Optimism prevails despite tough year

The noises coming from the three meat companies that have declared an annual result to September 2010 are optimistic, although tempered by the knowledge there’s less livestock around this year and farmers need to achieve better profits. The companies with the most reason to be happy are Alliance and AFFCO who have both posted solid profits and reduced debt, as well as increasing their share of EU lamb quota.

Silver Fern Farms continues to be publicly very positive in the face of declining revenue and market share, not to mention another operating and after tax loss, because it has been able to achieve significant debt repayment leading to an improved equity ratio. Clearly SFF is relieved to have reached what it suggests is a stable state after several years of capital and structural upheaval, but from now on it really must post operating profits instead of relying on asset revaluations and conversion of members’ shares from liability to equity to bolster the balance sheet, and windfall compensation payments and inventory disposal to improve cash flows.

SFF must be disappointed, if not surprised, its appeal to Alliance shareholders to support a merger of the two co-operatives has fallen on deaf ears, with Alliance strongly urging suppliers to support one company (i.e. Alliance) as the only constructive way to achieve commercial rationalisation of the industry, rather than trying to solve the industry’s problems by merging two companies, one of which has no desire to merge.

AFFCO and Alliance have been the quiet achievers, just getting on with their business without many headlines, if one ignores AFFCO’s spat with the Meat Workers’ Union over terms and conditions at its Wairoa plant. I imagine ANZCO will also have had another profitable year, although it stays under the radar without any obligation to announce a result until notification to the Companies Office by the end of March.

A closer look at the annual reports of the only two companies that still report publicly with some extrapolation from last year for AFFCO indicates some key differences and conclusions. The most obvious difference is in the profit line which shows AFFCO at $21 million after paying full tax for the first time compared with Alliance at $6.3 million after pool payments of $12.65 million, while SFF lost $14 million having distributed less than $100,000 to members. The respective cash flows are also revealing, Alliance achieving $28.3 million closing cash flow after repayment of $45 million debt, compared with SFF at $335,000 after debt repayment of $66.1 million. AFFCO indicated debt would be reduced further from the very low level previously reported at 31 March.

This underlines the importance of debt reduction and cash to businesses operating in a competitive industry with low margins in a tight credit environment. Alliance and SFF both reduced their inventory levels significantly during the year by $80 million and $74 million respectively, in each case by about 50%.

The current financial year is unlikely to be a make or break year for the meat industry, but it will take some livestock producers and processors closer to the brink because many farmers are already farming at a loss, while processors will have to recover fixed overheads with reduced volumes to process and sell.

Loss making producers will have to get out of the industry sooner or later which will inevitably lead to concentration of land in profitable farm ownership; this doesn’t necessarily mean more overseas ownership or dairy conversions, because the outlook for sheep meat and wool is positive. Prospects for prime beef are also good with demand from Asia likely to increase.

The processing sector is puzzling because there is no indication voluntary capacity rationalisation is about to happen, but nor does any company appear about to fall over, if you listen to the positive messages from the large companies. However logic tells me they won’t all do well, because of the inevitable procurement competition for lower stock numbers. The critical point of differentiation will be relative processing costs and fixed overheads and this is where I believe SFF is the most vulnerable despite its significant debt reduction because of the required scale of investment in plant and equipment as the company with the largest processing capacity which has had to be ‘rightsized’ to compensate for the company’s reduced market share.

Nevertheless the commitment of $61 million to the Farm IQ project, presumably at least partly in cash, indicates firstly SFF’s confidence in its future business model and secondly the availability of sufficient capital to invest. The competitors almost to a man appear to see little in Farm IQ that they are not already doing themselves, so it will be interesting to see who is right, but whatever the answer, it will take more than one year for the benefits to show up in farmer returns. This season certainly promises to be the most challenging for some time, but with the meat sector strategy due soon and more optimism about market demand, it may be quite an exciting one.

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