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

Good day, and thank you for standing by. Welcome to the Fonterra 2023 Interim Results Investor Briefing Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Miles Hurrell, CEO.

Thank you, Akura, and good afternoon. Welcome to the Q&A session this afternoon. I'm Miles Hurrell, joined here by Neil Beaumont, our new Chief Financial Officer, Simon Till and Chris Rowe. As you've seen this morning, we released to the market our update for F '23 interim results. And hopefully, you had a chance to review them and watched the briefing video, which we also put on the website this morning. In summary, we've had a good strong first half with the lift in our earnings. Our profit after tax is up 50% from $364 million to $546 million. Earnings per share for the 6 months is $0.33, up from $0.22 last year. The strong earnings performance and the strength of our balance sheet has enabled us to pay an interim dividend of $0.10. We also upgraded our full year forecast normalized earnings from $0.50 to $0.70 per share to $0.55 to $0.75 per share. We've also announced a proposed capital return to shareholders and unitholders of around $0.50 per share, which is approximately $100 million, subject to the completion of the sale of Soprole. I'm now happy to open for questions with any of the team. Thank you.

[Operator Instructions] Our first question comes from the line of Matt Montgomerie of Forsyth Barr.

Well on a good result. I might just start on guidance. The last GDT auctions saw a reasonable roll-off in the stream return [ proxy ]. Just interested to hearing your comments on what's baked in at the upper and lower end in terms of the stream returns relative to what was experienced in the first half. And then related to that, do you think that reversion in the last auction was the beginning of mean reversion? Or do you think that's more one-off in notion? How are you seeing the demand-supply response in market of late?

So Neil Beaumont here, maybe I'll offer up sort of the following. I think that you are right. When we think about our forward guidance, we obviously do have regard to kind of the range of outcomes in terms of stream returns. And that's partly the reason why you actually see a fairly wide range. That said, we obviously do contract out on a forward basis a lot of that revenue. I would say, though, there are a number of other factors in terms of change in fair values of some of the assets that we also are marking to market now, which play a role in terms of that range. In terms of former specific guidance that you're asking for in terms of when do we see stream returns and getting some mean reversion there, we don't sort of tend to think in terms of that level of specificity. So I wouldn't necessarily offer anything up to your sort of specific question there. But I think the Co-op is certainly benefiting from a diversified asset base, diversified by market, geography and channel. And so what you're seeing in the results is these things can move quite a bit. And so having the exposures across all set of streams is actually the thing that adds the most value over long horizons.

Great. That's useful. Then maybe on the dividend, how are you thinking about that in light of the very strong stream returns and, subsequently, earnings? Would you look to flex outside the policy given the inflated earnings base? Or is the policy consistent irrespective of this dynamic?

Yes. So I mean clearly, it won't be till year end before we get to a final outcome. But the policy that remains, 40% to 60%, will flow through irrespective of the results that we have.

Great. And then maybe one more. Just looking ahead slightly further given the probable normalizing of market dynamics, $0.45 to $0.55 per share FY '24 EPS guidance, just any comments you can make on how you think the broader business was tracking -- or base earnings away from the stream returns and specifically in relation to that.

Yes, sure. So I think probably the easiest way to respond to that is that our [ LTA ] strategy we put out [ years ago ] still stands sort of the position we put out there to 2030. We always seem to be some unders and overs to get to 2030. The outcome of that hasn't changed. And in fact, we're probably going to go through a bit of a look to see if there's some things that need to move given cost of capital has changed significantly, milk prices moved off, our input that we put into there. But that position we've got out there to 2030 remains unchanged at this point. Probably the other point to note, though, is it's -- we are in sort of unprecedented times with the stream returns that we've seen, as you know. But with flex, milk does give us more flexibility versus the squeeze that may have been on through peak that we may have experienced in previous years. So you're seeing that play out in the result, too, that we can have the ability more so during peak production to follow the best stream return, which, in some cases, you don't get that flex when you're under pressure [indiscernible].

