Richmond beefs up to near recovery

Friday 22nd February 2002

Who'd be in the meat processing industry?

This is a business with huge capital needs, uncertain stock supplies and feast-or-famine cashflow cycles. Also, in the past couple of decades, there has been enormous oversupply of processing capacity, leading to ruinous competition for stock.

Given this, it is no wonder so many companies in this sector have flirted with bankruptcy. The industry is consolidating into a few highly efficient processors that have a realistic chance of delivering attractive returns for their shareholders.

One of these is Richmond, whose latest annual report portrays a company on a strong recovery path after some difficult times and confident about its future.

Chairman Sam Robinson in his review wastes no time in crowing about the company's "record year" before pointing out that operating profit was lower than forecast.

"Notwithstanding some disappointment in the level of operating profit, there is no doubt shareholders are seeing benefits of our value-adding programmes resulting from a wide range of strategic initiatives taken over the past four years. The company is financially stronger than at any time in the past five years, in terms of its balance-sheet strength and operating performance," he says.

These points are open to interpretation. The improvement in its balance sheet is created by booking a $50 million capital notes issue last year as an asset. While capital notes have some equity characteristics, investors with a conservative approach tend to treat them as debt.

Richmond's report indicates noteholders can redeem the notes for cash, which is definitely not a feature of equity and also describes them as "unsecured, subordinated debt."

By treating the notes as an asset, Richmond can pull together $178 million with which to offset its $351 million asset base. This is a ratio of 51%, which is considered prudent.

Put the capital notes on the other side of the ledger, however, and the ratio falls to 37%, which is a far more aggressively leveraged balance sheet and two percentage points lower than a year earlier.

To be fair, at no stage does Richmond describe its notes as equity - although it does portray them as an asset.

As for operating performance, it is true the company nearly doubled net profit in the year to September to $20.7 million on sales of $1.4 billion. On the other hand, this is a net profit margin of 1.47%, which most businesses would sneer at. It is a good performance only when compared with the bad ones of the late 1990s.

Meanwhile, net operating cash flow slumped to a $29 million shortfall against 2000's $13 million surplus. This is despite the company forecasting a surplus of $35 million in its capital notes prospectus.

The shortfall was caused by a blowout in accounts receivable to $34.3 million from $8.2 million and a $22 million increase in inventories to $103 million.

The only explanation given in the report is a note saying, "The original forecasts contained in the prospectus were based on the 2000/2001 business plan. The variances that have arisen to this plan are the result of variations to normal trading patterns which include fluctuations in exchange rates with consequent impact on trading results and the level of current assets and liabilities." More discussion on this important matter would have been welcome.

A highlight of the report is chief executive John Loughlin's commentary. This gives a clear yet succinct description of the opportunities and challenges facing the company while painting an appealing picture of how Richmond is transforming itself from a traditional slaughterhouse business into a modern food company. The annual report is so well designed it almost makes the company look glamorous.

It quickly becomes apparent that he is a significant factor in the company's success and this is reflected in Mr Robinson's comment that Mr Loughlin's appointment to the board "is a strong signal of the confidence the board has in his leadership."

While Mr Loughlin may be the right man for the job, the board seems a little light on experienced meat industry executives. An example is former Air New Zealand chief executive Jim McCrea who, for all his talents as an aviation industry leader, gives no indication in his director's profile of knowing one end of a cow from the other. Having an aviation executive on the board of a meat company makes about as much sense as putting a banker in charge of an airline.

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

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