Wednesday 13th February 2002
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John Loughlin: Richmond achieved an operating profit last year but also had a negative operating cash flow of $29 million. There are several reasons for the negative cashflow.
- Our involvement in bobby calves was particularly capital intensive in 2001, as we had a significant growth in numbers processed as well as procurement share, and in addition to this the product values per head were up very substantially over the previous year. This reflected enormous strength in the product markets as well as some additional value added processing.
- The leather and wool sector of our business became increasingly difficult from July onwards and particularly after September 11. We agreed to delay shipping dates on quite a lot of intermediate sector goods in order to hold together sales with customers with whom we had longstanding relationships. This resulted in increased stock and debtors. Overall this was a successful strategy, but it had a significant impact at balance date.
- Our move toward deeper market penetration resulted in additional working capital utilisation. This is particularly true of our initiatives with lamb and venison in the European market and with beef in the North American market.
- Also, as I said to shareholder at our AGM - and did not like admitting it - I felt we did not display the urgency on moving stock late in the season and collecting debts that we should have done to produce a better outcome.
Our cashflow position has improved significantly since balance date and we are tracking very much in line with budget now. There are major seasonal effects in veal and venison which have now moved through the pipeline into the marketplace, and no longer consuming working capital and impacting on cashflow.
I don't like to comment on other companies, but in respect of the differences between AFFCO and Richmond I can say that Richmond processes and markets bobby calves as a principal activity, whilst AFFCO only toll processes and never takes ownership in the balance sheet. The timing of the calf business impacts heavily on August and September, immediately prior to balance date. Secondly, AFFCO is not involved in venison business which again requires the accumulation of inventories to service the Northern Hemisphere winter trade during their game season. Richmond is also involved significantly in added value leather processing, whereas AFFCO tends to be principally a primary processor and marketer of leather products. Finally, Richmond and AFFCO have moved in somewhat opposite directions in respect of some of our market activities, with Richmond expanding its in-market presence at the same time as AFFCO were contracting theirs. These factors would have contributed significantly to the differing cashflow positions.
John Loughlin: It is true that during the last quarter we were operating on very fine and at times negative total margins. However, at all times during that quarter we were operating at positive contribution margins i.e. contributing to fixed costs. The 2001 winter was a particularly difficult one and farmers were economically incentivised not to hold stock through the difficult climatic conditions due to high prices early in the winter. This is less likely to be a factor this year as climatic conditions have been very favourable and many farmers are putting in feed crops for the winter.
Our business is still largely a seasonal business, and is influenced by the timing of supply and the timing of demand. We were a little exposed last year by the lack of supply over the winter months where we had built up good markets which we believed would be important in the future. The negative contribution margins that we took to sustain this business still meant we were better off in the short and long term. However, we simply failed to earn the return that we were seeking during that period.
John Loughlin: In terms of research-based strategic initiatives in byproducts and other areas, it is our policy not to provide definitive comment on such matters.
We prefer to talk about byproducts as "co-products" because that gives them a more important focus and sense of significance. When we process an animal there are an enormous number of components which can be valuable in various ways. The Industry has exploited the easy muscles well in terms of its meat products, but there still remains significant scope for growth in value in many of the lower value meat items and in some of the other items which have applications in pharmaceuticals and other areas. There is a real opportunity for growth from value rather than volume.
John Loughlin: You are correct that Richmond's stated forward direction is value creation and margin growth and that we did not achieve a satisfactory result in terms of margins. Our per head margins were generally reasonably good last year but our margins as percentage of sales did not increase in proportion to product prices. I believe margins were largely eroded by the ongoing extent of competition in the North Island meat industry for the procurement of livestock. It was interesting that there was significant pressure out there which resulted in the exit of Te Kuiti Meats and Coromandel Meat Processors during the year. I believe these pressures were terminal for some companies and limited our ability to achieve our ambitions in this area.
I expect our margins to increase as we continue to differentiate our product and to create extra net revenue from the animal by taking up new opportunities for product extraction and processing. I also expect our margins to grow on a per head basis, and the numbers of livestock to grow due to herd expansions which have been occurring for some time now in beef and are beginning to occur in sheep. There is also genetic improvement increasing the amount of livestock available. Also I do not expect product prices to be at their current record high levels in New Zealand dollar terms too far into the future. The combination of rising product margins per head, increased volume and reduced product prices per head will have an impact both on margins as a percentage of sales and total cost profit generally.
