Fonterra Shareholders Fd

Kia ora and thanks for joining us. Welcome to our 2023 Annual Results Briefing. I'm Myles Hurrell, CEO of Fonterra, and I'm here with Neil Beaumont, our Chief Financial Officer. We're going to kick things off with an overview of our performance before asking Neil to take us through the numbers. And then it'll be over to you to ask your questions. Before we get into it, I want to start by acknowledging and thanking our farmers and our people right across the cooperative. We know it's tough on farm right now, but it's great to be reporting such a strong set of results today. Looking at the core metrics, profit after tax is up $994 million to $1.6 billion due to favourable margins in our ingredients channel and the gain on sale of Soprolo. The significant lift in earnings has meant the Co-op's return on capital has increased this year to 12.4%, up from 6.8% last year. And earnings per share increased from 36 cents to 95 cents per share. However, this has been against the backdrop of a farm gate milk price that has dropped across the season, down from $9.30 the prior year to $8.22 per kilogram of milk solids in 23. As I mentioned earlier, we know that our farmers are doing it tough, but a strong balance sheet has assisted us to pay a full year dividend of 50 cents, which is slightly above our dividend policy range of 40 to 60%. The 50 cents per share dividend comprises the 10 cents we paid after the half-year results, and the final dividends of 40 cents per share, which is to be paid in mid-October. As part of our strategy to focus on New Zealand milk, we completed the sale of Soprolo on 31 March this year. And in August, we used $804 million of the sale proceeds to give to unit holders and shareholders a 50 cent per share tax-free capital return. This meant fully-backed shareholders received $9.22 for the milk they supplied the cooperative. You'll also see we've introduced two new metrics. These are gross profit from core operations per kilogram of milk solids and cash operating expenses per kilogram of milk solids. Neil will touch on these in more detail shortly. Looking at the global dairy industry, on the milk supply side, we've seen growth in the EU and US largely due to growing herd sizes. However, production is down in Australia and New Zealand, both impacted by challenging weather conditions. On the demand side, imports were down in China, Asia, and the Middle East and Africa, partially offset by a little bit of growth in Latin America. Reduced demand from these key importing regions impacted pricing of our reference products, particularly that of Hormel powder. As mentioned earlier, this has had a flow-on effect to the Farmgate milk price. This graph illustrates how the price relativities compared to previous years. These high margins, mainly in the ingredient channel, are the key contributor to the earnings we're reporting today. The reduction in the Farmgate milk prices this season was primarily driven by lower product prices, again, particularly Hormel powder. Around 60% of the Farmgate milk price revenue was derived from Hormel powder sales, and the average Hormel powder price for the 23 season was 16% lower than the prior. In response to this, we allocated more milk to skim milk powder and its byproducts, particularly butter. And while skim and butter prices were also down in the prior year, it was to a lesser extent, in this case 14% and 10% respectively. Like most businesses, we've experienced inflationary pressures right across the board, which is part of the additional 13 cents you'll see in our costs. This includes things like manufacturing, transport, packaging and energy. This year we had a lower FX conversion rate than the previous year, which partially offset the decrease in product prices. I'll now hand over to Neil to take us through the financial performance in a bit more detail.

