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Units in 'overvalued' Fonterra fund take a tumble

Fonterra shareholder fund units dropped by more than 1% today as it joined the NZX50 and a research firm says the units are overvalued.

The dairy giant's fund – the first chance for non-dairy investors to get a slice of the New Zealand industry – has surged above its $5.50 offer price since listing in late November.

The fund (NZX: FSF) displaced Cavalier Corporation on the NZX50 today but by mid-afternoon had dropped 8 cents to $7.26.

Before the bookbuild, Morningstar Research warned of uncertainties with investing in the Fonterra units and said fair value was $5.50.

A fresh report, released this morning, reiterated that line – despite the units appreciating more than 30% since trading began less than two months ago.

The Morningstar report says the majority of Fonterra's returns relies on commodity products such as milk powder, which generates mid-single digit operating margins and has "no pricing power".

Fonterra will struggle to lift returns in higher-margin branded goods, the note says, because of competition from established multinationals Nestle and Danone.

"We believe the company is overvalued compared to our intrinsic value of $5.50 per unit."

Fonterra – the world's biggest dairy exporter – faces increasing competition in New Zealand, with two Chinese dairy companies announcing investments of $420 million in recent months.

dwilliams@nbr.co.nz

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Comments and questions
14

Has someone done an "intrinsic value" calculation of Xero?

Have you?

Is all in the growth and blue sky. Shame about the PE and EPS.

Compare the land and capital required to increase milk powder production with the server infrastructure required to handle increased Xero subscriptions, then come talk to me about value calculations again.

Punters have had a significant capital gain - that gain provided and secured by the owner-shareholders of Fonterra. So $5.50 is on the low side when you work out the real worth of the global Fonterra business.

But you don't own the global Fonterra business with these securities. You are better off buying the Fonterra debt. You still get yield and rank much higher up the security chain.

Whilst you don't "own" Fonterra (farmers do), you have exposure to the performance of Fonterra, which includes its global business (by definition). Have a look at the prospectus.

Yeah, but exposure isn't ownership. I think it is correct to price these as fixed-income securities using a YTM or DCF methodology. If you do that, you'll probably come up the conclusion that at present, the expected cashflow discounted by the risk adjusted discount rate (eg, the yield on FCG's bonds, plus a wedge for their shares' lower ranking) makes the shares a worse proposition that the company's own debt, and the securities of many other issuers.

House prices in Auckland are well over-valued by any measure, but the market frenzy and demand puts returns and common sense to one side.

Fonterra units are the same. Because of a shortage, investors turn a blind eye to the real returns they will get.

I did not buy my Fonterra units based on returns but the capital gains I was sure to receive when I sold them because of the shortage and the market demand.

Capital Gains? If the shares were bought with the intention of resale should not they be taxable?

Personally, I love the flexibility that Fonterra has, being able to move earnings into or out of the milk price as it sees fit. Makes a safe secure investment in a non-volatile commodity producer.

Thanks NZ investment bankers for putting me on to this one and not asking the hard questions. You really earnt your dosh on this one.

Wow, the price dropped 8c! Is that news - a "tumble"? Looks a great deal to me (and I am a shareholder).

Fonterra is desperately trying to talk down the unit price. Why? Because farmers are leaving in droves, selling their shares and using the capital to pay down debt.
Fonterra has replaced a suspected redemption risk with supplier flight. Good work, Princes St.

Imagine if a Kim Dotcom Mega became a bigger earner for the country and investors than Fonterra.