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Home / Business / Companies

<i>Allan Barber:</i> Finding solutions for meat industry

By Allan Barber
9 Sep, 2007 05:00 PM6 mins to read

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Opinion

KEY POINTS:

Recent debate in the meat industry has been about the disproportionate success of dairy farming in comparison with the poor returns from sheep, weak selling by New Zealand exporters, and whether a merger of the two South Island co-operatives will solve the problem. At least the kiwi dollar has gone in the right direction over the past month, but there's still a way to go before export prices will start to meet expectations again.

The call by two shareholder groups, Alliance and PPCS, for the co-operatives to merge finally resulted in the respective boards commissioning PricewaterhouseCoopers to conduct a review of the companies and make recommendations for improvements.

The review is now in the hands of the boards, but nothing has yet been made public about the contents.

So an analysis of the industry's ownership options might give some hints as to which direction the review could take when considering the prospects of a merger.

There are now four main processing company ownership structures in the meat industry. Until about 30 years ago there were just farmer-owned co-operatives and subsidiaries of overseas companies with interests on several continents. These survived, even flourished, in the days of heavy subsidies and large processing volumes.

Today farmer co-operatives still survive in the South Island, there is one public company, AFFCO, ANZCO is vertically integrated into the market thanks to Japanese interests holding a 73 per cent share, and there are several privately owned companies.

But the impact of the exchange rate, coupled with weak prices, has placed the performance of all companies under stress during the past two years.

There's no doubt when times are hard it is really important to have low debt and strong shareholders prepared to ride out the tough times, which is why Talley's is critical for AFFCO, the Japanese shareholding is really important to ANZCO, and strong individual owners are essential to private companies. Of the co-operatives, Alliance has successfully kept its balance sheet strong permitting reinvestment in its plants, whereas PPCS has struggled with its debt loading since the ill-advised takeover of Richmond.

I would be nervous of any proposal to merge the two co-operatives, because it would not be a marriage of equals. There will have to be rationalisation of processing facilities in the South Island, where the two companies will have more plants than necessary to process the declining sheep population, assuming that ANZCO's subsidiary CMP, Blue Sky Meats, and AFFCO's South Pacific facility are all there to stay.

The big question, with or without a merger, is whether the balance sheet and bankers will sustain the asset write off. In the case of a co-operative with shareholders who depend on payments for livestock supply for their profit, there is no strong major shareholder able to take the long view. The stability of the co-operative must lie in its collective strength as a result of processing and sales efficiency, leading to competitive livestock payments. When times are tough, loyalty is severely tested. My concern about a merger of PPCS and Alliance is that it won't really solve the problem of weak selling, neither improving returns to farmers, nor having any impact on the exchange rate. Instead it may end up weakening the stronger company without rescuing the weaker one, the net result being a $3 billion turnover with an unsustainable level of debt and inadequate profits.

There seems to be a view that Fonterra's success can be replicated in the meat industry, but it's not that simple.

Public and private companies make up at least 40 per cent of the meat industry, the WTO and major export markets wouldn't accept marketing by NZ Inc, and dairy exports are currently high-priced commodities.

Critical to success are logical marketing structures, co-operative not competitive selling programmes, supplier loyalty and above all a consistent exchange rate not driven by domestic expenditure patterns.

AFFCO, A DIVERSIFIED FOOD GROUP

Less than 10 years ago, AFFCO was in a serious, if not terminal, state in urgent need of yet another capital injection. It was one of three meat exporters of roughly equal size with turnover of just under $1 billion a year, and it was entirely North Island based.

Today it has a strong balance sheet with a majority shareholder holding 51 per cent of the company, it has a plant in Southland and it has expanded into the dairy industry, at the same time forming part of a diversified food group under Talley's control.

The model under which AFFCO is operating is completely different from any other meat exporter. The Talley's group of companies is involved in processing and selling produce eaten with every course of the dinner menu - seafood, fish, meat, vegetables, ice cream, and cheese. This, according to AFFCO Chairman Sam Lewis, will strengthen Talley's in negotiations with overseas supermarket chains which exert considerable power, especially over single product suppliers.

AFFCO holds 44 per cent of Dairy Trust, which has bought land at four AFFCO plants to build its dairy factories while enjoying the benefits of existing resource consents and effluent disposal permits.

This provides an inexpensive entry to the dairy industry which hasn't yet been reflected in AFFCO's share price and the investment will provide a buffer in times when international meat and dairy prices move in different cycles as they are at the moment.

FROM SHEEP TO DAIRY

Since the removal of subsidies 20 years ago, the landscape has changed dramatically. First, hill country previously used for sheep and beef changed to pine trees, and then hundreds of thousands of hectares were irrigated and converted to dairy. Lifestyle blocks have further eaten into farm land.

Nowhere has this process been more marked than in Southland and mid Canterbury where much of the best sheep farming land has gone to dairy. Prices may have been cyclical, with sheep recovering at times, but the trend is irresistible. Once the financial commitment to dairy is made, with the cost of cows and infrastructure, there's no going back.

Anecdotal evidence says there are clearing sales booked in Southland every day between January and May next year which means more than 100 farms going out of sheep. Most of them will convert to dairy.

This raises a whole raft of issues such as water supply, environmental impacts, pressure on dairy herd availability and prices, reduced lamb - the one product in which New Zealand is a world leader - for export markets, and implications for the economics of meat processing.

* Allan Barber is a meat industry consultant and former CFO with Affco.

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