Heavy market share losses affect Silver Fern Farms’ financial performance

In recent weeks there has been an exchange of views about PPCS’s acrimonious takeover of Richmond in 2003. Keith Cooper, ex CEO of the renamed Silver Fern Farms, emerged from anonymity in Middlemarch to castigate the appointment of Sam Robinson to the board of Silver Fern Farms as the Shanghai Maling representative. He was critical of Richmond’s rejection of the original approach by PPCS to buy the Freesia Investments shares from the Meat Board in the mid-1990s and Robinson’s role as Richmond’s chairman.

Changes at the top for both meat cooperatives and a return to profit for Ferns

The announcement by Silver Fern Farms which signalled a return to profit, albeit a small one, also heralded a changing of the guard. Keith Cooper will retire as Chief Executive at Christmas following Rob Hewett’s move into the chairman’s role earlier in the year.

 

There is a neat synergy about these developments which are mirrored by the changes at Alliance Group where Owen Poole handed over as chairman to Murray Taggart at the last AGM, while Grant Cuff has already announced his retirement as CEO. There will inevitably be speculation about whether either or both have been pushed or have gone in their own good time.

 

The word from the respective chairmen is that both Keith and Grant have gone entirely of their own accord after many years of loyal and competent service in one of the most competitive and bruising industries there is. It wouldn’t surprise me if both, especially Cooper, have decided there must be a less stressful way of spending their working life before they reach the age at which they want to put their feet up.

 

Running SFF during a period of substantial industry change involving seriously reducing sheep numbers, cut throat procurement competition and a perpetually weak balance sheet must have taken its toll. That said, Keith has always been unfailingly prepared to answer phone calls and questions while fronting a lot of the meat industry’s essential public relations issues.

 

Grant Cuff has taken a completely different approach, probably because he is by nature much more reticent than his counterpart; he was also content to take a backseat role and allow his chairman and predecessor as Chief Executive to front the industry restructuring issues. Alliance had had its worst period back in the late 80s after acquiring Waitaki’s South Island assets and under Poole’s management had never allowed itself to fall back into a similarly stressed financial position.

 

While not profitable every year, Alliance has successfully navigated its way through the last 20 years with its balance sheet intact as well as making the right investment and rationalisation decisions at most points along the route. The company remains a genuine cooperative based principally in the South Island. Cuff’s contribution as a manager and more recently as Chief Executive should not be underestimated.

 

SFF has had a much more colourful time over the same period. It entered the 90s as Primary Producers Cooperative Society (PPCS) with no assets outside the South Island, but had a reputation as a hard-nosed, tightly run business that did things its own way without showing any weakness to its competitors. Fortex which collapsed in the early 1990s learned the hardest way of all the rashness of baiting PPCS in its own back yard.

 

By the early 2000s PPCS, under CEO Stewart Barnett and chairman Robbie Burnside, fought a bitter campaign to take over Richmond based in Hawkes Bay. This takeover was eventually successful, although it weakened PPCS which became the country’s biggest, but possibly weakest, meat company. Supplier disaffection saw a steady loss of market share, while the asset base was in need of both rationalisation and reinvestment which has required substantial bank debt.

 

Keith Cooper took over from Barnett in 2006 since when he has led the company through a renaming exercise, the development of a high profile branded consumer meat business (although this is not yet necessarily profitable), sale and closure of a number of assets, establishment of FarmIQ and the conversion from cooperative to ordinary shares. This has been achieved in spite of heavy losses and a weakening balance sheet against a background of rumours about the company’s ability to survive.

 

At the present unlisted share price of just above 40 cents, members ordinary shares valued at $136.5 million in the 2013 annual report, have a market value of a little over $40 million funding assets of $833 million. This week’s announcement talks of debt being reduced by $100 million which will certainly bring down the $35 million interest bill as well as improve the debt to equity ratio, but the real need is for an urgent and significant improvement in equity.

 

According to the chairman Rob Hewett, equity options presented in the PriceWaterhouse Coopers report are still six months away from being able to be evaluated and presented to shareholders. It seems that a further move away from SFF’s previous cooperative status is inevitable.

 

The small $5-7 million unaudited pre and doubtless post tax profit is trumpeted as a $40 million improvement over the previous year’s result, but as a return on the massive asset base it is pretty minimal.

 

Cooper is getting out under better performance circumstances than would have been the case a year ago, but the jury is out on how successful his legacy will be. The new CEO Dean Williamson will need all his experience gained from running Riverlands as part of Brierley Investments meat business 20 years ago, as well as some new skills if he is to return SFF to fully profitable safety.

