The Shoeshine Column: Plenty of iron in Affco's new cut

Friday 8th December 2000

Affco chief executive Ross Townshend was a disappointed man at the end of the September year. The company's annual revenue was a record $993.36 million. Another half a truckload of lambs, he observed, and Affco would have been a billion-dollar company.

He must have been even more disappointed with the market's reaction to the profit announcement. Another year of solid recovery from the $73 million loss of 1998 - when it was clobbered by drought, the Asian crisis and asset value writedowns - and the shares fell 4c to 43c.

At $15.1 million, the gain wasn't as big as some had been hoping for. What's more, it included a one-off $4.5 million net gain due to "asset impairment reversals" without which the profit would have been $10.6 million, up a mere 65%.

Townshend wasn't apologising but he did note many shareholders had a 50c entry price and wouldn't be happy until they had their heads above water.

To Shoeshine's mind, investors are still pricing the shares with the past rather than the future in mind. Given the meat processing industry's appalling record of wealth destruction that's understandable but Affco isn't the company it was two years ago.

Last year's shortfall on the market's expectations was due mostly to the weather. The mild winter meant farmers had plenty of grass and hung on to their stock, leaving holes in supply of both cattle and lambs.

Consequently there are now some whopping beasts coming onto the market. There seems no reason Affco should not make in the first half of this year the money it didn't make in the September half. Supply shortage notwithstanding, the company has increased its market share in almost every species.

That's the result of one of the many changes Townshend has overseen since he arrived from Anchor Products in August 1998. Affco now offers farmers futures contracts with which they can lock in prices well before processing.

Other developments on the home patch are worth noting. Over the past two years $45 million of annual cost has been slashed.

This year it set up a joint venture with Landcorp Meats and Wanganui Meat Processors to combine marketing and processing in the southern North Island, creating a larger more efficient unit.

It also joined up with Germany's Raspe & Paschen, "a world force in natural casings for the sausage industry," in a move calculated to shift Affco's raw product further up the value chain.

But the real drivers of the company's future are in its moves offshore. The 30%-owned processing plant in China is accredited to McDonald's standards. The Big Mac has ambitious Chinese expansion plans which, Affco reckons, will alone account for the plant's total capacity if they come off.

Foreign supermarket groups and industrial buyers want to deal with fewer suppliers and are now demanding year-round supply. Affco is eyeing Australia and South America, both of which, it says, have seasons sufficiently different from our own to ensure 52-week supply.

The recently opened South American office will buy beef and lamb for the US, Canadian, British and Asian markets. Sourcing product from Argentina will allow the company to cash in on big volumes of currently unused European quota.

Because of a colder climate and lower stock counts per hectare, regions such as Patagonia in southern Argentina have the "organic" lambs New Zealand farmers find hard to produce. British demand for organic product is climbing and Affco says it can get even higher margins than it does for chilled lamb.

Affco's "internationalisation" serves two purposes. One is to extend its global reach and allow it to supply year-round.

The other is to reduce its exposure to New Zealand and the punishing stock procurement battles triggered by droughts.

Its so simple-sounding you wonder why it hasn't been done before. And there's a third reason to be bullish.

(At this point reader discretion is urged. There is a dire risk of provoking the Euros. On no account show your copy of NBR to anybody who sounds or even looks European.)

Cattle carrying BSE (bovine spungiform encephalopathy) have been found in France, Spain, Germany, Belgium, Italy and Holland. There is a strong possibility Affco, other New Zealand meat exporters, and farmers generally will benefit hugely from Europe's BSE woes.

For starters New Zealand has only 300 tonnes of beef quota into Europe but the spread of the disease in cattle is creating a big undersupply. That could lead European governments to increase quotas or even suspend them altogether.

The results of sheep testing are still awaited. Any detection of bovine spungiform encephalopathy will create the same situation for sheepmeat.

For sheepmeat two factors limit the potential gain. First, New Zealand already has a quota of 227,000 tonnes so the scale of the new opportunity is considerably less than for beef.

Second, there is the "safe side" factor - for both species the BSE scare will inevitably reduce demand for red meats of any sort, no matter where they come from. Time will tell how big a factor that will be, and for how long.

There is another potential opportunity to keep an eye out for. If the British sheep flock has to be slaughtered the Poms will need to start again from scratch. Who better to help them restock than New Zealand with its scrapie-free sheep?

There's no such thing as a sure bet but Affco can no longer be criticised for inertia in a changing world. Townshend and new chairman Sam Lewis have the get-on-with-it attitude many directors and executives, as Telecom's Roderick Deane noted recently, would do well to emulate.

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