Week Ahead, Local Earnings | Fonterra: Un-investable

11 May 2021

Global markets were higher on Friday (S&P 500 index +0.7%) as US stocks hit a fresh record after surprisingly weak jobs data eased fears about higher inflation and a reduction in stimulus. The much anticipated US employment data showed payrolls were up only 266,000 in April, trailing the projected 1m surge while the prior month was revised lower to 770k from 916k. The unemployment rate also unexpectedly ticked up, from 6% to 6.1%, in contrast to market expectations for a fall.

Surprisingly, all major groups in the S&P 500 rose, and it seems there is no such thing as bad news right now – with investors taking the “glass half full” view that slowing US jobs growth ironically calmed concerns that inflation would drive up interest rates. We think it is very early to establish a trend from one data release and we will continue to monitor developments.

European markets (Stoxx 600 index +0.9%) also hit a record high on Friday, buoyed by stronger than expected German exports data, the negative US jobs data, and upbeat Euro area earnings.

Locally, company earnings season gets into full swing this week across Australasia, with a number of stocks reporting after the banks kicked off proceedings last week.

Fonterra Shareholders Fund (FSF:NZX)

FSF shares have enjoyed a strong rally since September 2020, as operating conditions improved and demand continues to bounce back. However, since reporting its half year result, it has pulled backed heavily as high Farmgate Milk prices will persist (being beneficial to farmers) but will result in tighter margins and earnings for the second half. More recently, FSF sold off after revealing plans to restructure the co-operative which appears disadvantageous for non-farmer shareholders.

Fonterra’s Interim Report 2021 indicates that the Company has successfully managed to lower its costs and divest from unnecessary interests. While overall sales are down for the Co-Op for the period, improved margins have resulted in a lift to its gross and net profit.
Fonterra’s current valuation appears too lofty despite improving operating conditions and recovery in demand. As noted in previous reports, the structure of Fonterra means that higher Farmgate Milk prices aren’t necessarily passed to non-farmer shareholders.

Instead, the benefits flow to farmers in the form of higher pay-outs. We downgrade Fonterra to a SELL rating based on its current valuation as well as unfavourable structure for non-farmer shareholders in this current period of elevated farmgate prices. Add to this, there is huge uncertainty around changes to its structure, which may make it even more disadvantageous for non-farmer shareholders – as farmer shareholders may potentially be allowed to hold fewer FSF shares, increasing supply of shares on the market, which all-else equal would be negative for the share price. At the same time, it is possible that Fonterra buys back FSF and takes it off the market. 

Overall, we see far too much uncertainty until this is resolved, likely around the AGM in November – and we downgrade our rating to SELL.  

Australia & New Zealand Market Movers

The Australian market (ASX 200 index +0.7%) closed higher on Friday as travel booking stocks rebounded. Travel booking stocks rebounded after struggling earlier in the week as Webjet jumped 7.%, Flight Centre climbed 7.3% to $15.51 and Corporate Travel Management added 6.3%. Conversely, tech stocks continued to struggle as Afterpay fell -4.1% and Altium tumbled -3.1%

The Reserve Bank of Australia's Monetary Policy Statement reinforced its earlier decision to leave interest rates unchanged despite strong upgrades to economic growth forecasts.

In stock news, Macquarie fell -0.4% as its profit announcement beat expectations, but its lower-than expected dividend weighed. Interestingly, management declined to provide guidance during COVID.

In M&A news, Star Entertainment Group is reportedly proposing a $12bn merger with Crown. The Star believes a merger would deliver $150-200m in cost savings a year, which would translate to ~$2bn in equity value for shareholders in a combined group.

New Zealand’s main share index dipped slightly (NZX 50 index -0.2%) as investors continued to shun market heavyweights and decided Fonterra’s planned change to its capital structure will not work for them.
A2 Milk declined for the second day, and has plummeted this morning on another profit downgrade which is proving hard to digest (we will release a full update on this tomorrow morning).

Air NZ's share price was not moved by the news or the suspension of travel between NZ and Sydney due to covid and was unchanged. Over the weekend, the New Zealand Government announced it would resume quarantine Free Travel to NSW from 11.59pm on Sunday.

Briscoe Group shares lifted slightly (+0.3%) with investors already factoring in first-quarter sales being up $173.1m compared with $97m in the same quarter last year. This reflected the fact the homewares and sporting goods stores were closed for 33 days in last year's first quarter. Management guidance is for 1st half 2022 sales to be comfortably ahead of 1st half 2021 ($292.4m) and earnings to be comfortably ahead of the prior period.

Argosy Property announced a revaluation gain of +NZ$77.9m largely driven by its industrial assets. Low interest rates and continuation of ecommerce and logistics tailwinds have driven strong demand for industrial assets.


3 Things Markets will be Watching this Week

  1. COVID, lockdown, and vaccine related news-flow globally continues to dominate headlines.
  2. Economic data highlights this week include inflation prints in the US and China along with the latest retail sales data in the US.
  3. Closer to home, retail sales in Australia are due on Monday while a number of earnings reports will be released including Pendal, AusNet, CSR, Pushpay, Graincorp, Xero, Orica, Goodman Property and Tilt Renewables. CBA will round out the bank reporting season with its Q3 update while Meridian Energy will host an Investor Day on Tuesday
Global markets were higher on Friday (S&P 500 index +0.7%) as US stocks hit a fresh record after surprisingly weak jobs data eased fears about higher inflation and a reduction in stimulus.

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