Silver Fern Farms still vulnerable

As always when the annual results have been published, the new season is already nearly three months old and the die is cast for future profit trends. AFFCO and Silver Fern Farms’ second half performance showed just how tough competition was for available livestock numbers, so the obvious conclusion is Alliance and all other meat companies must have suffered in the same way. The new season doesn’t look as though it will be any easier.

In times like this, cash flow and balance sheet strength are absolutely essential for meat processor prosperity, even survival and by these measures the big three are all in better shape than twelve months ago, although the improvement isn’t all down to trading.

Clearly SFF benefited to the tune of $37 million in its 2009 profit from PGG Wrightson’s faux pas, but it’s most unlikely Santa Claus will repeat the gift. Chairman Eoin Garden’s claim of 2009 being a ‘defining year’ for the company in its transformation from ‘traditional sales oriented meat processor to market led food company’ has some substance, but there’s still a long way to go, before the improvements will produce sustainable profits.

Comparison between the three published final results shows all three companies strengthened their main ratios despite a significant drop in operating profit. AFFCO and Alliance are both in good shape with liabilities at 21.5% and 30.3% of total assets respectively, while SFF succeeded in reducing its liabilities from 59% the previous year to 47.6%. Since balance date the capital raising has brought in a further $22 million. However this year looks more likely to be a defining year than last for the largest and most vulnerable processor.

A closer look at the balance sheets suggests AFFCO is in the strongest financial position of the three companies with equity at the highest percentage of total assets, while the asset register appears very robust – AFFCO has cash on hand, low inventories and debtors, and $62.5 million from its 35.5% shareholding in Open Country Dairy. Conversely its liabilities are low. This places AFFCO in the best position to weather the inevitable procurement storm facing the industry.

Alliance has put together a solid result for the past year, slightly reducing its debt as a percentage of assets. Equity has risen by $21 million (6.5%) from the year before, while liabilities have only risen 2.5%; however inventories also rose 8.3%, reflecting higher product values and noting Alliance’s inventory valuation is based on the exchange rate at balance date. Debtors were almost 20% below the previous year in spite of revenue being $212 million higher.

SFF is proud of its substantial debt reduction and consequently the strengthening of its balance sheet. Significant cuts to its level of inventories and debtors indicate a dramatic improvement in business control, with inventory down $40 million or 79% and receivables $53 million lower than last year. The company will point to the success of its Rightsize project, but these figures could also indicate a case of incipient anorexia from loss of market share.

Against a background of extremely tough livestock supply SFF must still focus on debt reduction to bring down its interest bill which continues to hobble efforts to compete on a level playing field with the other processors. The newly launched brand and product range, while attractively packaged, won’t earn tangibly better net market returns in the short term and added costs may more than offset any longer term improvement. However it is essential, if SFF is to retain its shareholders’ confidence, to post at least a competitive profit this year, as well as making distributions to members who commit to the Backbone procurement programme.

At the operating profit level, taking into account the respective turnovers, AFFCO at $25.365 million, including $4.363 million from Open Country Dairy, and Alliance at $27.139 million after member distributions were comparable. Despite not paying a dividend, AFFCO is quietly satisfied with its result, taking into account the relative importance of beef to its business in a season when bigger profits could be earned from lamb.

These two performances were well ahead of SFF which achieved an operating profit of just under $5 million with no member distributions. SFF’s shareholders have voted for a change in the company’s capital structure which transfers to them the share valuation risk with the opportunity to buy more shares than their initial entitlement, and there were no pool payments; all this at a time when their main competitor has made a reasonable profit and paid out $18.6 million to shareholders, made up of pool payments, 5c a share dividend and a bonus share issue.

These comparisons shouldn’t divert attention from the fact none of these large meat processors is making a return on equity which commercial shareholders would consider acceptable. That only happens once every few years as in 2008 and is unlikely to happen again, until either livestock numbers recover or there is further industry rationalisation.

At the risk of repeating myself, rationalisation won’t happen voluntarily and it won’t come about through an industry strategy. Meat is different from dairy because of the staggeringly large number of products from animals that don’t fit milk’s daily supply pattern. If farmers want a different industry model, they all, and I mean all, have to make a seasonal commitment to one processor and stop trading. I can’t see it happening any time soon.

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