Meat industry reform is back in the news in recent weeks with the long awaited release of the Meat Industry Excellence (MIE) report ( Pathways to long-term sustainability). The MIE perspectives have been well known for some years and so there were no real surprises in what they said. According to MIE, the most important issue is dealing with industry over-capacity through plant rationalisations and company amalgamations.
I will return to MIE’s solutions at another time, but here I want to look at the underpinning analyses provided by international consultancy company GHD, and some key insights therein that could easily be lost. When it comes to finding solutions, losing those insights would be a great pity. For Silver Fern Farms in particular, some of those insights make uncomfortable reading.
GHD are described in the report as an engineering and related consultancy company with extensive experience in the meat industry. They also work in water, energy, buildings and transportation.
In this article I will focus specifically on sheep. The issues for sheep and beef, and therefore also the solutions, need to be considered separately. In sheep there are more processing companies, more processing facilities, and lower facility utilisation than for beef.
One of the most important insights of the GHD analyses is that low utilisation in the sheep industry is essentially a problem of the three big sheep processing companies. The report does not make that explicit, but the underlying figures do.
The three big sheep processing companies of Silver Fern Farms, Alliance and AFFCO had a combined market share of 67% in 2013/14. Capacity utilisation was only 49% for Silver Fern Farms, even lower at 46% for Alliance and even lower still at 37% for AFFCO. ANZCO and Ovation are the two remaining multiple plant operators with a combined market share of 17% and capacity utilisations of 51% and 53% respectively. Then come the seven single chain operators who have a combined market share of 16% and average utilisation of 63%.
We can be reasonably confident of these results, given that the key calculations depend on information that is public. So in terms of plant utilisation, then small is indeed beautiful.
That raises some very interesting questions. What are the single chain operators doing that allows them to utilise their plant more effectively? The report provides no answers on that.
A second key insight relates to the variable and fixed costs for each company. These fixed costs are the plant-related costs. They exclude corporate overheads, marketing costs and finance costs.
The outstanding feature here is that Silver Fern Farms has variable operating costs about $3 per head higher than the rest, and fixed costs that are another $3 per head above most other companies. Putting those together, whereas most companies have combined per head costs of about $32, Silver Fern Farms has costs of $38.26. Relative to Alliance, Silver Fern Farms’ per-head costs are $6.17 higher. Relative to Ovation, the industry cost leader, per head costs are $10.01 higher.
The question has to be asked as to whether these costs are accurate. The GHD report provides no definitive answers to that, simply saying that the data are sourced from within their own company. However, if the data are accurate then this means that Silver Fern Farms has a considerable problem. And if the figures are not accurate, then why would GHD risk its reputation by presenting them?
Some years ago I asked a new director at one of the big companies what was the biggest learning from his first year of being a director. He replied without hesitation that it was how slim the margins are between a big profit and a big loss. And that has to be right. For the big companies, the difference between a multi-million profit and a multi-million loss is less than $1 per head. No company can be competitive if it is at a $6 per head disadvantage.
This issue has to be particularly crucial for Silver Fern Farms given that it is currently seeking new investment capital. Given that Silver Fern Farms processes over five million sheep per annum, it apparently puts them at a disadvantage of more than $30 million on their processing operations. That is a lot to make up through superior marketing.
If Silver Fern Farms cannot counter with data to show that GHD has got the numbers wrong, or that GHD is not being comparing like to like, then the challenge to get investors has just increased. The only potential counter argument I can see is if Silver Fern Farms can demonstrate that they are doing more value-adding than any of the other companies and that this also affects their costs. In relation to some companies that argument may indeed be possible, but overall against all companies that argument would seem challenging.
The GHD solution to national overcapacity is for 13 of the 34 plants to be closed down. They say that five of the plants that should be closed are currently owned by Silver Fern Farms, three are owned by Alliance, three are owned by AFFCO and one each by ANZCO and Ovation.
If this were to occur, then GHD estimates that Silver Fern Farms could trim their per-head costs by $5.61 per head but they would still be $1.91 per head above the new industry average cost and $6.11 behind cost leader Ovation. The other big players – Alliance and AFFCO – would become fully competitive with the medium and smaller companies with the exception of cost leader Ovation which would remain the stand out at $26.54.
Given these challenges that Silver Fern Farms faces, it is not surprising that Alliance, the other co-operative, lacks enthusiasm for any merger. High operating costs plus high debt make Silver Fern Farms an unattractive suitor.
There are more gems to be drawn from the GHD analyses which underpin the MIE recommendations. I will deal with those in future articles. But already it is evident that both the gems and the devil do indeed lie in the detail. So who will buy Silver Fern Farms sheep operations?