Has beef turned a corner?
Do recent rises in cattle price mean we are turning a corner, or is this a temporary aberration?
The Agribusiness Bulletin
The Agribusiness Bulletin focuses on national and local industry, as well as cross-industry insights and trends. This includes some of the drivers we expect to shape the future of the industry and potential challenges that may arise.
Beef has been and will be an important contributor to Australia's economy – it is one of the few industries outside of mining where we are relevant on a world scale. We are the seventh biggest producer in the world and the third largest exporter; so small gains can make a big difference to us as a beef-exporting country.
With recent rises in cattle price the question we’ve been asking ourselves is – are we turning a corner, or is this a temporary aberration?
Whilst all has not been well and there is definitely some pain out there, we argue in this article that beef may be worth a look with fresh eyes.
There are a number of factors why those in the beef industry and those investing in the industry should be optimistic.
The Australian cattle herd is at record lows. Given drought conditions and the destocking that has occurred, MLA estimates that the herd will fall to 26.8m head by June this year, the lowest level in 20 years. Supply is already tight and many graziers have enjoyed reasonable rainfall in recent months which is a positive for saleyard prices. Herd rebuilding is the name of the game now and MLA predicts it will be at least two to three years before levels reach those held before the most recent dry spell. Life is tougher for those having to rebuild breeding herds, but a sustained period of firmer prices will assist cash flows and market sentiment.
The Australian dollar
The macro environment is also favourable with falling domestic interest rates and a much stronger US currency driving our dollar below 80c. When you're in an industry that exports as much of its product that beef does and most of that is in US dollars it is a beautiful thing. Most economists will tell you the Australian dollar has been trading above its fair value for years and this is a natural adjustment. Of course they can never tell you when it will get back to that level, but it would appear most commentators are saying the balance of probabilities is for further softening of the AUD.
The China-Australia Free Trade Agreement (FTA)
We have previously set out in detail our Deloitte Access Economics team's view that the China – Australia FTA would have a subdued but positive effect on beef production and prices. The fall in tariffs making our product more price competitive in China isn't the real story. The real story is that Chinese consumers will now see that their government has given Australian produce a ‘de facto’ government approval and legitimacy on China’s supermarket shelves. The amazing growth of Fonterra in China is testament to what this legitimacy can bring.
The FTA underlines a theme we have spoken of many times, particularly in our Building the Lucky Country series, of the growing demand for protein from the emerging middle class of Asia. Our production will have no chance of feeding those masses, however the drag along effect of the demand will help. A lot. Particularly if we can exploit the opportunity in higher quality, higher value produce for Asian consumers.
No one can pick the weather and I am not about to, other than to say after a prolonged dry spell (and drought in many areas of Queensland and New South Wales), the odds are that we are closer to a wetter cycle. A good sign is that Northern Queensland, which has had a really troubled couple of years, has had some strong rainfall patterns this summer. The Bureau of Meteorology predicts a reasonably average upcoming autumn rainfall pattern, after being below average in prior years.
Input prices are also falling. Reasonable in-crop rainfall has resulted in lower wheat, barley, cotton seed, and other fodder costs for livestock producers. For instance, Darling Downs wheat has continued its downward trend of 2014, with prices down to $360 to $370 per tonne most recently. Recent pricing across the country also shows hay either steady or falling in most districts.
All these indicators point to an improvement in core profitability in the short to medium term.
However, core profitability is only half the equation of a good investment/lending proposition.
What is more important is the profitability in the context of how much has been invested, adjusted for risk ( the risk adjusted return on assets). We have been arguing for some time that land prices in some areas have been too high for the profit that many farms make. Reported returns on North Queensland beef farms of low single digits, were not sustainable, particularly given the business risk farmers take. There is a valuation/financial return gap which must be closed, although in the beef industry (with production cycles extending to years) these sorts of imbalances can take a long time to play out.
There are only two things that must happen to close the valuation/financial return gap, either land prices must go down, or profitability must go up. In recent times we have seen land prices coming down (and we will be watching the next ABARES farm returns report with interest - due in March), and with the recent changes in the market, profitability is improving. Whilst in some areas there’s a way to go before we see acceptable returns, with the positive signs we are seeing, beef is definitely worth another look.