The future looks bright

The outlook for the Australian agribusiness sector over the next five years is promising, provided companies have a clearly identified risk strategy, writes Christopher Niesche.

When the then Labor government banned the export of live cattle to Indonesia four years ago over claims of cruelty in abattoirs, supplier Elders was halfway through loading a ship for export to the Asian archipelago. The move might have come as a surprise, but it didn’t catch Elders off guard.

“What do you do to manage disruptions to your business? You do scenario planning. You set aside time during your strategy development time and talk about various scenarios that would negatively impact the company and then you ask what you would do about it,” says Elders chair Hutch Ranck FAICD.

The company, through managing director Malcolm Jackman FAICD, worked closely with the government and with the industry association to resolve the crisis. It already had a system in place to track its cattle and ensure that only approved abattoirs handled its beasts, and this became the industry norm. The live export ban was lifted after only a month following an agreement on animal welfare between the industry and government.

The “full-blown crisis”, as Ranck described the event, is an example of the many challenges agribusinesses face and an example of how quickly things can change.

Like all directors, agribusiness directors need to have a good understanding of their business and where its products fit in the supply chain and markets. For those who gather around the board table of agribusinesses, this includes commodity markets and what’s driving them, how free-trade agreements will affect their products and other trade issues such as non-tariff barriers, and government regulations both in Australia and overseas.

As with many other agribusiness leaders, Ranck is currently optimistic about the future. “For the first time in a long, long time, the stars seem to have aligned to support agribusiness in Australia,” he says. “The reason for that is the depreciated Australian dollar, firm and holding cattle prices, the pending free trade agreement with China and the completed free trade agreement with Korea.”

In its latest quarterly commodity price report, the Australian Bureau of Agricultural and Resource Economics and Sciences forecasts that the gross value of farm production will increase by 8 per cent in 2015-16 to around $57.1 billion, following an estimated increase of 4 per cent in 2014-15. At this forecast level, the gross value of farm production in 2015-16 would be around 16 per cent higher than the average of the previous five years.

Winners and losers

In Australian dollar terms, export prices of beef and veal, wool, wine, lamb, canola, live feeder/slaughter cattle, rock lobster, chickpeas and mutton are forecast to increase in 2015-16. In contrast, export prices of wheat, barley, sugar, cotton and dairy products are forecast to decline. Asia, in particular, is a huge opportunity for Australian agriculture. By 2030, Asia will be home to three billion middle class people, who will demand better quality food, including more beef and dairy and more packaged foods. The Department of Agriculture estimates that demand for food in Asia will increase faster than anywhere else in the world, doubling between 2007 and 2050.

Elders emerged from the global financial crisis in a weaker position, with a smaller share of key markets. The company divested its non-agricultural businesses and underwent two “tough” cost-reduction programs. “We emerged as a cost-effective agri-focused organisation with good opportunities in our key segments. Since the recapitalisation and refinancing, most of the decisions have been rewarding as opposed to being tough,” says Ranck.

Although the company exited non-agribusinesses, Elders remains a diversified agribusiness, with livestock sales and exports, wool and grain sales, production advice, farm suppliers and finance. It helps mitigate against the risk of drought, as does a geographic spread, because as Ranck points out, it is very rare that all of Australia is in drought at the same time.

Elders has a goal to produce a reasonable return, even in a bad market, and Ranck says it means the company has “no excuses in up markets or down markets”. He says the board goes through a mental checklist before it makes any significant decisions. “Have we unduly exposed the company to risk? Is there any risk associated with this piece of business that we haven’t clearly identified? Is the decision consistent with our capital light strategy? Is this an area that is part of our core competence? Is it synergistic with our overarching eight-point plan?”

Charlie Blomfield GAICD, managing director of consultancy Agricultural Management Company says directors need to strike a balance between taking a long-term view of where the business is going and responding to short-term crises, which can be very distracting.

“Directors need to have a strict set of self-imposed constraints that allow the business to operate within a realm of control. There are a number of things in agriculture that you can’t control, including commodity markets, weather and what the government may decide to do or not do,” says Blomfield.

These constraints can include sticking to the core business and being wary of too much diversification, testing and validating new revenue lines before launching, and assessing how other changes might affect the risk profile of the business.

It’s also about planning. For instance, a business going into a drought won’t know how long the drought will last, but the board can make plans and decide that if the growing season isn’t positive by a particular date then the business will take steps one, two and three. “When people don’t stick to their disaster plan, that’s when things really go wrong,” says Blomfield.