Thanks, Myles. I'm pleased to present to you our key financial outcomes for the year, as well as our new resource allocation framework and efficiency metrics. We have introduced a new resource allocation framework to increase our focus on the efficient allocation of our farmers' milk and cash. Our first priority is safe and efficient operations. We then allocate our farmers' milk toward either our ingredients, food service or consumer product channels, and the brands and offerings within those, according to where we believe we will see the highest risk-adjusted returns. Following this, we allocate the cash generated from these channels to one of the six buckets. Each bucket needs to compete with the others, and we allocate based on which will generate the best outcome for our shareholders. The resource allocation framework is embedded across Fonterra and seeks to deliver enhanced value in the form of a strong balance sheet, total shareholder returns, and farm profitability. The Co-op is focused on shifting our New Zealand milk into higher value products. This is a key driver of our strategy to deliver both a strong farm gate milk price and earnings growth. Looking at the graph on the left, you can see we continue to reduce allocation of milk solids to whole milk powder and increased allocation to skim milk powder, cream, and cheese, where returns are more favorable. Now looking at the chart on the right, allocation to our ingredients channel increased in FY23. This reflects the sell-down of the additional 2022 financial year inventory. We also put more milk solids into our food service channel as demand increased as a result of the COVID-19 related restrictions lifting, particularly in our greater China region. Our reportable segments show we are diversified across both channels and markets. Before we look at the numbers, it is worth noting that we have updated our segments to be reported down to a profit after tax level and now fully allocate our corporate costs and interest in tax within the segments. Looking first at core operations, which represents the business activities that collect and process New Zealand milk through to selling the products to our customer-facing business units. Core operations is up $532 million to $572 million, reflecting the favourable price relativities. Global markets profit after tax was up $77 million, reflecting improved pricing and higher sales volumes in the ingredients channel. This was partially offset by recognizing impairments of our New Zealand consumer business and Asian brands of $121 million and $55 million impairment, respectively. Looking at Greater China, profit after tax was relatively stable at $284 million where we saw higher pricing in the food service channel. This again was partially offset by recognizing a $46 million impairment of our Asian brands in the consumer channel. Our ingredients channel has solid results given the price relativities already discussed. Our food service channel's profit after tax increased due to improved gross margins combined with higher sales volumes. The consumer channel continues to be challenging and is down on last year, mainly due to impairments of our domestic New Zealand consumer brands and our Asian brands. This next slide is showing you the returns we generated across our three product channels relative to the capital they employ. As Miles and I have already said, the earnings performance for our ingredients and food service channels improved year on year, and so did their return on capital. This said, our consumer channel return on capital remains unacceptable, with a return on capital of negative 4.6%, down from 40 basis points in FY22. The consumer channel performance this year was impacted due to recognizing impairments of our New Zealand consumer business and our Asian brands of $121 million and $101 million, respectively. It's a key focus of ours to improve the value we extract from the capital employed in the consumer channel. I am very pleased to report that we have a strong balance sheet, and this remains a key priority for us. This has been achieved progressively over recent years through a combination of improved performance and increased financial discipline. Our net debt is down $2.1 billion to $3.2 billion, reflecting our lifted earnings, the reduction in working capital, and divestment proceeds. This number also includes provision at balance sheet date for the amount we paid out for in the capital return. The improvement in the gearing ratio reflects the lower level of debt combined with higher equity from our increased earnings. By reducing our overall debt position, we have created optionality for our business to support farmers through increased dividends, the ability to pay the capital return, and changes to our advance rate schedule. Importantly, we continue to be committed to maintaining our credit rating. Both S&P and Fitch have Fonterra as A-rated, which allows our businesses to access capital with more favourable terms should the need arise in the future. We are very focused on further strengthening our business by safely and sustainably driving down costs by approximately $1 billion by 2030. As Miles mentioned earlier, we have introduced two new core metrics which will keep us focused on driving efficiencies for the co-op year on year. These metrics will help us be efficient by ensuring that our costs are managed relative to the value we can generate and the milk volumes that we collect. The two new core metrics are cash operating expenses per kilogram of milk solid, where we will target a 4% improvement per year to assist long-term discipline in our global operating expenses, and gross profit from core operations per kilogram of milk solid, which will help ensure we stay focused on delivering value from our New Zealand operations, which is targeting a 2% improvement every year. Moving forward, we will advise progress against these metrics at our interim and full-year updates. Miles will now comment on the outlook for FY24.

Thanks, Neil. 23-24 season farm gap milk price is $6 to $7.50 per kilogram of milk solids with a midpoint of $6.75. Demand for imported powders into China remains soft, but it's still early in the season. There are indications demand for New Zealand milk powder will start to return from early 2024. In the meantime, we'll continue to respond to market signals and adjust our forecast farm gap milk price to ensure that the impact of current prices and currency movements is transparent. Looking out to F24 earnings, our guidance range for continuing operations is 45 to 60 cents per share. Earnings from discontinued operations will be affected by the timing of completion of the DPA Brazil sale. We anticipate that the favourable price relativities that we experience in F23 will reduce over F24 and impact our ingredients channel earnings. Our food service and consumer business gross margins are expected to improve over the year as the lower cost of milk flows through. The co-op is in good shape and we look forward to the year ahead. Thank you for your time.

Thank you. We will now conduct the Q&A session. As a reminder, to ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. Please stand by as we compile the Q&A roster. Our first question are from Ari Decker from Jarden. Please go ahead.

Good afternoon, Myles and Neil. Just first question just on the capex, which is stepping up in FY24. I mean, it looks like sort of circa $550 to $600 million is sustaining in-debt operations and those green investment requirements you've signalled. But just in terms of sort of the $300 to $400 million of capital being targeted to sustaining capital for other operations and for growth topics, can you just give a little bit of color on what is planned in FY24 in each of those buckets?

