Fonterra's credit rating cut by S&P

See also: Fonterra still “extremely strong” despite credit downgrade

Fonterra's [NZX: FCG] long-term credit rating has been cut a notch to A- by Standard & Poor's.

S&P says Fonterra’s peak capital expenditure and rising debt levels has coincided with a high level of volatility in the global dairy market, weakening its financial risk profile.

Fonterra's long-term rating was cut to A-, while its short-term rating was lowered to A-2 from A-1. The outlook is stable.

The cooperative's cash interest costs on funding rose $95 million to $427 million in the year ended July 31, reflecting advance payments to farmers, funding for the $755 million purchase of 18.8% of Shenzen-listed Beingmate Baby & Child Food Co, and its three-year, $2.1 billion investment programme to increase and update production capacity.

Fonterra's leverage has increased as a result, with the debt-to-equity ratio rising to 49.7%, from 42.3% last year.

"The downgrades reflect our view that Fonterra's financial risk profile has weakened in the past two years, as the company's peak capital expenditure and sizable debt-funded acquisition coincided with a high level of volatility in the global dairy market," S&P says.

While Fonterra has a high degree of financial flexibility in setting milk price forecasts, "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."

This "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," S&P says.

"In addition, Fonterra's offer of a loan to suppliers, in our view, implies there may be limited headroom to lower the payout at the bottom of the global dairy product price cycle."

Fonterra says the downgrade won't affect its strategy or farmer shareholder payout.

"We are progressing well with our business transformation and this will further strengthen our financial position," says chief financial officer Lukas Paravicini.

"Global dairy prices are also recovering, which is a positive development, particularly for our farmer shareholders."

Paravicini said Fonterra's current debt "is at expected levels for this stage of the investment cycle."

S&P says it acknowledges the recent recovery in dairy prices, and "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."

Still, S&P expects the group's financial risk profile to remain more consistent with the A- rating in the next few years, particularly given the potential for further volatility in the global dairy market."

(BusinessDesk)