Australia | Nov 25 2013
-NZ milk pricing pressures
-Competition subdues earnings
-Brokers diverge on price sustainability
By Eva Brocklehurst
Milk is giving a baker a headache. The dairy industry is a very competitive one, particularly in New Zealand. Baker and food manufacturer Goodman Fielder ((GFF)) has been plagued by price increases at the farm gate and the inability to offload the increases because of the competitive pressure from Fonterra, the giant in the NZ dairy industry. The company elaborated on these pressures at the recent AGM and brokers have taken the subdued news on board, lowering earnings forecasts.
There's one broker that's more upbeat than most. BA-Merrrill Lynch. The cost increases that Goodman Fielder sustain are envisaged to be short term. Merrills retains a Buy rating on the stock because underlying earnings are still expected to grow in FY14 and the company is increasing brand investment, which should support further top line growth in key categories. Moreover, Fonterra is expected to cave in eventually and seek price increases, allowing Goodman Fielder some breathing space. Merrills does concede this may take time but is prepared to look through the pricing pressures.
Other brokers are not so patient. Both CIMB and Macquarie have downgraded ratings. CIMB to Neutral and Macquarie to Underperform. CIMB understands that Goodman Fielder achieved a 10c/litre price increase that did not fully offset the 20c/litre increase in the pricing ex farm gate. This risk was evident back in August, as Fonterra had indicated it would be more willing to accept lower profitability in periods of milk price volatility. Without leadership from Fonterra, CIMB does not expect another price increase in the NZ market in the second half, so down go the earnings forecasts. Macquarie observes Fonterra, which produces 90% of the milk in NZ, has already increased the milk price from the farm gate three times in FY14. This reflects continuing strong international prices for dairy goods, driven by robust demand from Asia.
On the subject of another staple, bread, Australia is a dry place for the bakers. The average shelf price has increased but aggressive promotional pricing continues. Macquarie finds Goodman Fielder is caught between having to spend more promoting its brands and defending market share and the pressure from retailer promotion of private label brands. Outside of bread and milk, CIMB acknowledges that the sale of Integro and cost savings are standing the company in good stead with its balance sheet positioning.
Pricing pressure is expected to continue to put the stock under pressure and subdue earnings growth in the medium term as the potential for retailers to disaggregate the private label value chain is a significant threat, in JP Morgan's opinion. Such is the weak position of Goodman Fielder. The broker thinks significant earnings growth in FY14 will be difficult to achieve. The market may have been excited by the price increases on proprietary branded product the company was able to achieve back in June but realised average selling prices were unable to reflect this increase because of aggressive promotional activity. It's hard to see much upside and JP Morgan retains an Underweight rating with a preference for Coca-Cola Amatil ((CCL)) in the sector, noting that Goodman Fielder will need to significant increase its discretionary operating and capital expenditure to stabilise its brands and capabilities.
Deutsche Bank also sees no reason to change the rating, from Buy, expecting that the wholesale pricing of NZ milk will eventually offset the rise in farm-gate prices. Moreover, in the bread department the situation is better than it used to be. The issue for bread appears to be largely at the premium end, where George Weston is offering aggressive promotions on Abbotts premium packaged loaves. Goodman Fielder is trading at an 8% discount to the market and Deutsche Bank finds the valuation appealing for a business with leading brands. Mid single digit earnings growth is expected on average. The milk price issue was flagged back at the earnings report in August and Deutsche Bank thought earnings were always going to be weighted to the second half. Now that weighting will be significant.
On the FNArena database the stock has two Buy ratings, three Hold and two Sell. The consensus target is 76c which compares with 78.7c ahead of the AGM and suggests 17.4% upside to the last share price. Targets range from 68c to 81c. For FY14 forecasts the dividend yield is 5.2% and for FY15 it's 6.2%.
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