Yeah, thanks, Ari, and thanks for the question and for joining the call. I mean, I would just give some context, which is – You are right, and it's part of the reason that we wanted to sort of provide that profile. There is a bit of a bow wave of CapEx that we're facing with respect to regulatory requirements around wastewater and decarbonization. What I think I would say in terms of additional cover on that sort of kind of core sustaining CapEx is the vast, vast, vast majority of that is for our New Zealand operations as opposed to global operations, and it's really you know, kind of part of our long-term, you know, asset health, you know, kind of program. I'd say, and there's not a lot in that number, so I'd probably limit my comments to that around specific growth capital projects.

Yeah, but, you know, I mean, I guess if I look at the chart, it's suggesting sort of $150 to $200 million in each of sustaining capital for other operations and growth capex and 24, and, you know, you know, which aren't small numbers. Yeah, what sort of envisaged in 24 in terms of investment in those two buckets?

Right, you're talking about the $150 million?

Yeah, and each of sustaining capital for other operations.

Yeah, so you've correctly called that out. I don't have it in front of me right now, but that number is, so those are for our operations outside of us, so that's mainly dominated by Australia CapEx. And again, as I was saying, we folded growth capex in there as well, but it's a relatively small number. So the lion's share of that in terms of other would be based in Australia.

Sure. And just in terms of the capex for FY24, you know, and look in this question, I guess, applies across the buckets. Is that pretty much committed or, you know, is there still discretion there? as you go through the year in terms of whether you'll actually invest that full bucket.

I think I would say this. If you look at the resource allocation framework that we've gone public with this year, we will always spend the money to sustain our operations so that we can produce safely and efficiently, and we will always We will always spend our money for that even in times where results kind of aren't so strong because we think that's really, really important for the long-term core of the co-op. That said, through various procurement practices, et cetera, we're always trying to improve upon, you know, kind of improve upon that number. The regulatory capital really is, you know, pretty much fixed and required based on sort of based on regulation. So you will see some movement in those numbers as we sort of, you know, juggle the profile hopefully get better pricing, et cetera. But, you know, we wanted to provide you this profile for a reason because we wanted to be able to help the market sort of better model, you know, model cash flows.

Yeah, and then in terms of, you know, and I guess growth capex in particular, there wouldn't be any change to, I guess, when you outlined in the LTA, I guess there was a bucket of, you know, circa a billion dollars that, you know, would depend on the strength of the opportunities and that. And so certainly as we look at it over that more medium to long-term horizon, that would still be the case. Or have you got, you know, when you share the update to the LTA in early 24, are you sort of suggesting that you've got, you know, a lot more colour and visibility, at least over the next few years, on where that CapEx is going? And we should actually be starting to factor it in.

Well, I wouldn't want to preempt in terms of what specifically we might say when we update the LTA. I think what I can say on growth capital is, you know, every project's got to provide the appropriate risk-adjusted return for it to sort of qualify. And so, you know, we don't look at it in terms of sort of filling a bucket of spend. It either provides an economic greater return for farmers or, you know, or if it doesn't. If opportunities did arise, well obviously when they arise, we will sort of modify this chart. But yeah, I'm not trying to signal any deviation from our previous disclosures that we've put out there.

Sure, thank you. And then just a couple of quicker ones. Just on the earnings guidance, you have highlighted that it's based on continuing operations. Just in terms of the exit of DPA, which I think, correct me if I'm wrong, but you're sort of targeting for this calendar year still. Do you anticipate there to be any meaningful earnings benefit or cost associated with that exit that could impact, I guess, the earnings for dividend purposes? Or can we sort of size the dividend off that 45 to 60 cents guidance and the payout range that you have on that?

I think it'd be quite sensible to size the dividend off the 45 to 60 cent guidance.

Great. And then last one, just in relation to impairments. Just on the amount you laid out in the accounts for NZ Consumer and Food Service, are you able to just clarify how much of that is NZ Consumer versus NZ Food Service? And then just also just any color on what the 26 million of other impairments relates to?

So we're not providing any additional breakdown or detail on the breakdown between consumer and food service on New Zealand. And, you know, and on the other one, I'd say regrettably, no, I don't think we're providing any more particular details on that. It's really... you know, broadly a collection of a series of sort of smaller items, none of which that we thought were particularly meaningful to call out. So sorry about that.

No, no, that's great. Thank you.

Thank you. Just a moment for our next question, please. Next we have Joshua Dale from Craig's Investor Partners. Please go ahead.

Afternoon Miles and Neil. Just three questions from me. First one on your dividend payout. I appreciate there's lots of factors that go into that, but you paid above the top end of your dividend policy range this year and were at the top end last year. Do you think you'll keep the 40 to 60% range going forward?

