Cooperative model not ideal for all business types

Cooperatives emerged in the 19^th century as an important business structure designed to protect the interests of a group of members, based on the principle of equitable distribution of benefits related to use or supply. The first New Zealand cooperative was formed in 1871 by eight cheese making settlers on the Otago Peninsula; by 1890 40% of dairy factories were cooperatives and by 1925 there were about 500, of which only three remained after the formation of Fonterra in 2001.

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South Island farmers still being short-changed

When it comes to being paid for their livestock, South Island farmers appear to be earning considerably less for some species than their North Island counterparts. Trying to unpick the reasons for the differential is complicated by a number of factors, like traditional meat company secrecy, schedule price as distinct from premiums paid for volume supply, cooperative pool payments and loyalty rewards, shorter seasons, cartage, labour agreements and relative plant efficiencies.

MIE tried hard, but couldn’t make a difference

MIE’s decision to disband after three years trying to persuade the red meat sector it was going to hell in a handcart has come as no surprise. But the organisation’s founders and directors are not unnaturally disappointed at their inability to gain support for their plan to solve the endemic problems of the industry.

Independent report and road show fail to satisfy all Silver Fern shareholders

In spite of apparently solid support for the Shanghai Maling deal at the road show meetings, there are a number of long-term shareholders in the far south who feel let down and ripped off by the company’s determination to sell 50% of their cooperative.

 

Their displeasure has two main causes, one historical and the other current: the historical reason is the company’s departure from cooperative principles after the Richmond takeover; the more current reason is based on a belief there should be no need to commit to a partnership which sacrifices control of the cooperative. However one could argue control has long gone, with present controllers the banks being replaced by a Chinese meat company.

 

There is nothing now to be done about the Richmond takeover which was characterised by acrimony on both sides, as well as the substantial debt burden it imposed on PPCS which had been a successful business for over 50 years. These shareholders feel the company could have raised all the capital it needed, if it had insisted on new suppliers becoming shareholders; but because of the threat of a supplier exodus, PPCS decided to retain supply by accepting livestock from non shareholders.

 

This was an inevitable decision in the very different North Island climate and that horse has long since bolted. AFFCO’s status as a cooperative in anything but name had long disappeared before its capital restructuring in the mid 1990s.

 

The justification for selling half the operating business, including processing assets, brands, intellectual property and production supplied by the cooperative, can be found in the Notice of Meeting sent to shareholders and available on the SFF website. The attached Grant Samuel Independent Report contains essentially the same information as the Notice of Meeting which is logical, as much of Grant Samuel’s information came from discussions with company management and directors.

 

This is probably inevitable, but it raises the question whether an independent report, produced on behalf of and in consultation with a company, can ever be truly independent. The strong probability must be the conclusion will always corroborate the client’s preferred course of action, provided it makes sense.

 

That said, the partnership with Shanghai Maling appears to be an offer which ticks many boxes which are beneficial to SFF and, it could be said, its suppliers. Shareholders will receive a 30 cent a share dividend, having received no dividends and seen the value of their shares fall to 35% of par value; they are also virtually guaranteed to be paid a competitive price for their livestock and dividends in future. The company will be debt free and, in chairman Rob Hewett’s words, the value add ‘plate to pasture’ strategy will gain a turbo charge.

 

The key conclusion in the Grant Samuel report is the following excerpt which states “As a result of an improved financial performance and other strategic initiatives SFF Co-Op has achieved a degree of deleveraging over the last two years and it is arguable that given

time it will be able to achieve a more conservative capital structure without the need for new capital. Nevertheless, the Proposed Transaction achieves the recapitalisation, removes uncertainty, creates new opportunities for growth and is strongly supported by the Board of SFF Co-Op and the Banking Syndicate.”

 

The removal of the uncertainty that has bedeviled the company for several years and the unwillingness of at least some of the banking syndicate to extend facilities beyond the end of this month without a firm, bankable proposal are two very good reasons for accepting the deal.

 

In time the company will be able to transition to its intended supplier remuneration policy of rewarding suppliers for their ability to comply with market specifications. But first there must be a serious review of processing facilities and tough decisions about plant upgrades or closures, because SFF has more capacity than any of its competitors, quite a lot of it less efficient. The recapitalisation will enable this to occur without having to go cap in hand to the banks.

 

For suppliers who support the partnership proposal, the important points are survival of the company, certainty of payment and possibly belief in Shanghai Maling’s ability to enhance the returns from the ‘pasture to plate’ strategy without keeping all the additional profit for itself. Conversely the objectors believe SFF has departed irrevocably from its cooperative principles and should have been able to find alternative capital without selling half the business, while Shanghai Maling will take all the upstream margin.

