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Fonterra (ASX:FSF) Dominoes Debt But Is There More Pain Ahead?

Fonterra Shareholders’ Fund (ASX: FSF) has sold its 50% share of DFE Pharma for NZ$633 million (AUD$588 million) to a private equity firm in order to strengthen its struggling balance sheet. Here’s what you need to know.

Who Is Fonterra?

Fonterra Co-operative Group Limited is a New Zealand multinational dairy co-operative owned by around 10,500 New Zealand farmers. Its well-known brands include Western Star, Bega and Mainland.

Selling To Pay Down Debt

Fonterra has found itself weighed down by a mountain of debt and has been selling off assets in order to reduce the burden and the risk of financial ruin. This latest sale comes on the back of previous sales made during the year and brings total proceeds to over NZD$1 billion just from sales in 2019 alone. This money will be used to pay down debt.

Chief executive Miles Hurrell said Fonterra had set itself a tough debt reduction target but was pleased with the progress being made.

“It’s an important milestone in our Co-op’s plan to lift our business performance,” Hurrell said.

“This milestone, along with the significant inroads made in our capital and operational expenditure during FY19, makes for a good initial chapter in our business turn-around”. It puts us on the right footing to deliver our new strategy and a sustainable lift in our performance,” he added.

Bracing For A Grim Result

Fonterra is set to release its full year results on Thursday and is expected to report a loss of around NZD$600 million (AUD$558 million). The share price has significantly underperformed this year, falling approximately 33% amid concerns over poor returns and high levels of debt.

Only a few weeks ago, ratings agency S&P Global said in a report that Fonterra had “lost its way” and that poor governance had contributed to a “widespread misallocation of capital.”

Having already delayed the release of its full year results earlier this month, investors will be hoping the result is delivered promptly on Thursday and free from any further nasty surprises. Given the poor business performance and the ongoing internal business review there is the very real possibility of further asset writedowns being announced along with the results.

What Should Investors Do?

I think its fraught with danger to buy in before Fonterra’s results are released as there is simply too much downside risk from further bad news coming out from the ongoing review. I would be waiting to get a clearer picture of what management plan to do next, further potential sales and an update on the current performance of the business.

Whilst I will continue to view Fonterra through skeptical eyes, I do think it could make a reasonable investment proposition in the future if management is able to successfully de-leverage the balance sheet without destroying returns permanently.

At the time of publishing, Luke has no financial interest in any companies mentioned.

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