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

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

Thank you, and good afternoon, everybody. Thank you for joining us this afternoon. I'm joined by Selena and Phil from the Investor Relations team; and Andrew Murray, our new CFO, who I know a number of you will meet over the coming days. Hopefully, by now, you've had a chance to review the detail that we provided through the NZX this morning to give an overview of where we landed. But overall, very pleasing to see that the Co-operative has again delivered on our promises and have been -- put ourselves in a very strong position from a balance sheet perspective to go forward. I'd now like to just open straight away for questions. We can answer anything that you have on top of your mind and go from there. So thank you.

[Operator Instructions] Your first question comes from Nick Mar from Macquarie.

Just in terms of the guidance, obviously, the fourth quarter margins in Foodservice and Consumer were impacted by rising cost of milk, which will continue into FY '25 given the milk price outlook. Can you just talk through what gives you confidence that you can deliver sort of stable to slightly growing earnings across the Foodservice and Consumer channels in FY '25?

Nick, Miles here. So as we sort of talked previously, when you see sort of quite a quick move up in the milk price, certainly in the Consumer and Foodservice space, it's hard to pass on those price increases given we sort of run a sort of a quarterly contract a lot of the times in that area. So you'll see that those margins sort of strengthen again as we go into the quarter 1 period from what we ended in quarter 4. So that gives us the confidence into the future that we can pass on those milk price increases that we've seen.

That's good. And is a lot of that pricing already sort of put through into the market and has stuck accordingly?

Yes. I mean there are various markets at various rates of change and the pace in which you can put it through, of course, governed very much by what the competition play and how they operate. But overall, we're pleased with how the pricing is landing in our key markets.

That's great. And then some of these sort of growth projects that you've announced, the 3 of them, obviously, interesting projects. And you're sort of pretty excited about them. What kind of incremental return on capital are you looking for across that spend sort of against the 11.3% you delivered this year?

Yes. So we haven't specifically talked about the return on capital by project. But I think hopefully, what you've seen in the LTA we put out 3 years ago or so now and sort of where we're going, we do have very strict hurdle rates that we must achieve within the business before a business case even gets to leadership level. So take from that, that these are value accretive. Certainly, the 2 in Studholme and the UHT. [ Whareroa ] is slightly different in that we've got an aging asset down there that needed some work on. So there's some capital to be saved, put in a new investment but also some operating costs as we look to reduce our reliance on third party into the future. So there's a combination of both return but also efficiencies through [ Whareroa ] warehouse. But certainly, the UHT and the Studholme, you should take as very much value accretive and right in line with where we're heading as an organization.

That's great. And then on the IT spend, sort of really helpful you're starting to split out that spend with the digital transformation. We've had some discussions about what it looks like in FY '25, which is quite a material step-up. Can you just talk about the sort of duration and profile from here of that spend and whether or not you expect to get some return on that investment to some degree through cost savings or betterment of the systems?

Yes. So the cost side of it sort of peaks through '25, but it goes on sort of a year or 18 months sort of beyond that. But certainly, F '25, we'll see the peak of that spend. There are efficiency gains to be had by the implementation, but also ERP system was at the end of its useful life. And so it was almost a necessity to spend some money on that as well as the digital transformation side.

That's great. And then last one for me. On the tax changes, can you just talk about what the effective tax rate will be going forward for the business taking account the sort of offshore earnings piece that will be coming through as well?

So we would expect -- if we look at that with the combination of the offshore earnings, we'll probably sit around 25%, there or thereabouts.

Yes. And therefore, what percentage do you expect to be able to impute the dividend as a combination of New Zealand...

Yes, we expect it to be 100% imputed.

Your next question comes from Arie Dekker from Jarden.

Just the first question was just in relation to the in-scope businesses, just under $300 million of EBIT for FY '24 and well up on the PCP. You have made reference to your expectations for improved margins in Consumer, and they obviously dominate those in-scope businesses. But yes, is there any additional color you can give in terms of within your guidance, what you're expecting the in-scope businesses to deliver in terms of EBIT in FY '25?

No, we haven't broken that out for the look forward, Arie. But you'll see sort of where the return on capital sort of numbers landed for F '24, of which Consumer was one of the stronger performances we have from Consumer for quite some time. So we'd expect that trajectory to continue, I guess, into F '25, if I can give you that sort of indication.

