Fonterra Co-operative Group Limited (FCG.NZ) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Fonterra Full Year Results Briefing. [Operator Instructions] I would now like to hand the conference over to Mr. Miles Hurrell, CEO. Please go ahead.

Thank you. Good afternoon, everybody, joining here today, Andrew, Phil and Richard to answer any of your questions. By now, I hope you've had a chance to review the video, had a read of the results that came out this morning. Probably headline from our perspective, we're really pleased as a leadership team with where we've landed this year. A lot of hard work, of course, that goes into these results. But to be sitting here today, delivering a decent set of numbers for our farmer owners and unitholders is something that we are all very proud of. With that, I'll hand straight to the host to take us through the questions, please. Thank you.

[Operator Instructions] Your first question comes from Arie Dekker from Jarden.

First one, just on the CapEx in FY '25 at $930 million. That's quite a bit above what went through the cash flow statement at $700 million. Can you just sort of talk to that and just sort of confirm that there are some timing differences that will need to be incorporated into the cash investment in FY '26?

Yes. So that would be that playing out, Arie, yes. So we will see a bit of timing, obviously, just in terms of how things are ordered and then when they actually come through. So we would expect to see that pick itself up in '26, purely timing.

And that sort of -- because $200 million is a decent chunk, but I guess this was a ramp-up year, so more likely to occur. But is that reflected in the payables balance at FY '25?

Yes, everything would be appropriately accounted for in that way, yes.

Yes. Okay. Great. Then just on the -- I guess, the growth you've sort of signaled in EBIT through to FY '28. And I guess you could put it at circa $250 million is sort of the target. Can you just sort of talk to the extent to which that's sort of an aspirational target versus like a very clear path on what needs to be done with low execution risk, which way you'd characterize it? And also talk a little bit to the key drivers of the EBIT uplift from continuing operations.

Yes, sure, Arie. I'll have a go and then pass it back to Andrew for a bit of the detail. So it's far more than an aspirational target. I mean this is something that we are clear as a leadership team what we are going after. And it comes across the board from new business and you see the investment in Studholme, which will come online next year, the new investment in UHT cream at Edendale, so seeing those things commissioned and delivering upon their business cases. So that's an important part. We recognize there's some costs to be removed once the transaction completes and a little bit of stranded costs that sit within the organization. We're acknowledging that needs to also be done. So far more than an aspirational target, I wouldn't go as far as to say they're a line by line for every dollar that goes behind it, but certainly clear plans and the way that we operate as a leadership team and our Board in terms of plans and delivering upon those is very clear in how we operate these days. So I feel very confident. The execution risk, I mean, we're still in a global business, and we've got people out there playing games and the geopolitics and the like. So that's always a risk, but no more into the future than what we've been dealing with for the past 4 or 5 years.

Perhaps the only thing I'll add to that, just around there is a space about us continuing to -- we're executing the strategy that we've been executing for the past 12, 18 months. This is about us being really clear. We know what we're doing in Ingredients, we know what we're doing in Foodservice, and this is the extension of that. So it's not a whole lot of new things on top. We do obviously have the new capacity coming online, which Miles has already talked about. And we see that should start off the line coming out to '26. Two other things. One is that, obviously, there's a cost element to this. We have some very robust plans to take out any of the stranded costs related to the consumer business. So we're very confident in that space. And then, of course, as we get out to FY '28 in particular, we'll start to see the ramp down of those ERP costs, which '26 will be a big year in terms of what that looks like. So we'll start to see that ramp down as well. So if you look at it, yes, there's a bit of a cost element which we feel very comfortable on. And then we're executing the same strategy we have been for the past 12 to 18 months.

That's very helpful color. I guess the one follow-up, one thing you haven't sort of addressed is, yes, and it's a difficult one, but just, I guess, price relativities and the benefits also of sort of hedging and your risk management tools. Like is there a neutral view taken on that through -- given the benefits you've had in the last couple of years? Or are you assuming that you retain some of that?

No, no. So I mean, essentially, we assume mean reversion. So we will go back to sort of long-term averages to be fair. We've had a benefit in '25 certainly in terms of our hedging program, has actually helped us offset some of that narrowing price relativities that we saw in '25. But in terms of our way out, we are not assuming any benefit coming through in that space.

That's great. And then there's CapEx guidance provided for '26 and '27. Over the last couple of years, you've been very clear in signaling the lift in CapEx that is coming and sort of sitting at circa $1 billion through the balance of this decade. Just confirmation given the amount of decarbonization, wastewater and then your broader CapEx program that the level of investment around $1 billion for further out beyond '27 remains appropriate as sort of previously guided to?