 

In retrospect and in spite of a much lower key tenure, Grant Cuff leaves the meat industry with a more substantial record of achievement.

Silver Fern Farms heaves sigh of relief

This week’s announcement by Silver Fern Farms of an unaudited pre-tax profit of $5-7 million for the last financial year signals a massive improvement on the substantial losses of the two previous years. But in spite of the $100 million debt reduction, it does little more than provide some breathing space for the company to review its future capital structure options.

Future of red meat promotion under threat

Next year’s Commodity Levy Act referendum is one of the factors concentrating meat industry minds on the question of red meat promotional investment. B+LNZ is currently conducting a consultation round with individual meat companies to find out how this critically important, if contentious, topic should be agreed for the benefit of all industry participants.

 

B+LNZ Chief Executive Scott Champion told me it’s too early to make any predictions about the outcome, at least until after completion of the consultation round at the end of September. With the referendum about 12 months away, the process is geared to providing time to gather enough detail for promotional strategy development before taking this out to farmers to test it in advance of the vote.

 

The purpose of the discussions with meat companies is to ensure market expenditure is aligned with what the meat industry wants while enabling B+LNZ to fund its essential activities which must now confront new pressures such as environmental constraints. Any new proposal will also have to satisfy levy payers or risk derailing the success of the referendum, although improved sheep and beef returns if maintained should make a Yes vote more certain.

 

The present mix of promotion funded by the farmer levy includes two main strands – the first is country of origin marketing for lamb in the UK, Europe and North America and for beef in China, Japan, Taiwan and Korea, supplemented by some jointly funded variations that support individual exporter programmes; the second comprises campaigns with matching contributions from participating exporter groups across a range of markets and products.

 

For example since 2011 exporting companies have put $1 million a year into sheepmeat promotion in UK and Europe to supplement B+LNZ’s budgeted expenditure. Equally a group of exporters has shared in a campaign to promote New Zealand grass fed beef in China.

 

This strategy has resulted in a move away from generic mass marketing and advertising to more tightly focused campaigns based on research and analysis. This has reinforced the importance of educating consumers on how to cook beef and lamb. In addition to the website, social media is becoming an increasingly important weapon in reaching the target market.

 

While many years’ brand development investment in the UK has resulted in 90% top of mind consumer recall of New Zealand lamb, research has identified the need for exporters to target consumers closer to the point of purchase because of lamb’s premium price position. A large part of the promotional work in Asia to support New Zealand beef has focused initially on the benefits of grass fed beef – low calorie, low cholesterol and low fat – for the premium restaurant trade as the most effective way to reach consumers.

 

Spending limited funds wisely, whether contributed by farmers or meat exporters, is a crucial issue for New Zealand’s red meat sector, both internationally and domestically. Withdrawal of promotional support as a result of failure to get agreement between meat companies and B+LNZ would effectively mean the industry has chosen to shoot itself in the foot.

 

An immediate issue is whether it will be remotely possible to obtain agreement of all MIA members to contribute funds for the purpose of country of origin promotion and, if so, how much. Of the larger meat companies, Silver Fern Farms’ CEO Keith Cooper has indicated a strong preference for company brand promotion as opposed to the generic alternative. Instead of glossy marketing in traditional markets, he would be prepared to consider some funding for educational promotion in emerging markets. Other companies are still in favour of country of origin New Zealand promotion in specific markets.

 

Since it often seems there’s as much chance of getting an agreed meat industry position as there is of formulating an agreed United Nations resolution on Syria, I suggested to Champion this might be a challenge. However he said he was ‘reasonably optimistic’ of getting an industry agreement.

 

The big question farmers and companies alike must consider is what the long term impact of ceasing all country of origin promotion would be. There will obviously be some changes to the current promotional mix to make better use of available money, otherwise B+LNZ would not be in discussion with the meat companies on developing a promotional strategy that better matches its objectives.

 

The unanswered questions are how much B+LNZ is willing to spend on country of origin promotion as against jointly funded activities and what the companies are willing to contribute to the general rather than individual good.

 

In my opinion the New Zealand brand is an umbrella under which individual company brand activity should function, but it isn’t realistic for any one company to achieve consumer recognition for its brand in one, let alone several, markets without that support.

 

It is obviously important for meat exporters to support their own branded programmes in selected markets, while the New Zealand industry maintains its competitive nature.

 

But levy paying farmers have both an obligation and a right to support their product both in New Zealand and overseas. B+LNZ is farmers’ vehicle for coordinating their investment by investing their levy funds to the best effect. The meat companies have an obligation to reach an agreement which will support this investment constructively. If not the red meat sector will be in danger of completely losing its way.

