Fitch Affirms NZ's Fonterra at 'AA-'; Outlook Stable

Thu Aug 29, 2013 11:25pm EDT

(The following statement was released by the rating agency) SYDNEY, August 29 (Fitch) Fitch Ratings has affirmed New Zealand's (NZ) Fonterra Co-operative Group Limited's (Fonterra) Long and Short-Term Issuer Default Ratings (IDR) at 'AA-' and 'F1+'. The Outlook is Stable. Fitch has also affirmed the ratings of Fonterra's senior unsecured notes at 'AA-', subordinated notes at 'A+', and commercial paper at 'F1+'. Fonterra's ratings are underpinned by its scale, the defensive characteristics of its ingredients business, the financial flexibility afforded by the effective subordination of its farmer creditors, and the margin protection offered by its fully integrated business model. In a scalable industry, Fonterra is the world's largest processor and largest exporter of dairy products. It has a global production presence and the security of supply from a farmer base of approximately 10,500, accounting for 88% of New Zealand's milk supply. KEY RATING DRIVERS Price, Volume Risk Minimal: Fonterra has a demonstrated ability to sell its entire annual production despite volatility in global supply. Volumes and prices at Global Dairy Trade auctions which comprise mainly New Zealand dairy products rose over the last month despite the August clostridium botulinum scare. The global market for dairy products is deep and can absorb Fonterra's entire ingredients production which only accounts for 2.8% of global dairy consumption. Fonterra does not take a material amount of price risk as it is able to pass this risk onto Fonterra's farmer supplier/shareholder base. Market Dominance: Fonterra's ingredients business is the global market leader in dairy exports, commanding 50% of international exports in whole milk powder. Fonterra collects and processes around 88% of the milk produced in New Zealand from a supplier base of around 10,500 dairy farmers who are also shareholders in the co-operative. The group's strength in the global dairy trade reflects the quality of its products and its low-cost production. New Zealand's cost competitiveness arises from favourable climatic conditions for its grass-fed herd, the depth and breadth of Fonterra's supply chain, and the scale of the company's operations. Subordination of Milk Payments: Fonterra's constitution provides for an effective subordination of milk payments to principal and interest obligations (and other costs). In its forecasts, Fitch assumes a minimum 10% of milk supply costs at the end of each financial year (year-end July), to service principal and interest payments, based on Fitch's understanding of the legal framework underpinning the subordination of milk payments, and management's estimates of advance rates. Brands Insulate Profit: Fonterra's brands segments provide farmers with some insulation against a fall in the price of global dairy ingredients. Should dairy ingredients prices fall, Fonterra's brands segment may be able to maintain price points which can underpin gross margins for a temporary period. Fonterra may, at its discretion, pass on this benefit to its shareholders. These factors contribute to the continued viability of New Zealand's dairy industry. Farm Debt Levels Stable: The financial well-being of Fonterra's member farmers is an essential element underpinning Fonterra's ratings. Fitch expects Fonterra's distributions of milk price and dividends to farmers to exceed breakeven levels over the rating horizon. Fitch expects farmer debt to milk solids production to reduce over the rating horizon as farmers fund higher levels of working capital with operating cash flow. Processing Capacity Risk: A risk to Fonterra's cash flow would be an inability to process milk that the group is contractually obliged to purchase from its farmers. The addition of capacity at Darfield in New Zealand's South Island has secured Fonterra's production capacity for at least the next five years. Upon commissioning the second plant at Darfield in FY13, Fonterra's peak production capacity will exceed its historical peak milk collections by two million litres, providing it with a sufficient capacity buffer. RATING SENSITIVITIES A positive rating action may be considered if debt to pre-subordination EBITDA falls to below 1.5x on a sustained basis. As at FYE12 it was at 2.44x and is expected to fall to 2.15x by FY16. Negative rating action could follow if debt to pre-subordination EBITDA increases to 2.5x on a sustained basis, or if overseas milk supply account for more than 30% of NZD cost (FY12 11.2% and expected to increase to 11.7% in FY13) he rating Contact: Primary Analyst Johann Kenny, CFA Director +61 2 8256 0348 Fitch Australia Pty Ltd., Level 15, 77 King Street, Sydney NSW 2000 Secondary Analyst Vicky Melbourne Senior Director +61 2 8256 0325 Committee Chairperson Kalai Pillay, Senior Director, +65 6796 7221 Applicable criteria, "Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage", dated 5 August 2013, are available at www.fitchratings.com. Media Relations: Iselle Gonzalez, Sydney, Tel: +61 2 8256 0326, Email: iselle.gonzalez@fitchratings.com. Additional information is available at www.fitchratings.com. Applicable Criteria and Related Research: Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage here Additional Disclosure Solicitation Status here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S FREE WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE, AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE CODE OF CONDUCT SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE. Fitch Australia Pty Ltd holds an Australian financial services licence (AFS licence no. 337123) which authorises it to provide credit ratings to wholesale clients only. Credit ratings information published by Fitch is not intended to be used by persons who are retail clients within the meaning of the Corporations Act 2001.

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