Yeah, I think I can say that we remain comfortable with that range. As you said, we do apply judgment in terms of making a recommendation to our board. Obviously, the actual dividend pays a decision of the board, but I think given a number of non-cash items that went through earnings, I think given given the strength of the balance sheet, we thought it was quite prudent in terms of the level of dividend that was paid.

Thanks. My last two questions are really around earnings for the year ahead, and I appreciate the guidance you've provided. But just firstly, your streamer's returns have obviously been very strong. Is there some sort of pressure in the market to eventually arbitrage that gap away? you know, in terms of the differential between reference and non-reference products? And does that pressure come from yourselves or your competitors? What's the best way to think about this?

I think what I would offer up is, you know, we've looked, obviously the really strong earnings that we've just reported have been as a result of some, you know, unprecedented stream returns. And so that delta between non-reference and reference pricing has been quite large. And so that's what driven earnings. You know, when we sort of look at the market, you know, we're not really identifying anything structural in the market that's changed, which would otherwise cause us to think that we wouldn't see mean reversion happen in terms of the relative gap between non-reference and reference products. I think we would offer up that. The other thing that I would certainly say, though, is obviously the teams in market are working incredibly hard every day with customers in terms of, you know, challenging pricing. where it's commercially viable, putting those price increases through. So regardless of what it is being sold, that we're maximizing the return.

Okay, thanks. And second question on your earnings. For the year ahead, you increased pricing in your consumer and food service divisions to better reflect the high cost of milk. You know, historically, but how sticky do those price increases tend to be as the cost of milk falls back down to lower levels like it has recently?

Yeah, I mean, there's clearly a competitive element to that. So we'll hold that price in the market as long as we can, but ultimately competitive pressures will come to bear at some point, one suspects. But as we sit here today, we try and keep those high pricing up irrespective of what's happened to COGS.

Got it. That's helpful. Thank you.

Thank you. Just a moment for our next question, please. Next, we have Nick Ma from Macquarie. Please go ahead.

Hi, guys. Just one more on the CAPEC. We looked at the CAPEC from 24 to 2030. It's about 9% higher than what it was in the LTA for the same period. Would you characterize the majority of it as just relation adjusting, you know, strong stick eye that we've seen in the last couple of years? Or is there sort of a step change and ultimately where is the step change between the sort of different buckets? And then finally on that, is there sort of more incremental returns on the additional capex to drive up the sort of long-term earnings?

I apologize, I didn't quite get the second part of your question, but your first part of your question, yeah, that's basically reflecting inflationary increases.

On the back of that, there shouldn't be particularly much incremental earnings from that capex.

That's fair. Recognizing that in terms of what ultimately drives earnings, there's a number of very material moving pieces for us, including realized prices and FX, just to call out too.

Yeah, that is great. And then thinking about sort of using the balance sheet when times are tougher for farmers, as we're seeing, and we'll see how long this kind of goes on for relative to break-even, what other mechanisms would you consider outside of the advance rate changes that you've already made to support farmers if there was sort of a sustained period of balancing your prices?

Yeah, so I guess I'll answer it another way, Mark. Nick, rather, if there's something in there around, are we looking at farmer support lines? That's not part of our agenda. I'll make that clear up front. But, you know, looking through probably our retail network, you know, what we can do to, you know, extend a little bit of terms for on-farm input that they purchase through our farm source network, but also as potential discounting and get costs down. So that's sort of where we're looking to use the balance sheet as appropriate, but nothing sort of significant beyond that. I think the question earlier around a dividend policy, there was no change to our policy at this point. It's 40% to 60%, so we're no change to that. But nothing significant that we're looking at at the moment. That's great.

Thanks a lot. Thank you. Our next question comes from Marcus Curley from UBS. Please go ahead.

Good afternoon. I just wondered if you could provide a little bit of more specific color around the quantum of stream returns in the result and what's assumed in the guidance for FY24?

So I think, Marcus, Richard Whiteman here, a couple of observations around stream returns. We think this year, sort of an estimate of the quantum of stream returns in the 95 cents is about 40 cents, and in the guidance for next year, the 45 to 60, probably a number of around 15 cents, which you sort of see from the price relative charts as coming forward.

Sorry, that was 40 cents contribution to earnings in... in FY23? Yes. And then you said $0.15. Would that be, is that at the midpoint?

