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

Good day, and thank you for standing by. Welcome to Fonterra 2024 Interim Results Investor Briefing Conference Call. [Operator Instructions] Again -- advice that today's meeting is being recorded. I would now like to hand the conference over to your first speaker today, CEO, Miles Hurrell. Please go ahead.

Good afternoon, and thank you for joining. As mentioned, Miles Hurrell here, CEO; joined by Simon Till, acting CFO; and Selena Robb, Director of Capital Markets and M&A. Hopefully, by now, you have had a chance to see the results, maybe the briefing video that we've put out earlier this morning. But in summary, a strong first half, lifted performance, lifted earnings across the organization. Profit after tax up 23% to $674 million; and earnings per share, $0.40, up from $0.33 last year. And of course, it's given the Board the confidence to give an interim dividend of $0.15. So I'm really pleased with the performance and how the organization is tracking. I'm happy to go straight to Q&A. Thank you.

[Operator Instructions] Our first question comes from Joshua Dale of Craigs Investment Partners.

Just first question. Of the EPS from continuing operations figure of $0.43, how much of that was stream returns?

Josh, Simon here. So look at that for the half year, it's around $0.06.

Okay. Brilliant. And you mentioned on Slide 11, your cheddar prices have adjusted down reflecting expectation of higher production volumes in the U.S. Do you have a read on how permanent you think that supply response is? And whether the stream return opportunity is now diminished medium term? Or do you still think you might get good periods you can capitalize on?

Yes. I mean, it's -- so I guess, how long the piece [indiscernible] if I can be honest. We are predicting this back to the long-term averages or long-term, long-running averages around our stream returns for the foreseeable future. So there'll always be pockets where it may be up or down. But we are planning for long-run averages back on the stream return basis.

Okay. Brilliant. And I guess it ties into my next question. I was a little surprised not to see any update to your long-term aspirations. Are you still comfortable with what you issued in 2021? Just regards -- with regards to your forecasting to 2030? What target...

Yes, sure. So in terms of the targets we put out there a couple of years ago, 2.5 years ago now, they are still -- remain valid. And of course, we'll be obliged to update the market should they change. So we see no change to that. And not at this point anticipating putting out anything regarding an update to that until we see change.

Our next question comes from Matt Montgomerie of Forsyth Barr.

Well done on another solid result. Just taking on from Josh. Could you just please comment on what you are factoring in for the full year with respect to stream returns? And I guess how locked in are the rates that you have outlined in one of your charts in the pack around the trajectory through the second half?

Yes. Josh -- I'm sorry, Matt, Simon here. If we look at the full year, the underlying assumption is that they will probably sort of trend closer to 0. So we are -- if you look at the outlook slide there, you can see them narrowing up. So by the full year, we expect that to be pretty close to 0.

And then how -- like how contracted are those? Like if you were to see the next few options move materially as, I suppose, Wednesday night's one did a little bit, what's, I guess, the ability to swing around that?

At this stage, there's still a degree of variability. So hence, why that's one of the factors that go into the, I guess, the relatively widest range still at this time of the year. But in terms of contracted, that's in line with where we would be at this time of year. But yes, I think a few more before we sort of tighten that [indiscernible]

Yes. Perfect. And then maybe just on OpEx. There's a comment in the announcement around cost reductions coming through. Could you please expand on, I guess, where you see scope for cost reductions within the business? And then secondly, just talk to the scale efficiencies on merging the Australia on Fonterra brands that you announced a month or so ago.

Yes. So you've sort of hit the nail on the head in terms of that. That's one of the efficiencies that we're looking at and that we'll be looking at those things right across the organization. But I think we announced $7 million, I think, for second half in terms of the Australian efficiencies. So call that the efficiency gains that we'd like to see through the merger of those 2 organizations. Where we'd like to see -- where we plan to see a lot of the efficiency gains come over the next sort of call it, 4, 5, 6 years, a lot of it will be in our operations through technology, automation, simplification of our operations. So there's an upfront investment on that, and you'll see that show out in our OpEx slide that we talk to today. Part of it is an upfront investment around some of the technology that we need to invest in to enable that. That's one. I mean, the intention is to look at our entire organization to assume we're fit for purpose, but a large chunk will come through operational efficiencies as well.

And that upfront investment, is that -- you're going to continue in the second half, like I think it was $30-odd million in the first half?

Yes, it will. Yes.

Okay. I suppose, next question is just more broadly, it sort of feels like the base business is improving here when we take, I suppose, the cost comments in combination with stream returns. Yes. Would you be able to steer us where you think maybe base EPS feels right now in light of, I guess, the change you're seeing in the business, $0.40, $0.45 or similar, would be my feeling, but...

