Fitch downgrades Fonterra's rating outlook due to debt concerns

Fonterra's credit rating has been downgraded as risks and debt rise. Picture / Kenny Rodger

Credit rating agency Fitch Ratings today revised down its rating outlook on Fonterra due to concern about the dairy giant co-operative's rising debt and its risk profile.

"The Negative Outlook reflects Fitch's views on two evolving features of Fonterra's business risk profile and the company's elevated leverage position at fiscal year-end 2006," the agency said.

Fonterra's AA-minus rating reflected maintenance of its position as a near-monopoly for New Zealand milk production, and its status as the country's leading dairy exporter.

Fitch said changes to Fonterra's business risk profile had seen the gradual increase in milk sourced from third party suppliers and the growing proportion of downstream, value-add businesses to its total business activities.

"Fitch believes this is likely to weaken its financial flexibility as the proportion of milk production benefiting from subordination will continue to decline."

It said Fonterra's two key underlying strengths were its ability to set milk prices in New Zealand (its near-monopoly position) and its low-cost producer status,

"Historically, around 80 to 95 per cent of the company's total milk supply requirements have been provided by shareholders and this has afforded Fonterra significant financial flexibility through its ability to subordinate payments to shareholders in favour of unsecured creditors," said Fitch associate director Neil Johnson.

"However, since fiscal 2002, for example, the trend for dairy ingredients manufactured in New Zealand, as a percentage of total ingredients sales volumes, has been declining, albeit gradually.

"With Fonterra's growth and associated supply requirements gradually moving beyond local supply capacity, Fitch expects that the trend of increased supply from third parties will remain an ongoing feature of the business."

Mr Johnson said Fonterra's spending on position-building acquisitions, critical capex projects and higher working capital requirements had seen Fonterra's net debt rise to $5.63 billion.

That had pushed its gearing ratio (net debt to net debt plus equity) to 52 per cent above its target 45 to 50 per cent.

That was only nominally higher than that in 2002, Fonterra's initial year of operation.

Fitch expected debt to return to the upper end of its target range as capital spending requirements ease.

"That said, Fonterra's rating may come under pressure should the present degree of leverage become a more permanent feature of its financial profile," said Mr Johnson.

"Although Fonterra's investment activities pose the prospect of reducing the group's overall financial flexibility (because a decreasing proportion of payments are subordinated farmer payments), related debt remains at the holding company level.

"Therefore, bondholders continue to benefit from the subordination of milk payments to farmers, which are made from the holding company. The same holds true for any debt benefiting from holding company support.

"Creditors to Fonterra's associates continue to only have recourse to those associates and do not benefit from the subordination arrangement."

- NZPA

* An earlier version of this story incorrectly said Fonterra's credit rating had fallen.