Yes. I think probably we'll see '26, '27, it might be slightly sneak a tiny bit over $1 billion, like I wouldn't be surprised if we get into sort of $1.05 billion, $1.1 billion potentially even. It does come back down after that. So sort of 2029 onwards, I think we would see that coming back to more of a level that's more in line with sort of our depreciation replacement. So I see this as an uplift that we're doing in the next few years, and then we'll see it come back down towards the end of the decade.

Okay. And just because of the materiality versus depreciation, so just to be clear, so from '29 onwards, you'd be signaling CapEx sort of around $600 million.

Much, much sort of closer to that level, yes.

Yes. Okay. No, that's helpful. And then just last question, just net debt at the end of FY '26, you've provided sort of a '25 starting point, excluding mainland. There's a CapEx, I guess, increase, including some of the CapEx from the previous year that needs to come through. Would you see net debt when you get to the back end of this year still being on kind of a glide path to the $2.6 billion level signaled for '28? Or do you think that the debt profile could be quite flat through the period through to '28?

Yes, I mean we're definitely on a glide up. So I wouldn't expect it to be particularly high during '26, but then as that sort of -- remember, of course, that we're paying a lot more tax payments, et cetera. So cash -- there's more cash going out the door. We see that kind of flow through. So I think through '27, '28, you'll see it go up towards that $2.6 billion. I think FY '26 will probably be a relatively light change.

Your next question comes from Matt Montgomerie from Forsyth Barr.

Well done on another solid set of numbers. I might just go back to Arie's question about bridging us to FY '28 in terms of operating profit target. Andrew, you made a comment about, I guess, being very comfortable on the cost element that comes out. It'd be useful if you could, I guess, quantify what portion of that, call it, $250 million bridging from FY '25 to FY '28 is the cost base versus, I suppose, the mix change through the Ingredients and Foodservice divisions.

Yes. So I mean, I think broadly, Matt, we probably see it about 50-50.

Okay. Yes. That's helpful. And then just on ERP costs. So I think you sort of signaled $250 million over '25 and '26. At what point -- do you have a number in for '27? Like when -- because there's obviously still probably a couple of hundred million there left to go. Is that all happening in '27? Just I guess, it would be useful to phase us into '27, '28.

Yes. No, no, no, so I get where you're coming from. So look, there will definitely still be some spend in '28. So that's the way that we've got it phased out at the moment. If you're willing to put a number in '27, say $70 million to $90 million, maybe somewhere around that sort of number. Definitely, '26 will be our peak year. We'll see it come off in '27 and then there will still be a little bit left in '28.

Yes. Perfect. Maybe one for Miles. Just on the balance sheet in terms of, yes, I've noted the change in gearing guidance commentary from 2 to 3x to less than 3x. I suppose if we look at the balance sheet, forecast implied we're looking at maybe 1.1, 1.2x gearing to EBITDA in '28 using the numbers you've provided. I guess my question there is like where is the comfort levels now in the business, and I suppose what I'm getting at is scope for further, I guess, special dividends over and above, I guess, paying the top end of your dividend payout policy range.

Yes. Well, certainly, I wouldn't bank on any further capital returns at this point until we've made further progress throughout '26 at least. But as you see from the residual funds from the sale of circa $700 million, we'll put that through the capital allocation framework and make some decisions throughout '26 and beyond. But the rationale for the movement from 2 to 3 is to not be under pressure to move back into 2 to 3. If we feel comfortable less than 2, we will do so, but that really is just a signal that we'll certainly be less than 3, but on the more conservative end of that certainly in the near term.

Yes, makes sense. Then one more, Miles. Just obviously you and the Board and management team have done a fantastic job over the last 7 or 8 years, I guess, what do we call tidying up the low-hanging fruit. And clearly, the consumer is the last major jewel, but I'd be interested around, I guess, any further, call it, low-hanging fruit you see. Like I note, China consumer, in particular, obviously, a reasonable drag still over the last couple of years, which is now included in Foodservice profitability. So that feels like one. But I suppose, comments on that, plus anything else that you see from your point of view.

Sure. Well, generally low hanging fruit implies they're quite easy things to get hold of, Trust me, it's been a heck of a sort of 6 or 7 years, but I'll put that aside for the moment. Look, we acknowledge there's work to do in China, but the rationale for keeping China consumer is all about the link between Anchor and Anchor Food Professionals. It's very much aligned in that market. So beyond Anchor, you need to understand where we take that business into the future. But it's certainly been on our ticket for the early part of this financial year. So you'll see some progress on that because we know it's an important element. What I think you're starting to see play out this year, the year prior even to a certain extent is that as you start to get more focus on what we know that we're here for, we're starting to deliver. And so to see our way away from consumer at some point throughout '26, notwithstanding, of course, there's going to be some transitional service agreements that need to play out. Once we're sort of free of that, then I think we're just the tip of the iceberg in terms of where we can take this organization. So there's still a heck of a lot more to do. But I wouldn't say it's low-hanging fruit. There's still a lot to be done.