Yes. I think maybe the best way to answer that is the earlier comment on the LTA. If you look at that sort of trajectory over there, I think that's -- obviously, as we've always said, there will be some pluses and minuses year-on-year, but I think those ranges are still the best guidance that we would offer on that.

Our next question comes from Arie Dekker of Jarden.

Yes, there's a comment just in the press release around a strong pipeline of farmers wanting to join the Co-op, which is obviously positive, going against the flow, I guess, over the last wee while. I mean, could you just sort of -- what are your expectations, I guess, for the next season? Are we going to see a reasonably meaningful jump in the number of farmers? Or is it going to be over the next -- is your expectation that it will look over the next couple of years?

Yes. Arie, Miles. It's more over the next couple of years. I mean, some of our competitors have a contracting period of a couple of years plus a day. So we are seeing a strong indication of them wanting to join, but a lot of them will come in the year following. I guess if your follow-on question is how we look for capacity. We have no concerns at a national level at all. We have no concerns around capacity to cater for that milk that may return. Of course, recognizing there is also a bit of land use change coming off the back end as farmers exit the industry. So there's a bit of -- there's a net-net position here. But despite, when we look through that, we see no concerns at a capacity level with what we have. There may be a little bit of shuffling milk between reads, which is normal for us, but we feel comfortable at this point.

Yes, I was going to ask about the capacity. And then I guess more specifically, I mean, do you have good capacity sort of around Dunsandel and Pokeno?

So North Island is certainly not a concern for us. We feel very comfortable in North Island. South Island, there will be a bit of pressure around that Dunsandel, as you refer. But as we've done previously, you can just simply shuffle milk further North or South. And if we've got to go across the Cook Strait, that's what we'll do.

Okay. No, that's good and obviously, really encouraging. Just on the CapEx, I mean, it was -- wasn't particularly high in the first half against sort of expectations for the full year. Should we expect it to be a bit a bit below what you'd earlier guided to for FY '24? And is that just timing sort of related?

Arie, Simon here. I think that's the right sort of conclusion, but I guess just a couple of comments in terms of half year is not always the best indicator just because of a lot of it does happen towards the latter part of the year. But I think overall, if we look at the number that was at full year, we do expect that to be back a bit. And some of that will be timing, and some of it clearly on some of them, their estimates. And as you work through them, clearly a key part of our whole efficiency is making sure we're getting best value there. So -- but a combination of timing and maybe just better outcomes.

Yes. Okay. No, that's good. Well, great result, and that was all for me.

Yes, thanks. Arie, just maybe before you go, maybe just probably one other point to call out here as we sort of went into that LTA going back a couple of years. Of course, the change in accounting rules around software has changed probably that a little bit. So there might be more of an uptick in OpEx and a down -- and pulling back of CapEx, when I look at that sort of plan between the 2. Net-net, it's still cash, but maybe that's playing out a little bit as well. It's not material at this point, but it's probably worth just calling out.

Our next question comes from Nick Mar of Macquarie.

Just on the guidance range that implies that the second half. Can you just talk about what the swing factors are for [ milk ]? I guess what you're most concerned about the [ sort of still keep their ] bottom of the range, which would imply a [indiscernible] low earnings for the [ second half ]?

Nick, Simon here. Sorry, I think I got most of it. It was a bit hard to hear. But in terms of the -- so firstly, that's the continuing operations. So that's the $0.50 to $0.65 you're referring to. So I think there are 2 or 3 factors. The first one is there's always a seasonal element. So just in terms of timing of ingredients, revenue versus cost. So that's always a factor that plays through between H1 and H2. And touched briefly on the stream returns price relativities in terms of the -- what we're assuming there. I think the other couple of areas are if we look at the first half performance and you clearly can break back Q1, Q2, we -- and if we look at the chart Miles referred to with the milk price profile, we are going to see increasing COGS in that second half. And there is -- built into that forecast some tightening of margins in the Foodservice and Consumer. And so I guess in terms of variance, if we're able to continue to have the really good pricing outcomes that we've had in the first half, then you could maybe expect some upside on that. But at the moment, we have assumed some tightening of margin over the second half and maybe Q3 more in line with Q2 and then a bit more tight in Q4.

Yes. So at the bottom of the range which would be sort of [indiscernible] in the second half. So I guess it's just as all of those things going against you, so the stream return gets worse...

Pretty much.

More than you expect here.

Yes.

Now apologies...

That would be the cumulative of those, yes.

Yes. That's great. And then just on sort of [ a round ] question, but you might have mentioned that living anywhere in the document. What's the sort of thinking behind that? Is that still a priority for you guys?

Sorry, just...

Living model?

Yes, I couldn't quite hear that one.

Yes, you know this. It's a long strategy for us and still an important part of our portfolio. So you sort of...

Okay. No, that's great. And then just in terms of feedback you're getting from your farmers. The milk costs obviously come back up, which is positive. How are they feeling about the season and on profitability? Is it a breakeven again?