John Loughlin: There is a very small impact from PPCS coming on board as a major shareholder. PPCS currently owns only 16.75% and Richmond continues to operate as a sovereign company. Having said that PPCS is behaving very positively as a sound cornerstone shareholder. The companies have quite different business mixes which is providing some opportunities with synergies in marketing, for example PPCS has particular strengths in the Pacific where Richmond does not whereas Richmond has particular strengths in parts of Northern Asia due to its heavy emphasis on beef. Synergies to date have been positive but not large. I think the biggest constraint has been that both companies have been working on their own plans and have their own targets for individual achievement. In the coming 12 months I would expect greater harmonisation of these and this to be important in unlocking synergies.
John Loughlin: The question of foreign exchange conversion rates is not a significant one for us. We basically hedge our receivables at the point of buying livestock and don't have large forward or unsold positions in the currency market. There is unlikely to be any material impact from forex conversion rates on a year by year basis.
John Loughlin: The five factors that explain our success appear to be:
- We have a very efficient, well-located processing infrastructure which is very advanced having evolved from three companies and been extensively reconfigured to meet our needs going forward.
- We have an extensive marketing structure in nine overseas countries and the local market, while elsewhere in the world we are supported by strong agents in various parts of our business with whom we have longstanding sales relationships.
- There has been a lot of focus on the culture of the organisation and building teamwork for success.
- We have had financial strength right through the period and have been able to invest in our business and have taken those investment opportunities well. That has allowed us to acquire or merge with competitors, rebuild the infrastructure and invest in the marketplace.
- I believe we have a high quality of management at senior and middle levels and have programmes to develop talented managers coming through.
John Loughlin: Yes we did invest both in working capital and in plant and equipment during the year. Most of the investment in working capital reflected the factors outlined in the answer to Question 1. I think there is improvement we could have made there, and indeed we have subsequently done so. In some areas we have worked to enhance margins. In some instances these are still at the embryonic stage, and have yet to pay back.
In the case of investment in plant and equipment, we operate in an industry which has been starved of investment for a long period of time because it had failed to generate the operating cashflows. The payback on the projects we put in place at Takapau, Oringi and Pacific is significant. There is generally a delay in terms of commissioning new plants and also again to run at their full potential. I would expect to see this clearly emerge when we hit full volumes during the 2002 financial year.
John Loughlin: The price risk for meat products is essentially borne by farmers as all companies tend to buy livestock and sell products in simultaneous markets which reflects the same price influences. Consequently the key for a meat company is the margin between the buying price for animals and the sale price after costs for products.
The outlook for meat products I believe is positive generally for lamb, particularly in Europe where the factors associated with foot and mouth have left that market undersupplied, and also in the United States market where we are growing our presence at retail.
Our prospects for beef are similarly reasonable for a three-year horizon. I don't believe we are at the top of the cycle yet and do not believe that we will be too far down the other side three years from now. I think it will be a fairly flat top, and I don't expect much upside from here and any seasonal downside with peak supply will be reasonably short-lived.
The venison situation has been very depressed as the market has come off significant high levels, with the descent quite steep. Venison supply will put a cap on the ability to recover pricing in the coming year.
In the case of mutton, prices have been at record levels at recent times reflecting a substitution of mutton for beef by manufacturers. I see a period of weakness in mutton pricing over the coming three years as this one-off effect washes out.
John Loughlin: We did write significant new business at the Anuga Food Fair, but details of this are commercially sensitive.
John Loughlin: The question of which countries produce the best margins is a complex one because it also depends on the methodology used to work out the best margins. Our business is basically a disassembly one and all animals have components which go to various markets. In respect of lamb, the forequarters may go to the Middle East, the French rack and loin may go to the United States, the legs and rump may go to Europe, the breast and flap may go to China, the pelt may go to Korea, the petfood items may go to the United Kingdom, United States or New Zealand and the tallow may go to Asia. All of these market options may present the highest overall margin combination for the animal reflecting the differences in prices for particular items. As a general observation though, we tend to get our best prices for lamb products in Europe; we tend to get our best prices for beef in North America; and we get our best pricing for venison from Germany, although at times the United States comes out on top. We get our best prices for leather items from Italy or Korea.
John Loughlin: In terms of my master plan for the business, I have given the business a good kickstart in the direction I believe it needs to go. I have seen my involvement in the business as being over 5-8 year duration and have just finished my fifth year. I don't yet have a fixed view on when it is appropriate to go, but have a very strong desire to go in the right way with a managed transition to somebody who can take the baton on and sprint the next leg of the race faster than I could.