Your next question comes from Joshua Dale from Craigs Investment Partners.

Well done on a very solid set of numbers yet again. First question, your return on capital target is 10% to 12%. It looks like you could probably get a higher return than that by just buying back your own shares. Given where your balance sheet is at or is going to be at, a buyback is something you're considering?

We'll always look at that as part of our capital allocation framework. So as we evolve through, that is certainly part of the discussion that we'll have with the Board.

Got it. And again, in light of the strength of your balance sheet, it was sort of interesting to note that you've kept your dividend policy payout range at 60% to 80%. In what scenario do you think we could be looking at a 60% payout?

Yes. Well, there's nothing sort of in the foreseeable future. Like much of you on this call, I suspect our farmers and our Board have got some pretty long memories, and so the last thing they want us to see is to start to get too excited and start to change our thinking. So just make sure that there is an element of let's realize why we're here. And so the last couple of years, we've paid us sort of the top end of our policy. In fact, even beyond that when it was at a lower range. But it's important we keep the range there because things happen and when you're dealing in an international market and storms come up on you bloody quickly, it's important we keep that flexibility and conservative nature of the balance sheet. But you've seen the strength of the balance sheet, you've seen our history in delivering and therefore, paying out at the higher end. That's certainly how management is focused on, but we need to be conscious of whose capital we're dealing with there.

And last question. The existence of the Fonterra shareholders' fund, does the strength of your balance sheet lead you to take another look at whether it's worth keeping that in its current state?

Like the earlier conversation that Andrew said, I think all these things are always on the table, but it's not a hot topic right now.

[Operator Instructions] Your next question comes from Marcus Curley from UBS.

I just wondered if we could go back to the stream returns, gents. Could you give us some sort of color in terms of how you would sort of quantify that in terms of the benefit in the FY '25 year? And by the look of things in the presentation, you're sort of expecting a similar number for FY '26, if that's correct?

Not quite. So if you look at FY '25, we'd probably say with the benefit of our hedging book, we would say about 100 -- maybe just $120 million max would be the benefit that we saw versus FY '24 in terms of that space. So that's certainly what we were seeing, but that is because of the benefit of the hedging book. Obviously, stream returns are narrowing. You're seeing that narrow towards the end of the year. We started out in FY '25 in a reasonable spot, but we certainly don't see that that's where we would actually end through the year. So we do see it changing. So we see it in '26 sort of reversing back to where we were in FY '24 is essentially the sort of space. It's more of a long run average and that sort of mean reversion is certainly what we'd be expecting it to go through.

And what was the number in '24?

In '24, yes, about $100 million less than FY '25, yes.

Okay. So $120 million benefit going to, broadly speaking, a $20 million benefit. So $100 million headwind but baked into the guidance for the continued operations in FY '26?

Yes, that's right. Yes.

And so could you then provide a little bit of color in terms of where, let's say, the underlying growth in the business is coming from in FY '26 against the backdrop of that $100 million headwind?

Yes. So I mean, we do continue to see good margins in market. So that's clearly there, particularly from an Ingredient standpoint. So we've got good robust demand there, which we're seeing continue through. Foodservice is one that we're going to need to watch pretty carefully. Those high milk prices are definitely putting some pressure on margins in Foodservice. So we do need to see that pricing in the market particularly goes up there. So those -- still volume growth yet, but I would like to see margins come up a little bit. And the other thing that we have the benefit of in '26 is that we did have some one-offs in FY '25, probably about $80 million worth of one-off costs in '25 from impairments, et cetera. So we won't have those in '26. So we're getting the benefit of that on the other side.

So those one-off costs of $80 million were normalized out in the FY '25 result?

No. We didn't do any normalizations with the exception of the costs related to the divestment.

Okay. Where did those run-off costs occur?

Sorry, I missed your question.

What line items were the one-off costs in FY '25?

You'll see it in a couple of different spaces, predominantly in Q4.

A couple of smallish -- smallish in the green scheme of things but they add up. Quality issues we had earlier in the season, an exit of a business earlier in the year and brand impairments. Quite a few small -- I mean, historically, we still have $80 million in each item, but a number of small things that added up to about $80 million that we decided not to normalize.

Second question, just on the guidance. Does that incorporate the benefit of the lower net debt in that continued operations EPS?

So at the moment, that would be a relatively small space for us. Obviously, we've done the continuing business depending on what time the sale comes in and how long we hold funds for, there may be some potential upside in terms of us holding funds until we can distribute it back to shareholders. Until we have more clarity on exactly when completion data is, when funds come in and when they'll go back out again, we won't make any other projections on that, but there is a potential there for some upside.

And you mentioned briefly or just acknowledged that the China consumer business is still loss-making. Could you talk a little bit about what sits in behind that? I know, Miles, you briefly talked to it and what the plan is around that?