Sure. Great. That's good. And then just in terms of capital investment, other capital invested of $106 million in the notes. I see the fund investment or Ki Tua, I think it is, sort of up to $61 million. Could you just talk a little bit about where the investment is sort of being targeted there? And I see that sort of stepped up from '23 to '24. Are you expecting to continue to sort of increase the investment intensity in Ki Tua into '25 and '26?

So the simple answer to that is we're not entirely sure at this point, Arie. And the reason I say that is that we'll look at each of these initiatives in its own merit. But we're -- for us, it's around sort of looking at that next horizon innovation and how do we partner with companies that may be starting to look at that next phase of innovation that complements what we do around our specialty proteins in particular. And so while we've sort of wrapped it up under the Ki Tua framework, which brings about a tighter governance structure that we've bought to it, we've sort of been running these for a few years now on and off. And you may remember our investment in [ WiFoods ] sort of '18, '19 or thereabouts, food spring, similar time lines. We got dragged along in those sales processes, which as a minor shareholder, you don't have a lot of choice. But they were very successful for us, if you could say that. But those sort of investments, as we look to how do we complement what we do here in New Zealand with theory and bring it into sort of that next horizon, so that's sort of what we're looking at in the investments in the Ki Tua space but tightly governed by both the leadership here but also some external Board members that sit on that Ki Tua fund as well.

Yes. And then I mean I guess, the nature of your investment and minority stakes can have positives as well in the venture space and those governance arrangements you sort of talked about. Like does that include really clear sort of hurdles? And is there a preparedness to -- if they're not meeting your expectations to just sort of step away and not fund follow-ons rather than just sort of stay the course? Any examples of that yet?

Yes. No, not yet. 100% of that is the way we'd be operating in the space. So getting in at the right time and out at the right times from the game here. But each of these initiatives will be measured on their own merits. Probably just for clarity, while there's some capital going into these areas and our forecast going forward, we have assumed no earnings at this point. So just to be clear on that as well in our forecast.

That's great. On to the next one, just the dividend, and I see that you clearly highlighted a special dividend. I mean if I look at the balance sheet, it's well below in terms of gearing where you expect it to be when you presented the LTA 3 years ago. Should we sort of expect to see the payout ratio increase given your increased confidence in your ability to fund the sustainability and growth investment versus where you were 3 years ago?

Let's just say that's always a topic of conversation. So you're in the right space, Arie, that we need to continue to focus on that because we are in a very luxurious position compared to where we've been clearly. But we do have that significant capital plan coming up, mainly around decarbonization and water in particular. But it does start asking the question around our dividend policy into the future. So we'll continue to work on that.

Yes. And then just the last one for me. And I imagine just given the significance of the consumer noncore review that it's not on the immediate horizon. But is buyback still something that is sort of in the arsenal for the Co-op when it's looking at allocating its capital?

Yes. So the capital allocation framework, which was sort of launched last year, certainly has a buyback as one of the options. And as you allude, very unlikely we'd be wanting to get involved in one of those given the work we're doing around our Consumer, but certainly to be an option post that, whether that's a sale or no sale, we'll certainly be putting that back on as an option to think about.

Great. Great result.

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

I just wonder if we could start with the Ingredients business. Miles, I just wonder if you could talk to what are you assuming. What was the benefit from stream returns in your calculations in the result? How are you thinking about those into the guidance of '25?

Yes. I might ask Phil to take you through a couple of the key points as we look to sort of the outlook. Clearly, we've come back in '23, '24 season from that record high and -- but certainly not back to the, I guess, the normalization level that we've seen. So there is a step-up from where we've seen, and we are holding some decent spread between the 2. But maybe, Phil, if you want to give a bit of detail.

Yes, thank you. So Marcus, I think when you think about last year, as Miles alluded, there was obviously a good $0.39. So we're talking about the $0.39, $0.40 coming through in price relativity benefits. This year, it's around the $0.12 EPS, if you want to think about in terms of the core operations and the impact it took on its margin. And then if you think forward -- play that forward, the -- relatively said, Ingredients is going to be stable in terms of outlook. The [ piece ] there to watch, I guess, as you can see that those lactose prices are going up, which is when you think about the Co-op and earnings versus milk price, that is favorable. But we are also still seeing those price relativities narrow, which is the offset. So that's where we did to our position on being stable year-on-year.