Unravelling the schedule gap between North and South Islands

Every year when livestock numbers pass their peak in the North Island, there is a constant stream of trucks carting stock across the Cook Strait to plants for slaughter. There are two obvious reasons for this – either there isn’t enough South Island capacity at the time or the cost of procurement plus transport is less than the price in the North Island.

 

These two explanations are two sides of the same coin, because there is no need for South Island processors to pay more than they have to when their plants are full. This is even more evident from the species with the largest price gap which is cull cows, possibly wider than it has ever been. However there is absolutely no point in paying dairy farmers over the odds for what is a fully depreciated asset they have to get rid of.

 

But the price gap isn’t restricted to cull cows, because the same applies at the moment to bulls and prime. Admittedly there aren’t very many of these species being slaughtered at this time in the South Island, but the current NZX Agrifax Farm Gate report shows a gap of 48 cpk on prime and 68 cpk on bull, $144 and $214 per head respectively at 300 kg.

 

So I decided to do some research into the variation between the two islands to find out if there was a more fundamental reason for the difference. All the companies spoken to were very willing to discuss the issue and provided plenty of logical explanations.

 

Alliance’s Livestock General Manager Murray Behrent reckoned the gap is almost entirely procurement driven, although he added the South Island pays lower levies than the North.

However there is plenty of evidence South Island farmers get lower rewards than their North Island counterparts, especially at certain times of the season.

 

There was general agreement from Silver Fern Farms, ANZCO and AFFCO on the importance of procurement competition in determining the main reason for the divergence between the two islands. But other factors mentioned include the seasonality of the South Island, a flatter kill profile in the North, relative plant operating and processing costs, differing union agreements and cartage costs, and a higher proportion of chilled production in the North Island.

 

Plants in the North have more ability to recover fixed overheads because of the kill profile which allows better utilisation of plant and employment of labour. Keith Cooper highlighted the respective scale and efficiency of Silver Fern Farms plants across the country: three times as many cattle processed in the North Island, but the same number of slaughter facilities, while two ovine slaughter plants process the same volume as four southern plants.

 

Conversely the shorter killing season in the South Island means higher labour costs and larger facilities capable of handling the peaks. Nor at this stage do sheepmeat operations in the South have the benefit of an extended bobby calf kill when lambs are not so readily available.

 

The lamb kill has changed markedly in recent years with both islands having a similar number of lambs to slaughter, compared with 20 years ago when the South Island had up to 50% more. Over the same period, but especially since the formation of Fonterra, the land use profile has changed dramatically to dairy, boosted by the increased dairy payout and rise in the amount of irrigation.

 

In spite of plant rationalisation, notably at Belfast and Mataura, carried out by both SFF and Alliance, they have found it a challenge to handle the change of processing configuration dictated by today’s land use. There is less opportunity to dedicate South Island plants to specific types of production and certain customers, while it is also harder to justify installation of machinery to save co-products which are an important source of revenue.

 

SFF operates on a regional basis within each island rather than on a North and South Island pricing structure, although the company continues to publish only two separate schedules which Cooper reckons are ‘pretty close to the mark.’

 

Another factor mentioned to me is the fact there is more contracting in the South Island, with the contract price generally being quite a lot better than spot prices. But North Island procurement prices are more volatile and are adjusted up or down faster than in the South.

 

The inevitable conclusion is South Island farmers suffer a price disadvantage because of a shorter season leading to the need to recover overheads over a shorter period and the resulting peak kills which cause backlogs at the very time farmers must get livestock slaughtered. They also suffer from being serviced by plants which are generally older than the North Island plants and which were originally built to handle a different mix of species. This must adversely affect the processing margin and procurement price.

 

Even taking all these factors into account, suppliers must question the justice of companies with operations in both islands paying more, in some cases substantially more, to their North Island suppliers. But judging by the reasons given to me, South Island procurement prices are unlikely to improve to the point where they match those across the Cook Strait. In that case raids by North Island processors are unlikely to stop any time soon.

Beef + Lamb NZ expenditure on overseas promotion under review

Next year sheep and beef farmers will have their five yearly referendum under the Commodity Levies Act when they get to vote on whether they wish to continue funding Beef + Lamb New Zealand as their industry good body.

Just what the doctor ordered, no way or only a matter of time?

There are three possible responses to the prospect of an overseas, probably Chinese, investor buying seriously into the New Zealand meat industry: bring it on, not on your life or it’s inevitable.

