Global dairy prices may be soaring, but that hasn't translated into higher returns for unit holders of the Fonterra Shareholders' Fund (ASX: FSF). Shares in the fund are down 6.6% to $5.30 in the last 12 months and are skirting their 2012 listing price.
Owning units in the fund gives shareholders rights to receive dividends from any profit paid out, but does not represent ownership of the company. These dividends have been under increasing threat in the last six months.
In August last year the company announced a worldwide recall of products related to three batches of whey protein, after fears they may be contaminated with bacteria that can cause botulism. The fallout is continuing for Fonterra and last week French food giant Danone confirmed they will be seeking up to €350 million ($532 million) in damages from Fonterra for the costs of the recall as well as brand damage.
But Fonterra is still one of the world's largest dairy producers and as New Zealand's largest exporter it still has some factors going for it.
Rising dairy prices
In November Fonterra reported that dairy commodity prices had risen an average of 3.9% over the previous period and were up a massive 52% over the same period in 2012. The price rises reflect growing demand, especially from Asia, which accounts for about 50% of global dairy trade sales.
This is a trend that could continue in years to come as Asia continues to grow in wealth. It is also a factor that gave Fonterra the confidence to buy 9.06% in Bega Cheese Ltd (ASX: BGA) last year, around the time when Warrnambool Cheese & Butter Factory Co. (ASX: WCB) became an international takeover target.
Continuing problems
In December Fonterra reported that the gap between the price for milk and the price for cheese and casein meant that the company had not been able to "maximise profits" in the current environment, and would be slashing its dividend from $0.295 cents to $0.09c. At the current share price that puts the company on a yield of just 1.7%.
Foolish takeaway
Fonterra is a big company with strong potential. Unfortunately that potential is not being realised at present. Since dividend growth is tied not only to increasing dairy prices, but to management performance, the Danone lawsuit represents a hefty risk hanging over the company.
Fonterra may be good for farmers, but it has a way to go before its shareholders' fund becomes a 'must-have' for investors.