Our next question comes from the line of Joshua Dale of Craigs Investment Partners.

Just a quick question for me. Your normalized earnings adjusted for $4 million of impairments related to Hangu China farms but not the $162 million of impairments relating to the New Zealand and Asia consumer businesses. Can you just remind us what the earnings base is from which you calculate dividends in the 40% to 60% payout policy?

We use an attributable earnings basis. So it's our overall earnings less any positive one-off items, and those positive one-off items are considered separately as to whether they should form part of a dividend payment. And in relation to Hangu, that's sort of a tail end of the strategic reset. So we -- remaining normalized items we have relate to asset disposals, whereas the impairments are that -- like any other asset mark-to-market activity is the way we think about it.

Okay. So even though the noncash, you don't sort of consider them. Well, you're effectively reducing your dividend off the back of a noncash write-down. Is that how you're sort of operating?

Yes, yes.

Our next question comes from the line of Marcus Curley with UBS.

I just wonder if we can start with China. It's obviously had a relatively strong performance in foodservice in the last 6 months and, obviously, the markets reopening out there. So I just wondered if you can talk about what you're seeing at the moment in terms of demand in foodservice and maybe consumer brands as well and whether you think the performance that you saw in the last 6 months is like just forms a base that you can accelerate from looking forward.

Yes, Marcus. It's Miles. I mean the simple answer is, yes, we are seeing good demand post the lockdowns that China experienced in foodservice. So we are expecting that to continue, of course, and get into this late stage of the year with this [ India ] milk constraint. You're not going to see a massive windfall on the back of having the supply. But when we look out sort of into the new season and beyond, we're still very positive about the Chinese market. The consumer market is still a bit lackluster, I guess, is probably the easiest description. Of course, previously, we had a high exposure to Hong Kong in there, which has been impacted for a number of reasons for the last couple of years. And so we haven't seen the demand shift in the consumer that we'd like. But overall in foodservice, very positive still.

And no demand impact from -- look at things, quite material price increases you put through, Miles.

Yes, we have had some price increases earlier in the year, benefited, of course, by the Europeans having quite strong pricing, too. So that's been helpful. But you do get to a point where consumers start to think about what they do in their purchase. So that's -- we're sort of [ standing ] at those points now if we're not careful.

And then just pivoting, secondly, into the consumer brands. Obviously, you put some write-downs through there. Does that signal that there needs to be sort of a broader review of some of the brands you're operating and separately? Or -- in addition to that, the Australian milk price is going back to very high levels. Does that change your attitude with regard to some of the Australian-based brands or ingredients offerings?

So the simple answer is no, it doesn't. I mean the consumer numbers that you see there have obviously been pulled down by the impairment, both the [indiscernible] and the consumer brands in Southeast Asia. That sort of is -- it masked what is not a bad performance against what is a relatively high milk price over the long term. So overall, doing okay. But again, it comes back to the point Neil raised earlier around the channel and market flexibility we had. Consumer was sort of the hero going back a couple of years at a time when foodservice really struggled through China. So having that flex is important. We've just seen a couple of headwinds in the New Zealand market, in particular, and in new impairments through Southeast Asia, which you saw more macroeconomic issues as well, which is when you look at the holding business -- maybe you want to comment a bit on that, Neil.

Yes. I mean as people on this call would appreciate well, changes in discount rates as several banks sort of changed their rates may impact on value. And so once we're down to sort of fair value, we're taking the good and the bad in terms of changes in value on things that are just macroeconomic factors. And the other thing that obviously has a big impact on the consumer business is just foreign exchange, which obviously will hedge over periods of time. But at the end of the day, we ultimately take those underlying economics. So that's a factor. I did just want to sort of reiterate maybe a point Miles was making, which is I think as we continue to seek to be disciplined allocators of capital, you always want to think about those decisions sort of through the business cycle. We do happen to be in a pretty highly inflationary part of the cycle right now. And so as a result, it's not entirely surprising to see consumer-facing channel not performing as well. But I think the strength of the Co-op is having that diversification across the market channel and products and any decisions that were ever made either to invest more or invest less, you've got -- you really got to look through the business cycle.