Price volatility

While managing volatility is one of the key challenges for agribusiness directors, it can also work in companies’ favour if they understand how to benefit from those price margins. “Without price volatility, it’s pretty hard to make any money in commodity markets. You need that volatility to create a margin. If you understand the economics behind it, you can then start to participate actively in that market,” says Blomfield.

Almond producer Select Harvests, for instance, makes sure that it is in a position to take advantage of good prices. “The company has put in place strategies and operations to ensure that when we do have good years, we do very well. We think it is also important that the organisation understands how to mitigate risk in difficult years,” says chairman Michael Iwaniw MAICD.

“We look very closely at how the company operates in poor years and put in place a number of actions which will reduce the impact of the variations in the business caused by volatility in agricultural conditions.” An example is that the company spent capital on dryers and frost fans and introduced extended harvesting hours to reduce the risk of loss of yield and damage to almond quality during adverse seasonal conditions.

Following a number of poor-performing years, Select Harvests sold off some assets a few years ago to strengthen its balance sheet and now keeps gearing below 40 per cent so that it has more flexibility. The company also places a premium on its relationships with customers, reasoning that even during a global oversupply of almonds this will ensure that it will always be able to place its products. “As the chairman, I can meet customers and understand the market. I think it’s important that you maintain and develop customer relationships,” says Iwaniw.

Graincorp is a bulk commodity exporter and trader, but customer relationships are also important for the firm. “It’s actually getting to understand the customer better, working with them, becoming a trusted partner in their procurement side in terms of grain,” says chair Don Taylor FAICD.

“Our vision is to become more relevant to our Asian customers. We’d like to think in five years’ time, if they’re looking for grain from one particular place in the world or the other, that we will be able to trade them grain not just out of Australia but out of multiple origins around the world.”

The strategy can help mitigate the effect of price movements, which Graincorp can’t do anything about. Taylor says the variability of the weather is the bulk grain exporter’s biggest challenge, and as a result, not overinvesting, but also not underinvesting. The ASX-listed company has diversified into “adjacent” businesses which are not so weather dependent to try to reduce the company’s vulnerability to the weather. These include divisions which produce malt and crushing oil seeds. This is especially important now that declining global freight rates have eroded Graincorp’s competitive advantage over producers like the US when exporting to Asia.

Constant changes

Taylor says another challenge for the board is the ever-changing rules and governance procedures in agribusiness in Australia and around the world. “You have to recognise that sometimes things will happen which you might not have expected,” he says. “You might have a market that’s been importing then they have a big crop of their own. They don’t want to import, so they find some sort of non-tariff barrier to stop trade – they’re the sorts of things that are hard to anticipate.”

After Bega Cheese lost the takeover battle for Warrnambool Cheese and Butter, which would have increased its milk supply, to Canadian dairy giant Saputo, it had to look elsewhere for more milk, even as supply to the entire industry had shrunk.

The company embarked on a world-first program of working with farmers to increase their quality, sustainability and animal husbandry which customers are increasingly seeking – and just as importantly – co-funded business improvements with those farmers to help them increase their milk supply.

“When thinking about that sort of program, the board obviously has to think about the use of capital for that, how we could readily measure the return for that capital and indeed, like any project that isn’t off the shelf, think about the design of it,” says chairman Barry Irvin AM GAICD.

“It was a very good supply chain project but it hadn’t been done before. Again, what that required was making sure that (a) the decision was right and then (b) the governance around this group was correct and it required a new sort of thoughts around how to manage the risk on a project like that.”

It’s an example of the sort of creative thinking that is necessary in agribusiness, where companies operate up and down the supply chain.

One of the key challenges that Bega faces is reputational risk. It deals in a highly perishable food commodity and once a customer’s trust has been lost, it takes a long time to win back. The board mitigates this by keeping a very close focus on the production process and moving board meetings from site to site.

Irvin says that Bega limits its focus to a handful of dairy products so that it remains competitive in all of its product lines.

“We only invest in cheese and consumer-packaged cheese, dairy nutritionals, particularly in formula and cream cheese. You have to be disciplined and be very clear on what you’re going to do and how you’re going to deploy the capital. If that’s successfully done, you can have elements of your business that are not commodity exposed, the revenue is very secure, and the returns, although sometimes subject of pretty robust competition, are fairly reliable,” he says.