Down on the farm

Friday 1st February 2002

Agritech company Tru-Test is expanding rapidly and considering a public listing. Roger Armstrong, who knows his sheep, is impressed with the company's wealth creation so far.

Kiwis do farming well - better than anything else, perhaps. It is in our collective national blood, with even soft-palmed, shiny-arsed office workers being able to tell the difference between a Border Leicester (long, aristocratic noses) and a Merino (horns, big hair).

Even after decades of manufacturing growth, farm production alone still makes up about 50% of our exports. Yet this sector is totally under-represented on the share market. Those agricultural companies that have shown up have not generally covered themselves in glory - Waitaki and Fortex both ended in disaster, and even market leader Wrightsons has had problems.

Any sharebroker on an overseas marketing trip would love to have a top-quality agricultural company to pull out of her briefcase. Investors should be searching for successful New Zealand agricultural companies that can take their expertise and products to the world.

That's why the investment community is so interested in little-heralded agritech company Tru-Test, which, after a year of break-neck expansion, is considering a listing this year. Tru-Test is owned mostly by staff, but has taken on two large institutional shareholders over the past year in what appears to be a precursor to listing. The board is already arguably the equal of any listed company, in terms of the quality of its independent directors. The recent acquisition of shearing equipment company Sunbeam will probably see the "go" button pushed on a public float.

Tru-Test owns a number of brands that, although not so well known in Parnell cafés, are icons down in the paddocks of New Zealand: Tru-Test milk meters and scales; Speedrite, Stafix and PEL electric fences; Cyclone fencing and Hayes fencing tools; as well as Sunbeam. It sells 95% of the world's milk meters, is a global leader in animal weighing equipment and number two in electric fences.

Investors take note: Tru-Test has a fantastic record of wealth creation. Many investors think the key to creating value is growth, but this is only half the game. To create value you have to also make a return on capital employed at a rate a higher than the company's cost of capital. On the New Zealand market, Baycorp, The Warehouse and Fisher & Paykel Healthcare are some of the very few high-return, high-growth companies. My bet is Auckland-based Tru-Test is set to join this elite group.

Returns? In the past two years Tru-Test has earned 35% and 38%, respectively, pre-tax return on capital employed and could break 40% in 2002. Growth? Since 1987 Tru-Test has averaged about 22% compounded growth in turnover, including that forecast for 2002. There have been a couple of small capital raisings but generally most growth has been funded through the company's strong cash flows.

Even stripping out acquisitions (Stafix, Speedrite, PEL, Cyclone and Sunbeam), the company tends to grow fast, with about 15% "internal growth" expected for this year. And Tru-Test has a track record of putting a turbo boost on those acquisitions it does make. For example, the Speedrite electric fence business has increased sales 314% over the five years of Tru-Test ownership.

Success drivers

Got the picture? I like the company. Okay, I own shares, but I'm just as likely to knock the management of companies whose shares I own as hype them. But Tru-Test has been successful, for two main reasons:

First, Tru-Test has invested in R&D (6–8% of sales) in a field more associated with no.8 fencing wire than high-tech gadgets. Few of its competitors in the agricultural equipment area have a similar research bias. Tru-Test boffins have developed sophisticated and hardy scales for weighing cattle, bananas and agricultural products. The scales feed data into farmers' computers, helping the farmer analyse daily weight gains, for example, and improve herd management. The company's electric fences - along with those of fellow Kiwi company Gallaghers - are on a different technological plain to those of other world manufacturers. And the company dominates the milk meter market through delivering unfailing accuracy.

Second, Tru-Test controls its own distribution, both locally and overseas. This strategy has seen US sales alone grow from virtually nothing to become a substantial part of the business in 15 years.

On the expansion path, Tru-Test made three significant acquisitions last year. The under-performing PEL Holdings was picked up for only a modicum of goodwill. It was strategically significant for Tru-Test, giving the company market leadership in electric fences in New Zealand (about 65% market share) and Australia (about 50%). PEL also distributed conventional fencing products, which Tru-Test is expanding aggressively.

It then bought the Cyclone fencing business from Fletcher Building, picking up another great New Zealand farm brand at roadside stall prices. While not high-tech, Cyclone fencing gear gives the company huge economies of scale in New Zealand distribution. Tru-Test is now by far the largest supplier of goods (excluding fertiliser and fuel) to New Zealand farmers.

To cap it all off, Tru-Test ended the year with the purchase of the rural division of Sunbeam Australia. This adds another famous farming brand, but more importantly, when combined with Tru-Test's existing Australian operation, gives the company the most far reaching and efficient distribution network in rural Australia.

These acquisitions highlight another reason Tru-Test, if managing director Des Scott decides on an initial public offering, would be a good buy. In the agricultural market small companies can be bought cheaply, relative to earnings and assets. It is not a sexy sector, where companies with big chequebooks roam. The trick for Tru-Test is to transform the new businesses into better performers, either by better research and development on the product or by utilising the company's powerful distribution network to increase sales.

There's just one more thing that gives me a good feeling about Tru-Test: its "blue skies" product sitting in the wings - an electronic milk meter. Milk meters are used by herd improvement organisations, such as New Zealand's Livestock Improvement Corporation to measure each animal's productivity and link that back to the overall breeding programme. Currently this huge data-base operation is done manually using Tru-Test's mechanical meter. It is a lengthy process, subject to human error. The electronic meter would help eliminate errors and speed up the process, hopefully justifying to potential customers the big step up in cost. If the electronic milk meter takes off, Tru-Test's sales forecast of $130 million could conceivably grow 50% over a number of years, from this one product alone.

Agriculture is often thought of as a low-technology industry but the reality is New Zealand's farm productivity is higher than anywhere else in the world, partially because our farmers are more open to innovation. For example, over 40% of New Zealand beef farmers use scales to monitor stock weight gains, compared to only around 10% of US farmers. If farmers in other parts of the world catch up with our farmers in terms of sophistication that may be a bad thing for the country, but great news for Tru-Test.

Disclosure of interest: Roger Armstrong owns shares in Tru-Test and Fisher & Paykel Healthcare

Roger Armstrong
finn.ltd@ihug.net.nz

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