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Dairy Equity says it has invested nearly half of its capital in deals to buy Fonterra shares, a major advance for the only scheme offering public exposure to the dairy giant's equity.
Dairy Equity now owns or has commitments to buy $21 million in Fonterra shares, nearly half of the scheme's $46.1 million in paid capital, according to chairman Peter Jensen.
This is a step up from the $9.1 million in "swap" deals it said it had secured as recently as June 20.
Under those agreements, Dairy Equity gets the value-added component of the milk price and any rise in share price - but both of these are under pressure as soaring commodity prices sap the profitability of Fonterra's value-added businesses.
Fonterra's fair value share price is forecast to rise from $6.56 to $6.79, 20c below the independent valuer's midpoint range of $6.99.
And while its payout is forecast to hit $5.53 per kilogram of milk solids for the 2007/08 season, the value-added component is expected to slip from 51c last season to 20c.
Jensen said he believed the dip in the value-added component would only be a short-term consequence of lower margins in Fonterra's ingredients business, which could bounce back if the dairy giant kept cutting costs and realised other growth opportunities.
And the projected decline in yield for the next year offered Dairy Equity a "unique window of opportunity" to acquire Fonterra shares from farmers, Jensen said.
"Rather than reduce our offer price for Fonterra shares, withdraw from the market for the short term or even return capital to investors ... the directors have decided to take full advantage of the current situation to acquire Fonterra shares at the current fair value share price."
He said the drop in yield gave farmers more incentive to sell to Dairy Equity than previously.
"In the directors' view, the current environment provides the first realistic chance to fully invest its paid capital in fair value shares."
However, Jensen was disappointed Dairy Equity's shares were trading at a "significant discount to asset backing", but was confident that discount would reduce as the company became more fully invested in fair value shares. He said the company would consider buying its own shares to remedy this situation. Dairy Equity closed at 42c yesterday.
However before calling in the next 50c on Dairy Equity's part-paid shares, Jensen said the decline in yield would mean the directors would need to review whether to keep investing in swap agreements.
"We'll pause at that stage - which is probably three or four months out - and probably consult with the market and our major shareholders before we ask for the rest of the money."
Given Dairy Equity's slower-than-expected acquisition of Fonterra shares since its initial public offering and the fact shareholders would be "adversely affected" by Fonterra's projected low yield, Jensen said the company should halve its base management fee until it decided to call in unpaid capital.