 

So far Chinese interests have recently bought a minority stake in Blue Sky Meats and an application to buy Prime Range Meats is with the Overseas Investment Office; ANZCO is just under 75% Japanese owned with New Zealand management and staff holding the balance. ANZCO’s ownership structure has remained like this for over 25 years bringing positive benefits to the company, its suppliers and New Zealand as a whole.

 

This year rumours have been rife of Chinese interests looking seriously at buying one of the remaining large meat companies. There aren’t too many likely candidates for sale, although Keith Cooper, CEO of the rumoured target, Silver Fern Farms, laughed when I asked him the question and said he had heard the rumours too. However he denied there was any truth in them.

 

If we apply the old adage ‘where there’s smoke, there’s fire,’ there are at least three compellingly relevant issues here: first whether the farmer shareholders would be willing to sell, second how much a buyer would be prepared to pay for the assets which are substantially funded by bank debt and third the OIO’s criteria at the time.

 

In light of Shanghai Pengxin’s $70 million deal to buy Lochinver Station, currently subject to OIO approval, and the political uproar it has created, it seems like a good time to assess the merits of selling all or part of a meat processor and exporter to overseas interests. The ownership structure of ANZCO clearly establishes a precedent, but my instincts suggest it could attract a different response today, especially if there is a change of government in September.

 

I asked Minister of Agriculture, Nathan Guy, for his comments, but his one line reply indicated unwillingness to speculate or comment on a private sale matter. However Damien O’Connor, Labour’s spokesperson, was happy to give me his thoughts on the issue. He agreed any application would almost inevitably meet the OIO’s present criteria for approving an acquisition. However he was very concerned at the potential loss of control of the whole value chain which would condemn New Zealand farmers to taking the price at the farm gate without the potential to benefit from adding value. He would support a change in the Overseas Investment Act, although it isn’t clear what form this would take.

 

O’Connor’s concern at losing the value chain was echoed by Rick Powdrell, Federated Farmers’ Meat and Fibre Chair, and MIE’s John McCarthy, but as McCarthy said, it will be up to farmers to determine the ownership stake in the industry they desire.

 

Overseas investment does not necessarily imply total ownership, as ANZCO’s shareholding shows. But the debate about foreign ownership is in danger of becoming polarised; broader, more relevant questions would be about sources of capital, whether local or overseas, the degree of ownership and the structure of any partnership. More important than any of these is the alignment of an investor’s values and objectives with those of the company.

 

The sale of productive agricultural land seems to be an especially emotive issue. The concern about overseas, specifically Chinese, ownership of farmland is driven by fear of one country becoming too dominant. The fast rise of China to be the biggest buyer of sheepmeat by volume and whole milk powder makes us nervous. However it’s worth remembering the hundreds of thousands of hectares of forest that were sold earlier this century in the central North Island without much objection.

 

Although overseas ownership of our meat industry is not a new development (remember the Vesteys), it is appropriate to reassess how we should react to the prospect of one of our meat companies being the subject of a takeover offer from a Chinese investor, most particularly what sort of criteria we would expect the OIO to impose on a prospective buyer to retain some control of the value chain.

 

In the event the target actually happens to be Silver Fern Farms, its status as a modified farmer owned cooperative and the amount of bank debt on its balance sheet are two relevant factors. If any investor tried to buy 100% of the company, it would be a complicated exercise, but more significantly it would risk alienating a large number of suppliers. They might take the money and run, no doubt many of them to the south.

 

Therefore a wise investor, Chinese or otherwise, would attempt to find an investment structure which preserves the loyalty of the existing shareholder suppliers and delivers value to all parties. An investment also needs to offer a return which has not always been easy to achieve in New Zealand’s meat industry.

 

One thing is certain. The election has already provided a platform for some political parties to play the foreign ownership card as a means of attracting votes. If there is a change, the motley collection of parties forming the next government will have the challenge of agreeing their position on foreign investment. To see how they honour their various election promises while maintaining New Zealand’s international trade commitments will be interesting to say the least.

Whatever happened to the importance of the fifth quarter?

There has long been a belief in the crucial importance of the meat industry’s fifth quarter to profitability. This somewhat obscure term refers to the co-products which contribute an essential revenue component over and above the value of the meat.

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.

Lipstick doesn’t hide the ugly truth

Silver Fern Farms released its annual loss accompanied by a press release which attempted to put some gloss on what was in reality an awful result. It was an improvement on the year before, a matter of some pride on the teleconference this morning, but a $36.5 million loss was only $5.8 million less than the previous year.