Neal Wallace: Vote all about profitability in farming

A season of high lamb prices could lull some SFF shareholders into a false sense of security.

Thursday's vote by Silver Fern Farms shareholders on a new capital structure for the company, is more than a poll on whether they are happy to inject new capital into the co-operative.

As with the vote last September in favour of an ultimately failed partnership with rural servicing company PGG Wrightson, this vote was also a litmus test of whether farmers support the status quo production-driven meat company business model, or whether they want to change to a market-driven model as proposed by Silver Fern Farms.

Farmers well know the ailments in the meat industry - overcapacity, procurement wars by companies needing to maximise animal throughput, a lack of profitability, a lack of product innovation - and they want change.

But, SFF runs the risk that a season of lamb prices 30 per cent higher than last, could lull some SFF shareholders into a false sense of security.

This past season was an anomaly, following three previous seasons of woeful lamb returns, but healthy bank accounts could give the perception all was well. The need for change remained, but meat companies have once again shown a reluctance to take those necessary quantum steps even though they can take little credit for last season's higher prices.

Two-thirds of that increase was due to a more favourable exchange rate and the balance to a world shortage of lamb. This was why the SFF vote has become a weather vane of farmers' appetite for change.

SFF has shown a willingness to make the hard decisions and next week's vote was another case of the company reinventing itself, albeit out of financial necessity. Those difficulties stem largely from its protracted and, some say, ill-advised $150 million debt-funded takeover of Richmond, which has left its balance sheet still needing bolstering.

Shareholder equity slumped to 34 per cent in 2005-06 and interest-bearing debt and bonds in August last year was $245 million. By year's end, debt equity was expected to improve to over 50 per cent and debt to below $150 million.

In the past two and a half years it has closed five lamb and one venison processing chains, focused on its food business, disposed of non-core assets, repositioned and rebranded itself and launched a new plate to pasture integrated supply chain business model, supplying product to customers in the form they want it when they want it.

Chairman Eoin Garden said part of that evolution was to strengthen the company's finances but also to reduce reliance on debt funding and the risk of redemption.

It was also about generating greater profits in an industry which traditionally has judged success on market share not on profitability or market returns. And herein lies the greatest problem facing SFF - convincing farmers to concede some ownership - but not control - of their co-operative, to raise fresh capital, a conflict which scuppered Fonterra's restructuring proposal and is the scourge of co-operatives.

While trying to appease shareholders by enshrining in them 60 per cent of voting shares, SFF has also risked alienating outside investors who can buy tradeable shares in the company but not have any control.

Brokers have already said they would not advise investors to put their money in the company because of the lack of influence, but the industry's traditional lack of profitability and low return on investment could also be a barrier.

Garden accepts this as an issue, but argues that if the business performed and was profitable, farmer-shareholders would not want to sell their shares.

"The sad thing is that the debate and concern is about the ownership model and not the profitability model."

Here he has a point: SFF argues the capital raising was part of a total restructuring package which would fundamentally change the way it - and most meat companies - have traditionally operated.

The fresh capital was not to fund a production driven model aimed at maximising animal throughput, but to fund mistakes of the past, specifically the legacy of the Richmond purchase, and to invest in the future.

Fonterra's restructuring was ankle tapped by concerns the company would have to pay two masters - farmers for milk and dividends to shareholders, and SFF shareholders have similar concerns.

But there was one very significant difference.

Market dominant Fonterra set the national milk price but the meat industry was more competitive and competition would set the price.

SFF faces a challenge of not only paying competitive prices for livestock, but also growing its portion of market returns through its new business model to generate higher income to pay dividends to investors.

It was a tough task, the company accepts, but a model widely used in other industries.

Mr Garden said to achieve those dual goals required investment and he wanted that to come from the company's owners, for them to see value in the direction the company was headed and reap the rewards. Those rewards would come from the culmination of two and a half years of initiatives to reinvent itself.

Project Rightsize, which aligned processing capacity with stock availability; Backbone contracts for livestock supply; joint ventures in non-core business such as processing and marketing meal and tallow; investing in x-ray and robotic technology; and the purchase and integration of Rissington Logistics and Marketing.

Another part of the restructuring package was changing the company structure, reducing from 10 to five the number of farmer directors, removing the ward election system and increasing from two to three the number of independent directors.

Some shareholders have baulked at this, but the company argues that its new business model meant it needed directors with specialist skills.

Mr Garden said a no vote by shareholders was a sign they were happy with the traditional model - a notion he clearly disagreed with and has support from a recent Ministry of Agriculture and Forestry report on the meat industry which found that most people it canvassed believed the meat industry "has been systematically underperforming".

The MAF report said the industry's future lay in creating value from its products rather than competing on price and cost reduction alone.

The industry has made all the right noises about a vision of an economically and environmentally sound industry that invested in innovation, had a greater focus on the market and was more co-ordinated across the value chain, but MAF said there was little confidence those strategies would be delivered.

Traditionally, the meat industry has measured success on what it paid for livestock today, and for farmers that would remain a crucial yardstick, but the company wants them to look at industry profitability as a more relevant measure.

Chief executive Keith Cooper said should the restructuring proposal get the support of shareholders, the success of SFF in five to 10 years would be measured by the portion of animals bought on the spot market compared to those contracted for its integrated plate to pasture programme and the success of its automated lamb processing and the volume of product sold as fast moving consumer goods packs.

The meat industry needs to change, but the sector has shown little inclination to do so collectively. With this vote, SFF shareholders can initiate that change. If they reject the restructuring package they need to ask themselves who would front up with the capital the company obviously needs.

It would also leave begging the question what would it take for shareholders to change and modernise the performance of one of our largest export industries.

SILVER FERN'S TRANSITION

* Debt and bonds in August last year were at $245 million but debt should drop to below $150 million this year.
* Five lamb and one venison processing chains have been closed since 2006.
* The company has disposed of non-core assets and rebranded itself.

- OTAGO DAILY TIMES