Could you call out what lactose price assumption is baked in the '25 at this stage?

No, we don't give out commodity price forecasting.

Okay. If -- can we just talk about operating cost for a second? So just one point of clarification. Have you called out the total amount for the IT transformation spend in FY '25?

Yes. I think we do...

What we'd say, Marcus, there is -- if you think about your $0.70, that earnings this year and in the -- if you want to pick your midpoint for FY '25 in terms of that, we've called out the 2 main drivers. Obviously, the tax change that we have and then also the IT spend is the other half. So in terms of that $0.10 of the change year-on-year, we haven't called out the full spend.

Okay. And what's the risk in relation to changing those systems over or upgrading those systems?

I guess no more than any other sort of business initiative we take on. It's a very well-governed piece of work, and we were sort of, I guess, 8 months sort of into it now and very pleased with how it's progressing. It's not a [ bit ], if I can say that, in terms of our ERP transformation. We'll be picking markets and factories to transition over time. So that also sort of eliminates some of the risks. But I don't see it as any more risky than anything else to be sort of lean into, but it's certainly something that we're keeping an eye on.

Miles, is that an upgrade of an existing system or a brand-new system?

It's an upgrade. So we're running AAP in our main ERP system. So it's an upgrade of our SAP system, and then on top of that, adding some digital functionality into our supply chain.

And then -- sorry, just talking about operating costs, excluding IT transformation, can you give us any color in terms of what sort of cost pressure you think is going to be in the business? Obviously, you've been sort of streamlining staff. How are you thinking about the overall OpEx budget in '25?

Yes. So if we take a look at '25, I mean, obviously, as we continue to push more into Foodservice and the Consumer channels, that does increase our OpEx as we sort of favor those channels. But we have a number of initiatives, which are aimed at actually offsetting the impact of inflation through the rest of the -- yes, just basically through the rest of the business. So we're feeling actually quite comfortable that we can maintain a good level of OpEx but with the investment in IT and digital being the outlier.

Okay. And then finally for me, I just wondered if you could talk anything about -- it sounds like you're about to make an announcement next week with regard to the sale of the Consumer business. Is that the right interpretation of what's been said today?

No, no, sorry. So next week, we'll announce -- Monday, we'll announce our strategy or an updated strategy. But at the same time, you should recognize that sort of some of the announcements we've made recently re Studholme and UHT Cream and Edendale is sort of in line with where we're heading. So it's a reinforcement of sort of where our current trajectory around our B2B business, but we were making no further updates on the consumer business until certainly later in the year.

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

Okay. Is that a new question, Marcus, that just popped up on my screen? It is a new question. Go for it.

I just wondered if you talk a little bit about the China volume outlook. So obviously, we're hearing, I suppose, pretty subdued messages out of the China Consumer at the moment. What -- specifically, what are you seeing at the moment in terms of Foodservice demand? And do you think there's scope for any substantive growth in volume sales there heading into '25?

Yes. We are predicting still some growth in that market. So despite the '24 season or even the '24 calendar year-to-date, that market being a sluggish at a macro level, we're still seeing great growth that's come through in our Foodservice business, which I think plays to the importance of the New Zealand provenance, the innovation, the sort of our shift-led sales model that we operate. So we're still predicting that to continue into '25. We're comfortable with that. Where we've seen the hit in the last couple of years clearly is around the milk price given the sluggish demand on the back of increased milk. So we're starting to see milk decline or come off of those highs in China. And that's been a key driver of that upgrade of the milk price to $9 today as well.

Okay. And while I've got you, any views on the level of milk production growth this year? It looks -- obviously, the season is off to an okay start. Is it a year where you could actually see some reasonable growth?

I would like to think there is. We haven't had a great spring for a while, actually. So yes, it's a fantastic start across the country, but it's far too early to sort of talk long term, full year. We sort of like to get a bit closer to Christmas and what the sort of the weather patterns look over the early part of summer before we make any predictions on our forecast for the year. But certainly, we'd like to see a bit more milk than what we've had previously, and so far, this year has started well, as you say. Okay. If there are no further questions, again, thanks for your time. The Investor Relations team is, of course, available at any time if you have any follow-ups. But again, thank you for listening and also your ongoing support of the Co-op. Thank you.