And then just changing direction to ingredients. What do you think your position will be as you see some moderation in the ingredients commodity prices on price premiums? So it looks from the data and I think you commented on this before, Miles, that there's probably been some reasonable underachievement in nonreference products given the strength of the base commodity price. So do you think those price premiums return as you see some easing off of the commodity prices?

And you're specifically talking milk price products here or generally?

No, I'm talking casein and [indiscernible]. And yes, so the -- I suppose to nonreference products, like -- and my observation is given the price achievement that you published relative to GDT, the gap or the price premium, as I always call it, it has contracted a lot. And so it does feel like when you look at the numbers that you've given up price premiums because of just the strength of the underlying commodity relative to the milk price. So my question is if that is sort of broadly accurate, do you sort of regain those price premiums as you see commodity prices ease?

I think I understand the question, but we can pick it up off-line if need be. But when you do get a bit of softening in the commodity pricing as we're starting to see in recent times, it does give you the ability to push you a bit harder because you don't get into that burn-off of demand. That said, you're still at the one with the international market and what the international players and the commodity markets are doing. Probably the challenge I put to -- I think that the margins for cheese and proteins have actually been quite strong. And while maybe in New Zealand dollar terms they may have come back somewhat, purchasing power in the markets and we operate is actually still in pretty good space. So I'm feeling okay about the margins across our ingredient business. The bigger question I think was asked earlier on around do we see a mean reversion over time of stream returns. And the response really is clearly, our job is to hold on to that as best we can and the flexibility in our plants now that having peak milk such we do gives us more opportunity to take advantage of that. Marcus, we can pick that up off-line, and the team are going to...

Yes. And then just finally, I just wondered if you can talk to what you think your net cash proceeds will be over the next 6 or 9 months as all the asset sales settle.

Well, the big one that we've got sitting out there is Soprole. And we've published what the sales price -- net sales price or net receipts on that transaction is. And that's -- there's a little bit of movement around that. But that information hasn't really changed.

Several billion -- $1 billion is what we announced for the proceeds. I wouldn't expect there to be too much out of DPA by the time we repay [ this ] in net assets, so...

Okay. So $1 billion and $800 million out, net debt reduction of $200 million.

Yes, that's a good way to look at it.

Our next question comes from the line of Arie Dekker of Jarden.

Just on China foodservice. And you sort of talked about the constraints you've got in the latter part of the year just in terms of volume on that. But if you sort of look beyond that in terms of volume growth sort of expectations, as that business, I guess, normalizes from a market access perspective in that, I mean are you sort of targeting mid-single-digit sort of volume growth again over the next few years?

Yes, that's probably a good place to start, Arie. We'll get to a point at some point at some stage where we need to think about the next wave of capacity to cater for that. But we've got a few programs underway to unlock additional capacity with no capital requirements, but then that runs out at some point. So -- but certainly, that -- the number you talk about is probably a fair reflection into the years ahead.

Sure. And then just on casein, I mean, I guess first question just for a better context, like, in terms of the stream benefit that you've been deriving, how much would you put down to casein versus the other nonreference products?

Do you have that handy, Chris, [ at all ]?

That's not one that we separate out as part of the results announcement. But certainly, the -- there's a variety of different forms of protein products sitting in that stream return results. So there's casein, caseinate, MPCs. They've all contributed strongly but differently at slightly different levels at least through that stream return result.

Yes. And look, obviously, visibility is a little bit limited. And then also I don't sort of, let alone, pry in the world of casein and caseinate and that. But I understand the demand dynamics sort of driving the strong pricing and returns you've been getting. Just on the supply side, and I think you called out manufacturing capacity in that, what do you sort of understand about manufacturing capacity coming on to sort of respond, I guess, to those very high prices? I understand they might [ be above ] and the U.S. that's come on recently. What are you sort of seeing there?

