Report Card

Friday 23rd February 2001

One of the characteristics of the New Zealand sharemarket is that some companies get little attention, despite having large businesses.

Meat processor and marketer Affco is an example. Its 40c share price and modest market capitalisation ranks it in some investors' minds as a market minnow.

However, as its latest annual report shows, it is a massive company with turnover in the year to September 30 of just under $1 billion. Its operating revenue of $993.4 million is 19% above the previous year while gross profit was up 77% to $23.2 million.

Perhaps the lack of attention the company gets is caused by the thinness of its profit margins. After interest and tax, it made just 1.2% profit on each leg of lamb or side of beef sold last year, although that is better than 1999's margin of 0.4%. After adding in Affco's share of associate company profits, its final margin is bumped up to 1.5% (0.8%).

In cash terms, the picture is even worse. Its operations received $1.9 million more than they paid out last year, a margin of 0.2%, although that is markedly better than 1999 when they showed a shortfall of 0.1%. This low level of operating cash flow does not indicate the company is able to return to paying dividends, which the report says is being considered.

The problem with low-margin companies is that there is little room for weathering adverse conditions. Fractionally higher costs or lower prices for its products can quickly turn a profit into a loss. That might have happened last year to Affco if it had not cut costs by $45 million.

No mention of profitability is made in the directors' report, which prefers to dwell on measures such as the return on average equity (nearly doubled to 14.4%) and earnings per share (more than doubled to 7.4c).

One of the reasons for low margins is the meat processing sector has too much capacity. Affco says there are still too many killing chains chasing too few stock. It is dealing with this by increasing its international customer base and presence. It now has 14 offices overseas, driving the sale of 5000 products to 101 countries.

Although margins may be slim, at least they are moving in the right direction. So are many of the company's other numbers. Let's not forget that two years ago Affco turned in a $72.9 million net loss after going through massive restructuring. Retained earnings have turned positive for the first time in quite a while and shareholders' funds stand at 44.4% of total assets, up from 42.7% in 1999.

The prospects for Affco partly depend on the fallout from mad cow disease sweeping Europe. Meat sales are down drastically in many countries, and it is not clear whether consumers are turning to grass-fed stock such as New Zealand offers. Affco says it is also monitoring early reports that BSE has been found in British sheep.

Industrial action by MAF vets, if sustained, could also affect profits.

Growth opportunities are offered by a joint-venture plant in China, which opened in May, and plans to increase the purchase of beef and lamb from outside New Zealand to ensure year-round supply to customers. Sales of higher margin chilled meat also appear to be increasing.

Curiously, despite a lengthy report by chief executive Ross Townshend, no hints are offered about the company's outlook for 2001. The company appears to be on the mend but there is some way to go before it can be considered as blue chip as its size suggests it should be.

David McEwen is an investment adviser and author of weekly sharemarket newsletter McEwen's Investment Report. Email: davidm@mcewen.co.nz

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