Investors should steer clear of the Fonterra Shareholders' Fund, which seeks to raise up to $525 million to reduce the dairy co-operative's redemption risk, until the units start trading, Morningstar Research says.
The units have too many pricing uncertainties in the bookbuild phase, it says.
The research firm gives a "do not subscribe" recommendation for the fund's initial public offering, saying Fonterra lacks pricing power over its dairy commodities, generates low returns compared to its multinational peers and investors won't know the price they are paying until after the bookbuild process is completed on November 27.
The float has an indicative price range of between $4.60 and $5.50 per unit, though Fonterra has discretion to price it above that range. Morningstar estimates fair value at $5.50.
Institutional investors report demand for the units has been heavy and scaling of applications is anticipated in order to meet demand.
"Our main concern is that prospective investors won't know the price they are paying and quantity of shares they would be receiving until after the bookbuild process is completed," analyst Nachi Moghe says in his report.
"As a result of this uncertainty, we would advocate investors wait for the units to list on the market and consider buying at a price below $4.95 per unit."
Unit holders in the fund will get the rights to Fonterra's share dividends without owning the shares or holding voting rights. The change will substantially reduce the share redemption risk on Fonterra's own books, which has billowed to more than $700 million in recent years, by giving farmers a venue to trade the shares among themselves.
Fonterra's main risks come from movements in global dairy prices, exchange rates and New Zealand's milk supply, Mr Moghe says.
A reliance on whole milk and skim milk powder and a lack of branded products means the dairy exporter has smaller margins than its global competitors. It will probably face "significant competition from companies like Nestle and Danone" as Fonterra moves to sell more higher-value products, he says.
"Multi-national food companies, on the other hand, have well-diversified operations in relation to sales and raw material procurement. They also mainly sell branded products which enjoy better pricing power than commodity products.
"As a result we think the valuation discount is warranted," Mr Moghe says.
Pricing and allocations are expected to be announced after the bookbuild on November 27, with the units set to list on the NZX on November 30 and on the ASX on December 5.