Smoke and mirrors or business as usual

This season shows many of the normal characteristics of the red meat sector, but it’s getting harder than ever to unravel the complexities of an industry which epitomises Winston Churchill’s 1939 quip about Russia – a riddle wrapped in a mystery inside an enigma.

 

In conversation with several senior industry executives, it has been possible to establish for certain only three things: first, this season is a bit easier than last and quite a lot better than two years ago, second, the trend to dairy support away from sheep and beef has gained momentum, and lastly China is extremely helpful for exports of both species.

 

There are conflicting views about other current issues and events. Beef is either tougher or easier than sheepmeat depending on the region or point of view, capacity must come out, but whose capacity again depends on the perspective taken, and, while some are closer than others to see the possibility, nobody is willing to predict a disaster.

 

One contact expressed the view the industry is not broken, but participants are responding logically to the present circumstances. Therefore the collapse of a single company is unlikely and, for farmer suppliers and other creditors, undesirable. In fact another opinion was such an event would be the worst outcome for the future credibility of the meat industry.

 

By charting a course between the various opinions and looking at balance sheets it has been possible to perform a fairly robust assessment of the state of the meat industry.

 

Taking the annual results released in December as a starting point, we know some facts for certain, although the six months since then will have caused some changes. ANZCO took the unusual step of releasing its result four months earlier than required, reporting a net profit after tax (NPAT) of $12.2 million on revenue of $1.3 billion and equity at 47% of total assets.

 

This compared particularly well with Silver Fern Farms’ after tax loss of $28.6 million and 39% equity, while Alliance’s net profit of $10.9 million on revenue of $1.4 billion was similar, but its equity recovered to 61% of assets. None of these results was very satisfactory.

 

Keith Cooper, CEO of SFF, maintains the company’s horror two years of losses should more realistically be considered as one bad year in 2012 because last year’s loss was caused primarily by a carryover of inventory. This build-up arose because SFF failed to sell into a falling market.

 

Cooper is bullish about this season, stating SFF has cleared all past year’s inventories on a rising market with China providing very positive support to the average market prices achieved. He is confident the company will meet its bankers’ requirements to reduce term and seasonal borrowings by $98 million with some margin to spare by a combination of inventory reduction, improved profit performance and sale of non core assets.

 

However this favourable interpretation of events assumes a continuation of good performance for the rest of the year which may be achieved till June, but the last three months are notoriously difficult to navigate.

 

If SFF performs well enough to reduce the size of its balance sheet as Cooper expects, it will have managed to convince its bankers of the security of the facility negotiated until 31 October 2015. But a more important long term issue will be to improve the overall structure of the business and avoid lurching from one year of profit into another period of losses.

 

This will be where the PwC report delivered recently to the company should be of great value. According to last week’s supplier newsletter, “The report has given your board a reference point on the capital base, aggregation opportunities, governance model, management structure, plant consolidation, assets sales, livestock financing and cost structures.”

 

I am a little surprised it has taken so long to commission this strategic review which should have been a prerequisite for obtaining funding with a deteriorating equity ratio and in an industry with such a thin margin for error.

 

The opinion of shareholders since the issue of tradable shares at $1 replacing the previous cooperative shares underlines the problem, with the shares having lost more than 60% of their value in less than five years. This suggests shareholders no longer believe the net assets are worth close to their value at the time of purchase.

 

Combined with the losses of the last two years this must raise the spectre of a possible reassessment of asset values for impairment, unless the current year’s result comprehensively addresses that problem.

 

Lower livestock numbers, excess capacity, land use change and the strength of our dollar mean the meat industry is far from out of the woods. But efficiency gains by all the leading processors, research initiatives, trade agreements and rising market prices give some hope for a future in which enough sheep and beef farmers will resist the change to dairy grazing.

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