Is the MG Unit Trust IPO a good deal?

The MG Unit Trust will let you share in the performance of Murray Goulburn. But it's dairy farmers who will call the shots.

Key Points

  • Units won't carry voting rights
  • No guarantee growth strategies will work
  • Complicated structure means AVOID

Imagine your dairy farmer neighbour offers you an opportunity to buy a stake in his company, MilkMade Pty Ltd. MilkMade makes dairy products and sells them to supermarkets here and overseas. Your investment will be $500,000, which will initially be used to pay off part of MilkMade’s net debt of $740,000. Then the company will roll out three new projects that will reposition its product range upmarket.

Early in the documentation, you read that you’ll receive the same distributions as your neighbour. So far, so good. But as you continue along, several concerns make you wary.

The first is that the distributions will be based on the milk price that MilkMade pays to its farmer suppliers, who are also shareholders in the company. Profit maximisation isn’t the main aim. The second is that your $500,000 investment won’t allow you to vote. MilkMade’s existing shareholders will retain complete control.

Table 1: Key offer details
Indicative price range $2.10
Market capitalisation $1.2bn
2016E PER 13.6
2016E yield 7.4%
Trading begins 3 July

This, in essence, is the deal investors in the initial public offering of MG Unit Trust must accept (you can get the real figures by adding three zeros to the numbers above). Units in the MG Unit Trust will provide you with a non-voting economic interest in the Murray Goulburn business. You’ll receive the same distributions as farmer suppliers (shareholders), but your interests aren’t the same as theirs.

Listed non-voting securities are uncommon in Australia, although they’re not unknown. In 2011 our colleagues at Intelligent Investor recommended the non-voting shares of News Corporation (prior to the demerger of 21st Century Fox). The decision here was easy – the stock was attractively priced and Rupert Murdoch had demonstrated an ability to build excellent businesses with strong cash flows.

No control over management

The case for Murray Goulburn is less clear, but let’s take a closer look at both the business and its structure. Always keep in mind that you won’t own voting shares but units in the MG Unit Trust, which give you an economic exposure to Murray’s Goulburn’s performance but not the right to appoint or dismiss management.

Understanding Murray Goulburn’s structure is important. The company’s shareholders are (and will remain) the dairy farmers who supply it with milk. These farmer suppliers prefer to receive a high ‘farmgate milk price’, naturally enough, so the company is quite different from most. Instead of maximising net profit, Murray Goulburn’s aim is to maximise the farmgate milk price. That’s why net profit margins are low (see Table 2).

Table 2: Financials (pro forma)
  2013A 2014A 2015E 2016E
Revenue ($m) 2,385 2,917 2,994 3,308
EBITDA ($m) 120 202 172 209
EBIT ($m) 68 149 115 143
NPAT ($m) 40 97 73 86
NPAT margin 1.7% 3.3% 2.4% 2.6%
Farmgate milk price $4.83 $6.31 $5.67 $6.01

Murray Goulburn is Australia’s largest milk processor, taking in 37% of Australia’s milk supply. Products include cheese, milk powder, drinking milk, butters and fats, as well as nutritional powders and infant formula. You’re probably familiar with Devondale, the flagship brand, or Liddells if lactose isn’t your thing. Murray Goulburn has had some success internationally, with Devondale UHT milk now the third largest imported UHT brand in China (albeit with just 7% of the market).

Happy farmers

A decent farmgate price not only keeps farmers happy – and willing to invest in their farms – but ensures Murray Goulburn’s milk supply. The company’s decision to reward farmers helped lift its milk intake by 4.3% a year between 2010 and 2014, a higher growth rate than competitors.

So the farmgate milk price is a ‘key performance indicator’ for Murray Goulburn. To align the interests of unitholders and farmers, the company has come up with a formula for the payment of distributions. It’s complicated but, in summary, distributions will be lower when the farmgate milk price is weak and higher when it’s strong.

Murray Goulburn’s business strategies are designed to lift the farmgate milk price over time, although it will swing about from year to year. One of the main reasons for listing is to help finance premium-product strategies to improve the milk price it can pay farmers.

Initially, most of the $500m raised under the offer will be applied to reducing Murray Goulburn’s net debt of $740m. That a company with an expected market capitalisation of $1.2bn has this much debt before listing should raise eyebrows.

After listing, Murray Goulburn intends to pursue three major capital projects in nutritional powders, dairy beverages and cheese. While the estimated spend is $550m-$635m, the company’s capital expenditure record isn’t unblemished. The company won a 10-year contract to supply Coles private label milk from 2014 but its purpose-built facilities came in late and over budget. The strategy to sell Devondale branded milk alongside Coles private label milk also appears to have been a failure.

While Murray Goulburn has had some success overseas, its premium-product strategy looks a little late to the party. While its capital projects are aimed at continuing the shift away from bulk ingredients, it still forecasts $1.1bn of commodity product sales in 2016 (down from $1.5bn in 2014). There is no guarantee that Australian or Asian consumers will accept the premium products Murray Goulburn has planned.

Investors hoping to benefit from a takeover will also be disappointed. While much of Australia’s dairy sector has fallen into overseas hands – with many buyers later regretting their acquisitions – Murray Goulburn’s structure makes it unlikely. Indeed, the company should be considered an acquirer of dairy assets, having missed out on Warrnambool Cheese & Butter after a takeover battle in 2014.

Premium possible

There’s no doubt that listing on the ASX usually imposes market discipline on former co-operatives like Murray Goulburn. In the short term, the MG Unit Trust might list at a premium to the offer price.

But in the longer term two things should worry you. The first is that, with its retailer customers exceedingly powerful, owning food businesses has rarely been a recipe for outstanding returns. Murray Goulburn’s size provides some level of comfort but only a little.

The second is that the desire of farmers to protect their interests might be inconsistent with the desire of investors to generate an acceptable return on their investment. Murray Goulburn’s structure has been designed so that your interests will always play second fiddle.

Macquarie Bank, the lead manager, has designed an ingenious solution to the problem of keeping Murray Goulburn under dairy farmer control. But complicated structures tend to end up being unsatisfactory for everyone eventually. Unitholders in the MG Unit Trust will be like silent passengers on a train to a secret destination. It’s no way to run a business – AVOID.

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