There is widespread agreement that some form of consolidation in the New Zealand red meat industry is necessary. There is also widespread acceptance that there is a problem with over-capacity in the sheep-meat part of the industry, although this is probably not the case for beef. The challenge is to find pathways to solutions that solve more problems than they create.
I am on record as saying that the opening game that we need to focus on, while working on finding more long-term solutions, is to get farmers aligned to processors. But some others are saying that we need to combine the co-operatives right now. So here I look at some issues that need to be addressed, and what a combined co-operative might look like.
Both the Chair of Silver Fern Farms (Eion Garden) and the Chair of Alliance (Owen Poole) have said that the co-operatives are holding discussions. Eion Garden emphasised at the Meat Industry Excellence meeting in Christchurch on 17 April that any proposal had to be ‘bankable’. I interpret that as meaning that not only does it have to be commercially viable, but it will need to get the approval of the relevant banks. The reality is that neither co-operative has a future without the support of their banks.
As of September 2012, Alliance had total assets on their books of $580 million, and liabilities of $285 million. The equity of $295 million was $12 million less than 5 years earlier. So essentially, Alliance has been drifting backwards over this period. Three years of profits from 2008 to 2010, albeit declining, were wiped out by losses in 2011 and 2012. That would not be comforting to the banks which held debt finance at September 2012 of $197 million.
When a company makes no long-term profits, questions have to be asked as to the value of their long-term assets that are tied up in generating the income. In the meat industry, the plant and buildings have minimal alternative use, and the land itself may need considerable remediation before it can be otherwise used. The greatest value may well be in the industrial land use and discharge consents that are attached to the land. And even these may have little value.
Accordingly, the banks are likely to look past these fixed asset values and focus on the current assets comprising inventory and trade receivables, but net of payables. In the case of Alliance, current assets minus payables total about $249 million. This is more than the interest bearing debt of $197 million, but not a great deal more.
During the current year, inventory at Alliance should decline from a very high level of $190 million, and seasonal financing should also decline accordingly. But the worry for any banker will still be that there is only a modest surplus of readily saleable assets (the remaining inventory and receivables) to cover the remaining debt.
With Silver Fern Farms, some of the specifics are different but the overall picture is no better, with some ugly numbers. The equity as recorded in the books is $349 million (including co-operative supplier shares as assets rather than liabilities), up from $242 million in 2007. So at least on the surface, Silver Fern Farms has been moving forward. In part this has been due to new equity capital raised.
However, liabilities at Silver Fern Farms has also increased, from $413 million in 2007 to $447 million in 2012. Perhaps more importantly, current liabilities are at $428 million whereas current assets are only $375 million. Interest bearing loans are $317 million. This would be a worry for any banker.
Combining the two co-operatives would be far from simple. To start with, Silver Fern Farms is a hybrid co-operative, with shares freely tradable. Shareholders do not have to be suppliers; anyone can purchase shares on the so-called ‘Unlisted’ Exchange. There are approximately 100 million of these shares, currently valued at 61c. My own view, which I have held since Silver Fern Farms moved to this hybrid structure some years back, is that although there was a clear logic to what was done, it made any potential amalgamation with Alliance much more challenging.
Some may even challenge whether it is still meaningful to consider Silver Fern Farms a co-operative. However, it does meet the technical definition, with most of the supply business being with members, and governance still in the control of farmer-appointed directors.
Assuming that the two co-operatives did agree to combine, the combined entity would initially have assets (as at September 2012 book figures) of $1376 million, liabilities of $732 million and equity of $644 million. By balance date 31 September 2013 both assets and liabilities could be expected to decline somewhat due to lower inventories and also lower associated working capital.
Bringing these two co-operatives together would require revaluation of all assets. Given the over-capacity, it is reasonable to assume that some fixed assets would decline in value and hence the liabilities (mainly debt) to equity ratio would increase to perhaps 2:1 or higher.
The challenge with the above is that bankers are going to demand more equity. A co-operative as such has limited options, and neither are such funds readily available from external investors for a troubled and declining industry such as sheep processing.
So what is the conclusion? Unfortunately the conclusion is something that many of us have known for a long time: there are no easy solutions for the New Zealand sheep industry. Such problems are not unusual for industries that are getting smaller and that is the sad reality of the sheep industry.
However, the sheep industry is not going to go away. It will remain the favoured farming system on land where dairy is not economic. On those land classes it can be profitable. But it will be a smaller industry than in the past, and there is more pain to be borne, particularly in the processing segment of the industry.
In the meantime, I will keep promoting the notion that the sheep industry, as a first step, has to get farmers aligned to processors, and stop the Sunday night spot pricing, that leads to so many of the bad behaviours in this industry. But that will only be a first step towards long-term rationalisation and some consolidation.
22 April 2013