Yes. So a lot more positivity in farmer sentiment. And while I haven't seen the numbers from [ bearings ] here of late, I suspect $7.80 is getting very close to, if not probably slightly above, the sort of the breakeven from the vast majority of farmers. So that's giving some confidence. Obviously, we need to see where the next season goes to give them some long-term confidence. But at the same time, they're feeling good, but also the change in advance rates we made today by increasing the advance rate over the next 2 or 3 months, it's also gone down very well with them.

Our next question comes from Marcus Curley of UBS.

Just a couple from me. In the presentation, there's, I suppose, a bullet point explanation around the margin pressure within ingredients in the half. The first one there is around the lactose price and then you've got effectively a volume mix issue. I just wondered if you could sort of call out the relative scale of these? Obviously, the change in the margin in the Ingredients business in the first half was pretty dramatic. I just -- so can you sort of get a little bit more color in terms of those components?

Marcus, yes, in terms of -- if we look at those total returns by stream, there's a minimal impact at the revenue level, which is probably what you're tracing through. So most of it is coming at the margin. So there are sort of the 3 factors there, and you mentioned a couple of them. One is also kind of the allocation intra-season between the milk, so how that gets allocated with the different components. So I would sort of say it splits between those 3 factors reasonably evenly.

Okay. I just -- I suppose, having covered this stock for a while, yes, it's the first time I've ever seen lactose price called out as a material impact on ingredients margins.

Yes. And the -- I mean, the -- you're right, mainly because the -- it's a factor, as you know, because the -- how that's assumed in the milk price versus the actual is a factor, and the price there is halved between the periods. So the USD 1,500 down to USD 700. So just, I guess, calling that out because it's more of a factor than it historically has been period-on-period.

And so within the Ingredients business, do you have to hand what the average milk price was that was used in the calculation?

You mean for the half?

Half, yes.

Yes. So it's around -- I can give you the exact one, but it's around sort of the $7.30 or $7.40 range.

Okay. And then I suppose the opposite is true in the Foodservice and Consumer business, where obviously you benefited from a lower milk price. From memory, there's a 3-month lag in there. I just wondered if you could also call out what the average milk price was baked into those Foodservice and Consumer margins?

I don't have these. I'll have to get Phil maybe to come back to you on those. But I think the -- I guess the key point you're saying is that there was both. I think there were 2 things going on in both of those Consumer and Foodservice. One was the lower COGS that you're referring to and obviously, the price. So I mean the margin, both of those were driving in, I guess, similar measure. But yes, if you -- I'm just trying to think what -- exactly what are you trying to get though from there in terms of the average input cost?

I know I just found it a little intriguing that you had I suppose the margin pressure in the Ingredients business because of the milk cost going up. But you had margin benefits in the Consumer business from a lower milk price. So obviously, there's some timing issues and composition issues. But it just would be useful to get what milk price went into both parts of the business. I know that there's timing differences, but it will be interesting to know how [indiscernible]

Yes. I guess, Marcus, just to be clear, it was largely the -- it's the relativity rather than the absolute on the stream. But yes, the total milk cost will be similar between the 2, but that's the period-on-period. I think the streams is different from the margin and the Consumer and Foodservice.

Yes. And probably maybe a little more [indiscernible], you've got COGS. Reduced COGS year-on-year has played a part. But the delta year-on-year, if we look at consumer as an example, it's not simply a COGS game. It's -- there's a whole lot of factors that have gone there. COGS has played a part, but certainly not the whole story.

And so -- and that, sorry, just leads on to my other question, which was in the guidance you're referring to sort of moving back to average margins in Foodservice and Consumer. Outside of milk costs, is there anything else that's working against you to get you down to those types of levels in the second half?

No. I think that's going to be the key driver there.

Okay. And your competitors in foodservice in China being mainly the Europeans, how is that playing out at the moment? They're obviously absorbing a higher milk cost than you guys at the moment.

Yes, which is why we've been able to gain a bit of share on the way through, share and higher margin.

Okay. Okay. And -- but your working assumption is pricing and market share broadly stable in the second half and you were higher milk costs and margins come down?

Yes.

Okay. And then just one small one for me. Just for the dividend in the half, obviously, you're expecting a smaller second half profit. But can you give us any color in terms of what sort of circa payout you're thinking about? Or what was your thought about at the Board level when you set the dividend $0.15?

A key component was, I guess, the strength of our balance sheet and the fact we're doing it in the first half. So a policy of 40% to 60% of NPAT at year-end still remains. But as you've seen for the last 2 or 3 years, given the strength of our balance sheet, we've pushed the boundaries on that. So certainly no color or no -- in fact, no conversation around where full year would land, but certainly confidence around the half.