First thing is, you should get into casein. It will help you [ see ] us. But you're asking a bit of additional capacity, both in the casein, caseinate space and also MPC. But are we playing at the bottom end of the commodity end of those products, so I can sort of put that under the comments. There is -- our job is continue to evolve those products and move them into functional foods, medical nutrition, active living category. So there's MPC, if I can say in that regard. So it's a relatively new product for some of our international competitors, and our job is to keep innovating to be ahead of the curve on that.

Yes. Okay. No, I understand. Just on the consumer businesses, and obviously, you both gave a bit of color on that and the impairments in that. I mean, I guess that sort of businesses and actually that there are points in time where they sort of have contributed positively. But if you sort of look through the cycle, these aren't the first impairments we've sort of seen in some of these consumer businesses. I guess a couple of things. Just -- but I know I haven't had a look at the detail, but that $160 million of impairment, what is that sort of relative to the value those businesses have been held at firstly? And then in terms of as you do reviews like you have and come in to a value on them, has it given you reason to sort of think about long-term ownership of them at all?

So I'll let Chris respond to the first part in terms of the impairment versus the current holding value. But like all these things, we are making the best use of the capital as an ongoing conversation, and it's something that is right in our [ crossers ]. So we'll continue to evaluate all assets, not just the ones performing as we've seen the impairments on, but it's certainly a way that we look at the business on an ongoing basis now.

And in terms of the impairments, they're at around about the 15% to 20% level.

Okay. No, great. That's all for me. And yes, I mean well done on such strong results.

Our next question comes from the line of Nick Mar, Macquarie.

Just in terms of Australia, obviously, reasonably good result there. Are there any other thoughts about whether or not you'd be opened to discussion about sort of divesting that business in part or some other kind of structure around it?

No, it's not a lot up for discussion. I mean other than the comment I made to Arie there that, of course, we should be looking at all our assets at any given time. But no, we are comfortable with our [ hard ] call on Australia. And we've actually got to sell them to a pretty solid position there certainly around our cheese category, which is going from strength to strength for us. So pleased with how the business is performing.

Great. And then just at a sort of high level, some sort of data showing that average cost of farmers is sort of north of $7 a kilo now. How do you think about that in the context of where long-term prices are and sort of how sustainable the cost structure of farms and, therefore, your ability to sort of pay for milk and make a profit while they're sort of operational in a good way, sort of all put together?

Yes. So firstly, I mean, $7 has probably been -- it's an old number now to speak by the time. Some of the bit rolls over for some farmers [indiscernible]. But that aside, clearly, it's something that we're mindful of will drive the revenue line and the OpEx line to try and give a decent return back, whether it be through nonmilk price products or, of course, milk price, the best we can. Farm Source is the other area where we try and remove cost and complexity for our farmers through our retail offering to try and use our scale to give them sort of on-farm cost advantage. But there is an element of the market is the market as well. And while we're certainly cognizant of the significant increase in costs the farmers happen to be, it's not something we have a huge influence over, as I say, apart from a few inputs that we can support them when possible.

And I guess what would it take for you to have to take a view that the farmers need support outside of the milk price and the dividend? Obviously, it was quite some years ago, and it was sort of in an exceptional circumstance where they were -- farmer support, let me just that put in. Can you roll out having to do that again given farmers have been through quite a few good years? Or is it sort of something that you'll always be open to fixing the balance sheet to support farmers?

Yes. I mean it's not something that's part of [indiscernible] at this point. We get the farmer [indiscernible] from a cash flow perspective. But I think the results we've put out today should be relatively well received, I think, across [ farmers ]. It's not -- [ they're sitting ] in our agenda to think about supporting [ millions of ] farmers at the moment.

At this time, I would like to hand back to management for closing remarks.

Thank you very much for your time today and your questions. Of course, the team are on hand to answer any follow-up questions if you need more detail. But again, thanks for your support, and we'll be in touch soon.