Fonterra Co-operative Group [NZX: FCG] has had its A+ credit rating cut one notch by Standard & Poor's over its investment in China's Beingmate Baby & Child Food, which the rating agency sees as a more aggressive push into the world's second biggest economy. Separately, Fitch Ratings affirmed its rating for the world's biggest dairy exporter.
S&P lowered Fonterra's long-term rating to A and affirmed the short-term rating at 1-1, retaining a stable outlook on both, it said in a statement. Fonterra is paying a premium to buy a fifth of Beingmate as part of a $615 million investment to drive its own brand of baby food sales into the world's most populous nation. The companies have entered into a joint venture, using Fonterra's Darnum plant in Victoria, Australia to manufacture the goods, and comes at the same time Fonterra announced a $555 million expansion in its domestic drying capacity.
"Fonterra's proposed sizeable 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," credit analyst Brenda Wardlaw said in a report.
S&P said the scale of the acquisition, its reliance on dividends from the equity holding rather than having direct control over cash flows, higher short-term leverage to fund the transaction and the capital expenditure worsen Fonterra's credit quality to the A rating.
"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," Wardlaw said. "Implicit within the ratings is our expectation that future investments are unlikely to change the proportion of milk supplied from New Zealand materially."
S&P said any further debt-funded acquisitions may weigh on the credit rating.
Fonterra has been grappling with falling global dairy prices this year as stockpiling in China and increased international production take the steam out of the market, though it expects prices to bottom out this year or in early 2015. The dairy group this week affirmed its forecast payout to farmers at $6 per kilogram of milk solids, having cut it in July as global prices dropped.
In a separate statement, Fitch affirmed Fonterra's long-term issuer default rating of AA- and the short-term rating of F1+, both with a stable outlook, because of its scale, the defensive characteristics of its ingredients business, its financial flexibility, and margin protection offered by its full integration.
Fitch was more positive about the Beingmate deal, saying it "expects positive stream returns to support Fonterra's operating margin," though forecast cash returns were more uncertain due to the growth focus of the Chinese firm and tax and capital repatriation complexities from doing business in China.
The ratings announcements came after the close of trading on the NZX and units of the Fonterra Shareholders' Fund, which gives investors exposure to Fonterra's earnings stream, rose 0.2 percent to $6.17, and have gained 6.2 percent this year. The units are rated an average 'hold' based on seven analyst recommendations compiled by Reuters, with a median price target of $6.58.
The units are also listed on the ASX, and were down 1.3 percent to A$5.50.
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