Options for funding the beef recovery
The Australian beef cattle herd dipped to generational lows in 2016, primarily due to severe drought in large parts of New South Wales and Queensland over a period of years. This prolonged dry period forced several years of above average cattle turnoff, however industry forecasts now indicate the national herd is now on a re-building trajectory.
A key driver in the turnaround was the favourable winter and spring rainfall patterns and market prices are being driven by strong re-stocker demand and coupled with a smaller beef cattle herd. Cattle prices have climbed to all-time highs, challenging the ability of under-stocked producers to buy replacement cattle.
For many Australian beef producers, particularly in the northern beef regions, the turnaround in seasonal conditions now brings about a new challenge. Producers must “walk the tightrope” in restocking their land while maintaining the financial capacity to meet ongoing operating expenses and finance repayments during the revenue lag (between cattle purchase and subsequent sales).
At risk during this time is equity; navigating the restocking phase without further eroding equity positions until such time as the business reaches a long term sustainable operating position.
What is required from producers and financiers?
The significant up front cost of livestock purchases may not be matched by significant income generation for a number of years. The length of time will depend on the operating model adopted, be it breeding and growing, or the shorter turnaround cycles of cattle trading. During this period, producers will bear both the upfront cost of cattle purchases and the “cost of carry” to get an animal through to its target market specifications.
In order to navigate this period producers will be required to have a clear expectation of their interim and peak funding requirements. From there, a tailored and clearly defined funding requirement can be developed.
In order to understand the funding requirement, a re-stocking strategy needs to be considered in conjunction with a detailed cash flow forecast model that includes sensitised scenarios for a range of possible outcomes. These scenarios would take into consideration some downside risks that could have an impact on the funding requirement, such as:
- Sensitivity to downward movement in cattle prices in subsequent years as the national cattle herd rebalances. While this scenario may provide excellent trading opportunities for savvy producers, there will still be a peak funding requirement that needs to be understood in order to position the business to take advantage of these opportunities as they present. Sale prices (in future years) cannot be guaranteed, making revenue difficult to forecast (and revenue could be at levels lower than the current market prices).
- Production costs (per kilogram of beef sold) may be higher than the historical average, where livestock are held back from sale in order to achieve higher sale weights or for herd rebuilding – overhead coverage can decline when operating with a smaller herd at the same time that overhead costs are not declining proportionally. Cost efficiency decreases when stocking rate is below optimum carrying capacity, and this needs to be factored into working capital calculations.
- Seasonal and other general production risks that producers manage on a day to day basis. The business can be more sensitive to these risks when recovering from drought, with studies suggesting land degradation remains a key risk to be managed (potentially over a period of years) once the drought has broken. Carrying capacity may not return to usual levels immediately after the season breaks and interim stocking rates may need to be adjusted in order to minimise the risk of asset deterioration.
Solutions - what options are available?
The options available will depend on the producer’s position at the start of the recovery phase. Producers can be grouped as follows:
Producers with strong balance sheets who are able to restock primarily from existing cash reserves or unused lines of credit, and can navigate the recovery phase with little additional external funding. These producers are well-placed to act on market opportunities – for livestock and property – and accelerate productivity improvement programs. However, these producers will be mindful of financial hurdles (debt or equity) being achieved. Scrutinising transaction opportunities remains ever relevant.
Producers who will be reliant on additional funding to navigate the period in conjunction with a potential restructure of finances. These producers could be at risk of short-term tight cash flow as upfront payments may not transpire into revenue for some period of time. It will be important for producers in this category to have a clearly defined “road map to recovery”, and to be proactive in working with their respective counterparties in tailoring a commercial outcome.
The range of funding options has broadened, in addition to the traditional sources of debt, in recent years to include:
- Specialist livestock financiers
- Forward supply contracts (typically for finished livestock but now also for future offspring, for example) with or without cash advances
- Co-investors, joint venture partners and various other forms of agreements between value chain participants
- Crowd funded offerings (though generally only on a smaller scale)
Producers who may unfortunately come to the realisation that they do not have the required equity to navigate the period using the current owner / operator business model. These producers will need to look at other solutions, such as:
- Entering into lease or agistment agreements as a landlord. Given the relationship between seasonal conditions and the national cattle inventory, the demand for agistment or lease arrangements is likely to be lower than in recent years as many regions now have the benefit of plentiful pasture. However, the free cash flow generated from lease or agistment may not be sufficient to meet the commitments of a highly leveraged business
- Divesting part of the business to be able to continue operating on a smaller scale, and within a sustainable debt/equity ratio
- Entering into a sale and (long-term) lease back arrangement (or agistment agreement as a tenant) where the livestock business continues without the corresponding land ownership (and associated term debt). This option represents a subtle but distinctive change in business model, where the owner of the land is not associated with the operator of the business, the so-called opco-propco model.
- Divest the business and move onto the next chapter of their life. Again, early diagnosis will allow a strategic sales process that may take as long as several years to fully execute.
Some of these decisions may be difficult, but early consideration and diagnosis is our best advice.
Matthew Donovan and Jackie White