 

At this stage it is impossible to predict whether, and for how long, Shanghai Maling will be content to remain in a true 50/50 partnership which is a notoriously troublesome business form. History suggests it won’t last this way for ever because, in a joint venture, one partner generally ends up screwing the other. Inevitably it will be the stronger partner that finishes on top and there are no prizes for guessing the outcome here.

 

Unfortunately those suppliers mourning the structural and philosophical change to their cooperative will have to face the reality of the financial position which SFF was faced with and the board has been compelled to resolve the best way it could. That’s what boards are meant to do. Equally, unhappy shareholders also have a choice and can look at the obvious alternative.

 

In proposing the deal with Shanghai Maling, SFF’s board has made a judgement call between the lesser of two evils: it has chosen the financial certainty of new capital in exchange for half the business, believing this to be preferable to the risk of losing supply from disaffected shareholders. The amount of time it took to come up with this solution suggests the board must believe it had no choice in the end.

Silver Fern receives an offer it can’t refuse

No wonder the deal between Silver Fern farms and Shanghai Mailing took so long to conclude, but from all appearances it was worth waiting for. Not that you would necessarily think so, if you read about the disappointment of some shareholders and the MIE group about the board’s unwillingness to give serious consideration to an alternative farmer offer of $40 million or some of the business commentary.

Cooperatives and private companies work best in agriculture

Good company performance demands clarity of purpose which is defined and monitored by a board of directors elected or appointed by the shareholders. There are five main types of company ownership structure that are or have been represented in New Zealand’s agricultural sector and each has advantages and disadvantages.

Surveyor believes in power of cooperative model, but says it’s up to farmers

Four months into his new job as CEO of Alliance, David Surveyor is really loving the challenge of heading a global business which is so crucial to farmers, consumers and New Zealand as a whole. He has always been interested in the agrifood space, as he terms it, and enjoys getting to know New Zealand through its agricultural producers.

Come on John, give them a break!

The last time I dared to question MIE’s desired reform of the meat industry, John McCarthy accused me of bias and warned me to watch out, if we are unlucky enough to run into each other. So this column will almost certainly result in another attack on my character and more threats to my personal safety!

Conditions not structures cause of red meat price drop

The pre Christmas surge of optimism, boosted by high beef and sheepmeat prices when export volumes were low, has largely disappeared. The impact of the drought in the lower North and South Islands has seen slaughter numbers increase dramatically at the same time as a series of negative events have reared their head in world markets.

Behaviour is the root cause of meat industry’s problems

I am not completely sure why we spend so much time and effort complaining about the meat industry or which problems we are trying to solve. However in the interests of encouraging progress and stimulating debate, I will try to define the problem: this appears to be that the meat processing and export sector is not profitable enough, whether in absolute terms or in comparison to dairy. Both may be true.

 

It is worth stating the unique challenges of the red meat sector up front. First, there is a market at both ends of the chain, procurement and sale of the products; second, New Zealand exports a higher percentage of its production than any other country which must travel further to reach its markets, not all of them equally buoyant; third, sheep and beef must be disassembled into multiple cuts of meat as well as many co-products, all of which are sold into a wide range of markets for variable returns; fourth the climate dictates when the grass will grow and livestock will be ready for slaughter; and last, but not least, the producer can choose when and where to send the livestock for slaughter except in a drought.

 

Statistics and financial reports show that only a minority of participants in the industry are making much if any consistent profit, whether farmers or processors. So the conclusion must be that everybody, except for a few good farmers or companies with a niche market, would be happier with a more profitable industry.

 

Everybody keeps blaming everybody else, but nothing seems to change, because individually the parties must attempt to survive at the expense of others. That is the fundamental reason for the state of the meat industry. It may seem obvious to outside observers that cooperation is the way to make progress, but the complex nature of the red meat industry poses a difficult dilemma. The answers are extremely hard to find; otherwise some genius would have found them already.

 

MIAG thought they had found the answer – merge the two cooperatives – and MIE, after promising not to make the same mistakes as MIAG, seem to be taking the same path. In 2008 Owen Poole, Alliance Group Chairman at the time, tried to achieve an industry grouping with 80% of processing capacity, as the minimum required to create a robust business model, but this foundered on lack of agreement between the larger processors.

 

When preparing the Red Meat Sector Strategy, Alasdair Macleod of Deloitte started out from the premise that Zespri and Fonterra were the models for the meat industry. But he soon realised that the meat industry’s characteristics and complexity made it different.

 

In the 1980s Pappas Carter proposed the concept of Tradable Slaughter Rights as the best way to bring about industry rationalisation; this was raised again last year as an option by me and with greater publicity by retiring Beef + Lamb NZ chairman Mike Petersen.

