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Opinion: Meat company's books bleed red ink, but turnaround predicted

By Simon Louisson of NZPA

Friday 28th April 2006

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Corporate New Zealand has been in such rude health in recent years investors have only paid cursory attention to balance sheets.

Back in the 1980s it was a different story and tables on cash flow were scrutinised carefully (or should have been).

This week, Dunedin headquartered Primary Producers Co-operative Society (PPCS) released a half year result that raised a few eyebrows when the cash flow numbers were examined.

It showed the country's biggest meat company, and one of the biggest employers with over 9000 staff, was haemorrhaging cash like one of the animals its workers slaughter.

Net operating cash for the six months to March 5 flowed out to the tune of $143.1 million.

Chief financial officer Rob McFarlane said this was a normal seasonal pattern for PPCS and indeed was a $14m improvement on the same period last year.

He said it turned around to a positive $20m by year end in 2005.

Formed in 1947, PPCS started marketing meat for farmer shareholders disillusioned with existing companies. It began acquiring meat works in 1982, starting with Canterbury Frozen Meat, and has since acquired plants from Waitaki, Fortex, Waitane, Mair, and Richmond. It operates 24 plants.

There is no doubt times have been tough in the meat industry due to falling meat prices, the high dollar and rising costs. PPCS warned a month ago it faced a $7.4m interim loss.

In fact, the pre-tax trading loss was $26.7m but an unrealised $19.4m profit on the sale of property on the outskirts of Christchurch reduced the loss to $7.3m.

PPCS sold the property just before balance date on a deferred payment basis and it will be some time before it receives the payment of around $30m. Settlement date was not disclosed.

The half year trading loss was a hefty $23.3m turnaround from last year's $16.1m trading profit.

A tax credit of $4.2m cut the bottom line loss to $3.1m, against a $13.8m profit a year ago.

The cashflow shortfall has been bridged by new borrowing of $155.8m. PPCS's borrowings, apart from $123m of retail bonds, rose to $415.3m from $380.3m at August 31, while shareholders' equity fell to $233.7m from $236.1m at August 31.

As a result, PPCS's equity-to-debt ratio has dropped to just 25% from 32%.

Two accounting professors spoken to by NZPA said that ratio was a concern and lenders would be watching that figure carefully in the second half.

"Three dollars of debt to one dollar of equity is getting very high - much higher than their competitors," said one.

PPCS has breached banking covenants with respect to earnings-to-interest-cost ratios on its retail bonds. Its bankers, led by Westpac, have waived the covenant. PPCS said the breach does not affect interest payments and "based on current profitable trading, we expect to satisfy the requirement for the remainder of the year".

The negative cashflow can be explained by looking at PPCS's trade receivables, which have risen to $179.6m from $135m at August 31 and inventory which has risen to $373.3m from $259m.

While these are assets, such a rise is normally considered a warning signal, pointing to slow payments by debtors, and or, slow sales.

With PPCS it is partly explained by the incorporation into its accounts of Hawke's Bay met company Richmond, bought after a bitter six year battle for a pricey $140m. It also reflects the very seasonal nature of the meat industry, plus tough meat markets in Britain and Europe.

PPCS said that if it had a March 31 balance date like rival Affco, it would have reported a $13m half-year trading profit.

"We still have strong orders for our lamb products into UK and Europe, but they haven't been necessarily as quick as we would have liked. To an extent, we are holding some stocks," said McFarlane.

"It may the nature of the meat industry - the inventories get cleared out, the debtors pay their bills and so the assets come down dramatically," one accounting academic told NZPA.

"But at last balance date, the shareholders' funds were 32% of assets and they have now fallen to 25% - maybe that's normal for them, it's hard to know - but certainly the people who have lent their money to them will be watching them."

PPCS's interest bill is likely to rise sharply again, having jumped to $10.9m from $8.8m a year ago.

PPCS is not listed, but reports its result because its retail bonds are publicly listed. Yields on PPCS's July 2007 bonds with a coupon of 9.75% have risen to 11%.

As a co-operative owned by its supplier farmers it does not pay an equity dividend. Shareholder suppliers are paid a rebate at years-end based on the result. It may be lean times on the farm this year and if cashflow doesn't track as forecast, they may have to dip into their pockets.

PPCS promised a "more profitable" second half but that assumes a resumption of traditional stock flows, plant efficiencies, a positive contribution from North Island operations following restructuring and "correctly reflected market returns".

Lamb prices have been in decline for two years and fell rapidly in 2005. PPCS processes 37% of the country's sheep exports, 35% of the beef and half of the venison. It has nearly $2 billion in annual turnover.

It said the first six months were the lowest months of profitability and this year was more difficult than most, but markets were improving.

"The trading results for March and April to date reflect these changes and are above budget."

"We are, therefore, on target to produce a positive trading result for the 12 months ending August 31, 2006, with shareholders' funds projected to exceed $260m at that time."

The extent to which the result and balance sheet is propped up by property sales will make interesting reading.

"We have various thousands of acres of land and as cities encroach on land holdings we are taking the options to sell them," said chief operating officer Keith Cooper.

"We are reviewing everything and saying `if it is not core to the business, do we need to hold it?' There is nothing new in this."

He said it was a good time to sell, given rural property prices.

There have also been rumours of meat plants on the block. Those rumours, and others, prompted PPCS earlier this year to send top staff a reassuring internal memo.

PPCS said its higher inventory reflected attempts to get higher margins by dealing directly with end-users and forward orders were ahead of last year despite the difficult market.

The annual report due in six months will make interesting reading.

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