Transaction news: March 2014
Australia’s Northern Beef Cattle Industry
Weathering the perfect storm
Drought, international politics, a fluctuating currency and product prices, falling property values, live export “bans” and unsustainable debt levels. A few of these factors impacting an industry would give most participants pause for thought, but all of them occurring simultaneously? It’s enough to drive you out of the industry – and sadly for many in Australia’s Northern Beef Cattle Industry that is exactly what is happening.
A bill currently before Federal Parliament calling for the introduction of an Australian Reconstruction and Development Board1 is a timely reminder of just how desperate the current crisis is for many operating in the Agriculture sector of the Australian economy, particularly those trying to operate in the beef cattle industry. The Australian Reconstruction and Development Board will be tasked with developing policy and financial structures in support of Australia’s food and fibre industries, but it remains to be seen how this bill will develop.
"With access to capital still restricted to many in this industry, it is critical operators are able to demonstrate to key stakeholders an efficient, flexible operating model and showcase management’s ability to adapt quickly to market shocks and implement change,” EY Partner, Chris Munday says.
Three key challenges facing the industry
- Unsustainable debt levels & falling property prices
In 1980, debt in Gross Value Farm Production (GVP) in Australia was at 32%2. Over thirty years on, this has since escalated to historically high levels of debt, reaching its peak at 135.4% in 2012.
Just as the residential and commercial real estate markets saw unprecedented growth in property values throughout the late 1990’s, and early to mid-2000’s, pastoral land prices also rose rapidly. Combined with readily accessible capital markets, banks’ lending to much higher Loan to Value Ratio’s (LVR’s) and farmers’ borrowing appetites increasing, gearing levels increased significantly during this period in the Australian beef industry.
Post the Global Financial Crisis (GFC), financiers became reluctant to lend to the historical LVR’s seen throughout the 2000’s, and this has significantly impacted industry members. The resultant loss of access to capital has affected numerous industries since the GFC, and none more so than the beef cattle industry, in which many participants had previously relied on higher gearing to raise working capital.
With the subsequent fall in property prices, unsustainable debt levels have been linked to materially reduced land values, in many cases eliminating land owners’ ability to finance desperately needed working capital.
In recent times, EY has observed flow-on effects of mounting debt and serviceability issues, including:
- Lack of maintenance and upkeep on farm machinery, equipment and buildings
- Lack of reinvestment in herd and/or breeding stock, resulting in gradual declines in stock quality and increased mortality rates
- Reduction in use of supplements also leading to reduction in herd quality and weight
- Cattle being sold earlier, at lower weights and profit levels, in order to address cash flow shortfalls
These issues are not always immediately recognisable, but can lead to longer-term impacts on carrying capacity, profitability and sustainability of cattle operations - eroding value for all stakeholders.
Drought has significantly intensified the financial pressures many industry participants are now facing, with 26 local governments in Queensland (representing almost 65% of the State’s pastoral area)3 now drought designated.
The level of annual rainfall has a significant effect on the industry's overall performance. During drought conditions, farmers are forced to reduce stock numbers, leading to material increased slaughter rates in domestic markets and driving down prices.
Favourable weather conditions allow farmers to strengthen herd numbers, which tightens supply and pushes prices upwards.
The industry has been further impacted by the previous Federal Government’s decision to temporarily ban live exports in 2011, after continued pressure from animal activists amongst others.
Indonesia has traditionally been Australia’s largest destination for live cattle. Indonesia’s decision to reduce quota numbers following the live export bans meant numbers hit a low-point in 2012/13 with 271,000 head exported4.
2013 saw a considerable rebound in these figures with some 454,152 live cattle exported to Indonesia (well over 50% of the total live cattle exported), the highest since 20105, with further increases to 750,000 forecast by the Indonesian government for 2014.
However, the elections in Indonesia this year have seen a significant increase in political rhetoric and changing view-points, such as the recent announcement that 25% of all future imports would need to be ‘productive heifers’6. Amongst the evolving Indonesian policies, Meat and Livestock Australia believe the 2014 total will be closer to 610,000 head, a 36% increase on 2013 figures7.
These frequent and often unexpected policy changes from both Governments have made it difficult for Australian producers to plan ahead and understand the demand cycle.
Implications and opportunities for investors and lenders
The challenges listed reveal a number of implications and opportunities for stakeholders. Industry participants are operating in an environment where operational planning is critical and the ability to be able to react to change is paramount. With no end in sight to the current drought conditions, it is inevitable some players will be forced to exit the industry in the coming months.
Financiers need to carefully monitor their customer’s security position and/or equity value, which in many instances, is being eroded due to an inability to finance a re-investment in herd, replace fixed assets, and maintain existing machinery and equipment.
Better industry operators have good herd management and planning practices that link into their financial processes and therefore better manage the impact of short-term cash shortfalls. It is important to understand how your business manages their herd in both the short and longer term, to ensure sustainable carrying capacity and ongoing productivity.
Those that survive and prosper will be the ones who have sound operational and financial management processes in place, an eye on the implementation of operational efficiencies and finally, maintain stakeholder confidence through open communication and the provision of accurate and timely reporting.
Questions to ask yourself
- Are secured assets being eroded due to lack of maintenance and upkeep?
- Are cash flow issues affecting the ability of the business to reinvest in the herd? Are cattle being sold ‘underweight’ in order to address cash-flow issues?
- Does your client have the right systems and processes in place to manage both their herd and their financial position?
1 Reserve Bank Amendment (Australian Reconstruction and Development Board) Bill 2013- On 12 December 2013, the Senate referred the Reserve Bank Amendment (Australian Reconstruction and Development Board) Bill 2013 to the Economics Legislation committee for inquiry and report: http://www.aph.gov.au/Parliamentary_Business/Committees/Senate/Economics/RBA_Amendment_2013
2 *EXPLANATORY MEMORANDUM RESERVE BANK AMENDMENT (AUSTRALIAN RECONSTRUCTION AND DEVELOPMENT BOARD) BILL 2013
3 65pc of Qld now drought declared – 21.01.2014: http://beefcentral.com.au/p/news/article/4152
7 McRae, T & Thomas, B, 2014, ‘Australian cattle industry projections 2014’, Meat & Livestock Australia, 2014