 

Three of the major processors, the cooperatives and ANZCO, with just over 60% market share took this idea to government, which rejected it, unless 80% of farmers and processors were in favour. While seductively attractive at first sight, on reflection TSRs only suit some players, because they will reduce farm gate competition, while protecting less efficient processors.

 

In any case it seems to be impossible to achieve the agreement of such a high percentage of either farmers or processors. There are still enough farmers who want to maintain their traditional livestock supply methods and stock agent relationships to make such uniform behaviour unachievable.

 

There are also quite a few highly efficient farmers out there who are profitable, based on high lambing and calving percentages, good pasture management, intelligent use of technology and constructive relationships with their processor of choice. Equally there are several privately owned, efficient and profitable processors who would be seriously disadvantaged by the introduction of tradable rights.

 

Farmer ownership is touted as the answer to the challenge of controlling the value chain, because in good times there should be bigger profits and farmer ownership would mean farmers would keep these higher profits, which is not necessarily true. It is often forgotten that meat companies, like all processing businesses, must invest in modernisation and new technology, or they will become steadily less competitive. Profits must be reinvested in maintenance, new plants, new technology and people, not just paid out to shareholders.

 

It will be interesting to see how the successful MIE backed board candidates find life on the boards of Alliance and Silver Fern Farms. The realities of the meat industry, especially cash flow, balance sheets and banking covenants, will concentrate their minds on these critical aspects at the expense of more idealistic ambitions.

 

Ownership carries risk. Therefore farmer ownership of both ends of the value chain entails double the risk of losses, when world markets collapse, unless payments to suppliers suffer correspondingly. The present exporters, both privately owned and cooperative, have the expertise to move between 85% and 90% of New Zealand produced red meat and co-products which is a far more complicated exercise than exporting 90% of dairy exports in the case of Fonterra.

 

Obviously processing over capacity contributes to loss of value in the industry, while it also affects behaviour – both forcing processors to pay more than is economically sensible for livestock and encouraging cash flow generating sale of inventory at less than optimum prices at certain times.

 

However it is wrong to blame the structure of the industry for lack of farming profitability. If there were a perfect balance between supply and demand (impossible to achieve in a seasonal industry), processors would pay a consistent price at all times, neither too much nor too little. Overall, farmers would still receive a fair, but possibly lower, average price for their livestock than under the present system.

 

It is the companies’ shareholders that lose from the present competitive environment with excess capacity and those shareholders may either be farmers or corporate owners. In the long run those companies losing the most money, which are by definition the least efficient, will have to go out of business.

 

The losers will be the shareholders and the banks, as well as the suppliers who have livestock at risk at the time of receivership. Merging the two cooperatives will involve a huge write-off of surplus assets with no guarantee of long term survival.

 

I am not trying to pretend that all is right with the present industry model with no improvements possible, but, judging by the reaction from the farmers who attended MIE meetings in the first half of 2013, I sense many of them have an unrealistic expectation of the potential improvements.

 

It also seems that farmers think it is all the fault of the processors and exporters and, if somebody waves a magic wand to merge the coops and enforce farmer ownership of the industry, it will all come right. But life isn’t like that!

 

For a start red meat does not have a premium position in global markets that guarantees all New Zealand production a top price. Those markets are there, but they are comparatively small; however meat exporters are adept at shifting all types of product into different markets at a whole range of price points. Occasionally they have too much inventory and prices drop which leads to accusations of weak selling.

 

When one combines that scenario with procurement competition, some farmers do well, but there is an impression of a dysfunctional industry. So the question is what can be done to correct it. The usual solutions proposed are rationalise capacity and move to single desk selling.

 

The first one costs money and is hard to achieve in a free market except through receivership or voluntary plant closure; the second one is naïve and will never work. Ultimately farmers must get on and do what they are best at, except they must use more logic and do it better.

 

Logic dictates that, unless farmers have very deep pockets, they cannot lead and pay for industry restructure; but what they can do is adopt farming practices which will lift them up the curve and bring in higher profits, by using the technology and information available from, among others, Farm IQ, Beef + Lamb NZ and Primary Growth Partnership investments.

 

The next piece of logic could equally be termed common sense. Work with your processor of choice to ensure that you are producing livestock to the required specification and delivery for which you receive a transparently fair price. If you aren’t happy with your relationship, either because your processor isn’t transparent, fails to accept stock when agreed, uses third parties for procurement or doesn’t convince you of their payment security, then change your processor.

 

The way farmers and processors behave in their dealings with each other will have the greatest impact on the future of the meat industry because greater trust will enable both parties to get on with what they are good at. Global market prices will fluctuate as they always have, but there remains solid demand and eventually profitability will improve.