, the scale of the proposed acquisition; a reliance on dividends from the equity holding, rather than having direct control over cash flows; higher leverage in the short-term from this transaction; and the capital expenditure, worsen Fonterra's credit quality to the 'A' rating level.

Ms. Wardlaw added: "The stable rating outlook reflects our view that the effective subordination of the company's payments to its supplier-shareholders remains entrenched within Fonterra's business model. Implicit within the ratings is our expectation that future investments are unlikely to change the proportion of milk supplied from New Zealand materially."

If Fonterra were to undertake further material debt-funded transactions, particularly in higher-risk geographies that alter the supply mix that may also undermine the subordination benefit, downward pressure on the rating could occur.

An upward rating trend is unlikely, as it would require an increase in lender protection from the subordination benefit.

We consider this scenario as unlikely, however, given that Fonterra's long-term growth strategy will inevitably include greater expansion outside its co-operative supplier base in New Zealand, in addition to organic growth in its home base.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

We welcome your comments below. If you are not already registered, please register to comment.

Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.

5 Comments

Comment Filter

Highlight new comments in the last hr(s).

Dairy farmers must be reeling in a state of shock as they and the bank manager recognise they are last in a long line of creditors as far as Fonterra management is concerned? - the following observation made by S&P hardly reflects the spirit of cooperation;
 
This is notwithstanding the fact that the proposed transaction does not affect Fonterra's effective subordination of milk payments to suppliers and its resultant discretion in setting the estimated forecast milk price.

not just last in line for revenue, but first call for contributions as well...
 
Determining the milk price under TAF was always going to be a challenge.  Given the absence of a competitive market, It was always going to be the outcome of complicated back-room calculations.
http://keithwoodford.wordpress.com/2014/03/23/finding-capital-for-fonterra/
 

Many owner/worker farmers know that,. Corporate farmers, it's not part of their job description to know so they're looking the other way and that's the corporate attitude...as long as they do their job correctly  The World owes them a successful company right?

It's why many of us don't want to be off trying to buy market in other countries.
The mere fact that increase in flows, creates massive drops in supply price is warning enough that we're a mature production market (not a developing one) so softly softly with expenses paid up is the way to go forward.  Leverage is for developing markets.

And why to I so often quote farmgate milk price?  Is it because I can only see as far as my own wallet?   No!  It's what has been said by Stephen and Henry...our farm gate price is after retained earnings, and last in line.    So anything happens, you can tell the strength of the company and the size of Leakage,, by what they can afford to payout. bottom line.

You could have added in sharemilkers there Cowboy, we've had it rammed down our throats a few times in the last few years that Fonterra owe us nothing. I noticed they never changed the Shareholders Councils name to the Suppliers council as it still reflects where they're coming from.

my sincere apology, yes.  Especailly Sharemilkers (and their junior staff) because they don't even get to see anything from dividend and company shareholdings - so while Fonterra might be trying to save its ship in Aussi and High-risk Infant formula, and pouring high cost structure work into more steel and concrete in NZ (and giving away product locally)... they are subsidising these operations out of what could be the milk price - a milk price which should be paying for better on-farm conditions and on-farm improvements.   People want to see precision fertiliser and high tech feed quality systems and effluent management, and less injuries from overtired staff...it costs moola... which comes from milk price and that's what those doing the work get paid from