Is that fair enough to describe? There's a wide range of possibilities there. I am always conscious when talking about the impact of stream returns and price relativities that it's a difficult thing to quantify exactly. And I think that Clearly, there's a wide range of possibilities that can happen through 24.

Okay. Maybe a different way of asking the question. You noted that there has been a moderation, but it looks like stream returns still remain very healthy. If we saw stream returns or relative prices remain at current levels for the rest of the year, do you have an estimate for what the stream return would be in FY23? Sorry, FY24?

I think, to your point, it's fair to say that the assumption of 15 cents assumes that stream returns, obviously, that gap closes as the season goes on. In terms of the... I mean, obviously, the number... You saw what it was last season. It was 40 cents. It's clear a wide range of things are possible if the gap stays open for the whole season.

And, sorry, just finally... a full normalization of stream returns, what would you normally attribute a contribution to profit on that basis?

In terms of the 40 cents, how much is a normal BAU level? Is that your question, Marcus? Yes. So somewhere between zero and five cents at that level?

Okay, perfect. And then secondly, I just wondered if maybe, Miles, you could talk about the current demand dynamics in food service in China, particularly what you're seeing from a volume perspective, obviously mixed messages in terms of obviously reopening versus economic pressure, and also same in terms of Asian consumer products.

I'll answer that just because Miles had to step away. I think... You know, there's obviously been a lot of press about some of the headwinds that are happening in China. I think, you know, what we would say is, you know, focusing more kind of on sort of maybe medium term is, you know, we're pretty comfortable that demand will remain robust. I think one of the things that's, I think, quite critical besides, you know, despite lower growth rates, they are growth rates, and incomes are rising, but I think quite critically, you know, the government's from a policy perspective has been quite clear that they think dairy is a core part of nutrition and they're being very consistent and persistent around that message in terms of recommendations, you know, to sort of to consumers. So that's certainly, you know, quite helpful. So I think, You know, on the ground, we're continuing to see, you know, our China food service business is one of our flagship operations for sure. And some of the price increases, specifically in consumer, you know, are, you know, so far are seen to be, you know, seem to be sticking. um southeast asia is is a little bit more of a little bit more of a mixed bag i would say um but still ultimately food service is strong i think the market that is really worth calling out is sri lanka which uh is uh has had a fantastic year and uh you know seems to be forming well and even just you know i know there's been challenges in years gone by around currency etc and that so far seems to be going uh seems to be going well okay and then um

Just finally, a couple on the capital structure. So what's the plans on the buyback as the year progresses?

So I think off the back of the new capital structure going live, we were providing some liquidity support. As things sort of went live, it turned out that we really spent very little money on liquidity support. The market seems to be operating well. fairly well. We have earmarked a relatively small amount of funds as part of our capital allocation framework that if we see value, that we may choose to go back into the market to buy back shares, but our driver would be different. It wouldn't be to provide liquidity support. We think that's going to no longer be required, but we would do it if we thought there was value.

And so you've got a valuation benchmark?

Well, obviously we have to have a view on value if we're going to end up buying back shares for the purpose of value, so sure. Have you formed that view on value yet? We've formed that view, but obviously we're not going to provide that information externally. Okay.

And the second question, could you give an update in terms of the farmers' ownership levels of FSS?

For FSS, if you take it on current supplying farmers, it's just under 10%.

Did you record that? I think that's well down. Do you have to hand what that was a year ago, or...?

So on supplying farmers, it has been easing up, but last year it would have been around the same level. You might have been thinking just in terms of there was some work done and it was released at the FSF AGM on just total, so even farmers that had left the co-op, that had been much higher, around the 50% to 60%, and that number still remains about that.

Okay. And then just, sorry, one more on the CapEx. Just to be clear for me, when I look at the blue bars, does decarbonisation and the other one, regulatory requirement for wastewater or including wastewater, do both of those go into the milk price range? calculation or is it just sustaining capital for NZ operations?

So the short answer is partially they do to the extent that they would impact a reference a reference producing company they do so obviously the decar mostly yes but the timing is a little bit different and the wastewater the non-reference products tend to be more wastewater intensive so less so.

Okay, so from a modelling perspective, is it fair enough to put all decarbonisation in and leave wastewater or other regulatory out?

So as a combination of both buckets, it suggests that the milk price will provide support for maybe 25% of that spend as an indicative number.

25% of the two? Of the two. Okay, great. Thank you.

Thank you. I would not like now to hand over to Neil for closing remarks. Thank you.

Well, I just, on behalf of Miles and myself, I really wanted to thank everyone for participating on today's call and your questions and your interest in the co-op. And we look forward to seeing you in the future. Bye for now.