Our next question comes from Mark Topy of Select Equities.

Sorry. Hello, can hear me?

Yes.

Just first question, just as a follow-on, just you read on some of those key global markets, particularly China, with the softness in demand and perhaps some suggestion they've worked through excess inventory levels they were holding. Can you give us some commentary around perhaps how you see the commodity pricing in the second half? And do you see stabilizing around these sorts of levels? Or what do you see as a potential there?

Yes. So I mean -- so the response we'll give you is very much a milk price question just so we're clear because the rest of our business in China are outside of, let's say, the milk price, and forming products is actually going very well. But we haven't seen China return to the demand levels that they have been previously. We would have liked to have seen them back by now. We are starting to see them work through that inventory overhang that we talked about last year, but we certainly haven't seen the demand rebound to the levels that we had. The futures have obviously come back. Next year's futures have come back a little bit from where they were, which suggests this may linger longer, but we won't be in a position to talk about our opening position for the '25 season until May, but we'll watch that closely. But as I say, it's very much a GDT/milk price question because outside of that, the rest of our businesses is actually going very, very well in China.

Right. Yes, because you do allude to demand sort of fluctuating a little bit. What's your sort of read on the global demand at the moment, putting aside China?

Yes, it is a little bit volatile. We've had a pretty good half from the likes of the Middle East, Africa reemergence there. A stronger oil price obviously plays a part, which was -- we've been the beneficiary of. And while we've got some concerns around the Red Sea and Suez Canal, that's actually supported our position also from a milk price perspective as we're able to get product into the Middle East versus the Europeans that have had the restrictions. So we're watching those things closely. There's obviously a few unders and overs through that. But fair to say there's a few uncertainties as we look out into the international market over the next sort of 12 months or so, but nothing that would keep us awake any more than what we've done previously, given our exposure to the international trading environment.

Very good. And just on retail pricing, perhaps in New Zealand and with the context in Australia. We're seeing prices starting to moderate here and maybe you can come back a bit, but I'm just wondering how you see that price increase cycle and the consumers wanting this to where any sort of further price increases in New Zealand, particularly.

Yes, it's probably not appropriate for us to comment on the retail segment here. The retail will make that call. We have obviously seen a little bit of trading down in the last 12 months or so as the cost of living crisis sort of [ bits ] in both markets. But generally that's where your brand positioning plays its part, and that's actually done us very well as you'll see from the results.

Right. And just if you could expand on that Australia, New Zealand merger, the Oceanic creation of business. The references to products integrity, does it suggest that you'll be able to perhaps ship some products into Australia with Farmgate Milk in Australia versus New Zealand? Or do you see the business or structure continuing the way it is at the moment in terms of New Zealand versus Australia?

We've actually always done that. I could be [ staying ] [indiscernible], but I think that all the mainland cheese in Australia has always been New Zealand cheese. So that hasn't changed. And the merger of our 2 organizations don't change in that regard. Where we see efficiency gains through that merger is [indiscernible] organizations. And can we -- given they're very, very similar markets from a consumer perspective, is there anything we can remove. And so that's where we're going to be focusing. But we've always seen product across irrespective of the market price, and both -- and the milk price, rather, in both those markets. And I don't see that changing any time soon.

Yes, I should have been clear there, of course, but so no increase? You don't see potential to increase the product that you're sending into Australia? [indiscernible]

There could be. And this year has -- there's said to be more product in recent times than it has done previously, but it's not an active part of our strategy to be looking at that. We'll just work with the milk prices that we have in each of those markets.

Thank you. I see no further -- my apologies. Our next question comes from Marcus Curley of UBS.

Sorry, guys, just one follow-up. Just on that, Miles. Obviously, in the pack, you talk about, in the Ingredients part, you have put pressure on the Australian margins. I would assume that, that's the export business struggling against the higher milk price? And if that's the right interpretation, is there any consideration for sort of reducing your exposure to the export parts of the business in Australia?

So it is the right assumption that it is regarding the international market prices is below the domestic price in Australia, so that's where our exposure lies. Clearly, we try and limit that as much as we possibly can. But product mix plays a part. Plant capacity plays a part. So to the extent you can, we'll remove that risk. But I guess, in simple terms, Australia is a fat market. They are strong consumers of butter in the Australian market, which leaves you a little bit of a commodity skin that's got to go somewhere. So you are at the whim, unfortunately, of the international market. But I'm not sure how that gets reflected in the year ahead because it's been a tough environment for all the dairy industry in that market in the last year or so.

Thank you. I will now hand back for closing remarks.

Right. Well, thank you very much for your time and the questions. Of course, the Investor Relations team are available at any time to -- for follow up questions. And I wish you a good day. Thank you.

Thank you.

Thank you. This concludes today's conference call. Thank you all for participating...