First NZ Capital still 'neutral' on Fonterra Shareholders' Fund

Units in the fund rose 0.5% to $5.91, just above the report's $5.88 target price.

One of New Zealand's largest stockbrokers, First NZ Capital, has retained its 'neutral' recommendation on Fonterra Shareholders' Fund [NZX: FSF], which gives outside investors access to the dairy cooperatives' revenue stream.

In an investor note, First NZ's equity analysts say the company has a long history of poor free cashflow generation and has consistently underperformed when investors' profits are considered against the cost of supplying the co-operative with capital. The authors argue the business is not very transparent and the level of detail offered by management is less than required. However, Fonterra Cooperative Group's decision to support its farmer shareholders through subsidised loans and bringing forward a dividend later this year is defended.

"We believe the approach FSF has taken to date to support farmers is reasonably measured and consistent with what a co-op would do ... FSF's actions to date are not out of line with what should be expected," the report said. However the authors say it is too early to determine if more support is off the table and whether Fonterra can keep hold of its profits to invest in growth.

Fonterra's results are broken down into what it terms "the good, the bad and the ugly." The good bits of the business, which the authors say "was very good," were earnings from ingredients, with the New Zealand ingredients business generating most of the group's earnings, while China continues to build into a significant business.

The bad is listed as the rest of Asia, with performance in Malaysia and Indonesia particularly challenging. The authors also say it's not clear what is happening in Latin America, with disappointing results compared to the second half of 2015.

The ugly was Australia and international farming. The Australian side of the business saw normalised earnings before interest and tax of a $28 million loss with an adverse product mix and the Stanhope fire impacting cheese production. International farming is described as a major concern, with the authors saying more detail is needed for them to be more convinced on the potential for returns.

Over the next 18 months, First NZ said it's looking for signs of improvement from Australia ingredients and sustainable improvement in New Zealand ingredients. However, they warn that it will not be until conditions normalise and global milk prices rise again that "we can get a better gauge on where FSF is at across the full set of group businesses."

Units in the fund rose 0.5% to $5.91, just above the report's $5.88 target price.