Fonterra debt costs to rise after S & P downgrade

Chief financial officer Lukas Paravicini said the co-op's underlying financial strength and credit quality remained strong. Photo / Jason Oxenham

Standard and Poor's has downgraded Fonterra's credit rating from 'A' to 'A minus', reflecting the agency's concerns about the co-operative's dairy giant's debt levels.

The move, which comes after Fonterra was placed on negative "creditwatch" by S&P in August, means Fonterra will face higher borrowing costs.

The downgrade reflected S&P's view that Fonterra's risk profile had weakened in the past two year, as the company's peak capital expenditure and a sizeable debt funded acquisition - the purchase of a stake in China's Beingmate - coincided with a high level of volatility in the global dairy market.

S&P credit analyst Brenda Wardlaw said Fonterra had a high degree of financial flexibility in setting milk price forecasts, which underpinned the 'A' category rating on the group.
Fonterra's chief financial officer Lukas Paravicini said the co-op's underlying financial strength and credit quality remained strong. "This is recognised by Standard and Poor's maintaining our rating in the 'A' category and reflects our fundamental strength and financial discipline," he said in a statement.

Paravicini said the revised rating would not have an impact on Fonterra's strategy or on Fonterra's farmer shareholder payout, which is currently forecast at $5.00 to $5.10 a kg. He added the co-operative's current debt was at "expected levels for this stage of the investment cycle".

Fonterra lowered its forecast payout progressively during the year to July 31 in response to the significant decline in global dairy product prices.

Nonetheless, the group's financial flexibility late in the season was diminished due to the speed and magnitude of the drop in global dairy product prices, relative to the level of advance rate payments to its supplier shareholders, S&P said.

This also resulted in a material increase in its working capital at balance date, which added to the already elevated debt levels from capital investment and acquisitions during the year.

Fonterra this year introduced a scheme whereby shareholders have been apply for a soft loan of additional 50 cents per share-backed kilogram of milk solids for production through to December. More than 7000 applications, representing 70 per cent of farmer shareholders, were received by the cut-off date.

S&P said Fonterra's offer of a loan to suppliers implied there may be limited "headroom" to lower the payout at the bottom of the global dairy product price cycle.

"However, we note that loan payments will be phased as savings from the co-operative's transformation programme are delivered," Wardlaw said.

"Notwithstanding the lower rating, we acknowledge that the recent increase in global dairy prices, together with reducing capital expenditure, better working capital flows, and likely transformation benefits should meaningfully improve the group's financial risk profile in the next one-to-two years," she said.

Downward pressure on the rating could occur if Fonterra were to undertake further material debt-funded transactions, particularly in higher-risk geographies that alter the supply mix and that may also undermine the subordination benefit.

At last month's results presentation, Fonterra said its gearing ratio rose to 49.7 per cent from 42.3 per cent a year earlier, but was 46.4 per cent when adjusted for a $900 million advance payment to farmers. The co-op has in the past aimed for a gearing ratio of 40 to 45 per cent. Chief executive Theo Spierings said Fonterra's debt not where the co-op wanted to be "but it is close".

The slump in commodities prices was reflected in Fonterra's revenue for the year at $18.8 billion - down 15 per cent on the previous year.

In March, Fonterra completed the purchase of an 18.8 per cent of Chinese infant formula manufacturer, Beingmate Baby & Child Food, for around $820 million. In addition, the company has spent over $2.3 billion on capital expenditure over the last two years on new plant.