Yes. So I mean the plan is very clear. So one thing that we did do and part of what's dragging the -- dragging it down is one of the impairments does sit in there, but also that we had some costs related to actually taking out some costs. So we made some -- basically, we took the team size down and we had some redundancies and stuff to pay. So there were some one-offs related to rightsizing, I guess, you would call it, the business, and then we actually had to impair from a brand standpoint as well. So that's what was sort of dragging it down through '25. We do still have some further cost optimization to do within that business during '26. And as Miles said, we will actually then trim the portfolio a little bit as well. So we'll take out some of the sort of more tangential products, get really focused on what does create value in that space, which is more of your core Anchor and less of some of your other parts. And that just gives us a much more -- it gives us a smaller business, but actually one that is more profitable than it was before.

I guess the way to describe it is that it's been -- up until now, it's been a stand-alone consumer business, while it reported into the China -- Greater China business at a high level stand-alone and therefore, sort of ran their own destiny. Their job now is to facilitate the growth of Anchor Food Professionals. So that completely changes the way you go to market. You still want to make sure you have a presence in some of those retail channels, but it changes the way you go about it and how you spend your A&P, how many people you need, your approach to distributors. So it's a completely change of model, of which Andrew said, we've picked up a fair chunk of those redundancy costs in the current year, in the last year, which gives us a platform to then go forward under a new operating model. That said, still more to do.

And Miles, does that include exiting some of the products, for example, like UHT?

Can I say maybe because there's obviously people involved in all this? So work to do, but I think you know what I'm saying.

Your next question comes from Nick Mar from Macquarie.

Just on the guidance, just talk through what the main drivers of the bottom end and the top end of the guidance range will be over the year.

Yes. Obviously, it's probably two things. Foodservice margin, we really need to make sure that we can keep Foodservice one growing, but also that we can keep margin in place. So Foodservice margin definitely there. Stream returns is always going to be something that plays out in the variability within our P&L. And so that is -- probably that would be the other biggest part that's playing there.

Yes. Downside, well, it's almost a rounding error. We are watching carefully the tariff situation in the U.S. I mean the 15% starts to bite, and while we've had some success with our key customers in that market, we're starting to get a bit of pushback as well on that. So we're watching that closely. And so you could see us sort of moving down on the guidance if we don't have any success there.

No, that's helpful. And then just talking about the mainland investment and the sort of numbers there. If we were to sort of adjust for the divestment costs, it looks like it did sort of $368 million of EBIT, which is sort of quite a lot higher than we were probably thinking. And if we sort of go back to the original presentation, it was sort of $200 million of kind of in scope EBIT before some of the changes in the perimeter and whatnot. Can you just talk through what's been the driver from that $200 million to, say, the $368 million where it's landed?

Yes. So there's three key things that are at play there, about four actually, if you include FY '25 and not '24. The perimeter is different. So if you look at what we had put out before, we are now including the Middle East Foodservice business, but also our manufacturing facility within Saudi is in there. So there's a bigger perimeter than was originally there. We have the benefit -- well, so we also have the stand-alone costs. So what we presented was a business that would be stand-alone, and that means that it had a lot of additional costs within there that are required in order for it to operate as a stand-alone entity. Those were costs that we obviously disclosed through the due diligence, but that cost would not be stuff that necessarily existed already because it was part of a broader entity. And then as a separated entity because it's not being created as independent, it will go to across the Lactalis. Some of those stand-alone costs are just not -- are not required. And certainly, they weren't in place in the business during FY '25. So that's probably the two biggest parts of it, if I think about what the changes were. So it's the perimeter and then the fact that the stand-alone costs weren't included.

And then the underlying growth piece, sort of how much is that being year-on-year and what's driven the majority of that?

Yes. So actually, two parts. The Australian Ingredients business was probably the biggest part of that. So obviously, coming off quite a tough FY '24 where they had a particularly high milk price in Australia. And so the Australian Ingredients business was probably the lion's share of that. But actually, the consumer margins held up pretty well in the context of the high milk price. So it's actually a good performance for Mainland in total, but the big driver would be the Australian Ingredients business.

[Operator Instructions] We do have a follow-up question from Arie Dekker from Jarden.

Just quickly on capital management. Could you just talk to the ability to tax effectively distribute post the $2 return? And I guess, just comment on how much available subscribed capital will be left post that $2 return?

Yes. So post the capital return, relatively little, I think. We're in the middle of hunting down to see if there's any, in any of the sort of predecessor companies, et cetera. But at the moment, there would be very little that would be on top of what we will be paying out now.

There are no further questions at this time. I'll now hand back to Mr. Hurrell for closing remarks.

Great. Thank you. Thank you very much for your attendance and your questions. Of course, the team are available if there's any follow-ups that you may wish to have. But again, thanks for your support.