John Loughlin: The move to the main board of the NZSE has been a good one overall for the company. It produced an immediate increase in share trading volume and unlocked liquidity for the longstanding shareholders. In saying that. many have chosen to reduce their ownership positions, which has really capped the performance of the stock. This is entirely understandable given the long held shareholdings, and the previous lack of liquidity.
I am also conscious that the track record of meat companies before us has not been good and that we have a major performance job to do to convince the market that despite our seasonal issues we should command a place in their portfolios. I am confident we will do that and this will be a real positive for shareholders in a value sense over time.
The most interesting positive and also negative in being listed is the fact that the standards required in terms of governance and compliance are very exacting and very close and you are subject scrutiny at a micro level by the Market Surveillance Panel. On balance I think this is very good and introduces strong disciplines into management and provides better outcomes for shareholders in the long run. In the short run it is demanding on management time and effort, much more so than being a public unlisted company. Also being a public company you are subject to more active scrutiny from the media which again is both positive and a negative.
John Loughlin: I do not believe the New Zealand investing community understands how our industry works. Of the four listed meat companies that went ahead of us, none of them are a compelling case for investment based on a sustained period of performance. The history creates significant grounds for suspicion, given the industry's quirks and its propensity for non-performance.
If Richmond is to progress in the way I want it to and capture the value I believe it can for its investors, we have a job to educate the market but more importantly to not let the market down with negative surprises. We have to be proactive in our communications, although with the benefit of hindsight I don't think we did well enough on the negative cashflow issue. We took for granted the seasonality of our business and failed to articulate the differences from other organisations. The market has treated us with scepticism for this, and in hindsight I accept their right to do so.
Because of the nature of the business we are conscious of the need to keep shareholders and the market informed about the variability that can be expected between first and second half result. This is evident in our history, and it will be the case again this year because of climatic conditions. While we are confident of an overall very good result that will please the market, the first half will be down on the previous year, and the second half outstanding.
John Loughlin: We have spent a significant amount of money on upgrading not only in the big projects at FoodTech, Pacific, Oringi and Te Kauwhata but also on a regular basis on all sites. We do have a very modern infrastructure which we are looking to keep at leading efficiency based on increased automation, and in incorporating new technology.
Financial benefits do take a little longer to flow as it takes time to get the machinery commissioned and running sweetly at high speeds. A bigger issue in getting the people culture right around the machinery so they utilise its capability rather than fighting it.
The investment in plant and machinery contributes to margins but not necessarily in a visible way. Our margins are higher because of the investment we have made than they would have been if we had not made it. They are relatively better but not necessarily absolutely better. The biggest driver on our margins is the pricing our competitors are prepared to pay for livestock viz a viz the sale return from components. I believe it will take a little longer than I had hoped to see the benefit of the margin improvement. However the investment makes our survival and ultimate prosperity that much more certain.
Of course, there are those in the industry who have not made a similar investment. While they seem to be prospering, without such an investment their operations will wither and they will not be there in the longer run. This is borne out by history. I am in my 10th year in the industry, and 10 companies have dropped out. In the short and medium terms they survive and do relatively well by not making an investment, but effectively they are selling the future.
The trend of rationalisation will continue, and as it does the more it will underwrite investor returns.
John Loughlin: I was surprised to be nominated for the Executive of the Year. I think there are other people in my industry and other industries who have achieved and would have been ready for that nomination. I also didn't feel I had achieved all I had wanted to in Richmond and it was like being measured while half way up the mountain. Nevertheless it was a great honour and I certainly got a very positive warm feeling from my nomination.
John Loughlin: I believe that the dividend will be lifted gradually over a period of three years. The 30%-40% of normalised earnings concept reflects the fluctuations you can have in the industry. Every year is different with different climatic conditions impacting on farmers capability to deliver and the market conditions impacting on demand. We are likely to be cautious in lifting the payout ratios as we can use internally generated capital to lower the risk profile of our business.
John Loughlin: The most frustrating part of the meat processing business is the variations in supply and the disruptions in the marketplace because stock is not available or because pricing expectations for farmers are out of line with the realities of the end product market. I believe we still have an adversarial value chain which is inhibited by too many external factors. I believe we could do a lot more to building consistent value our products with greater reliability.
The most rewarding part of our business has been to see farmer incomes rise significantly from the desperately low levels in the early 90s to good levels currently, at the same time to see workers incomes rising for the first time in 10 years and for this to occur at a time when our profitability is at record levels. To me this is a measure of real achievement, not only by Richmond but by the industry.
ShareChat thanks John Loughlin for taking part in this Investor Interview.
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