Late last year rural conglomerate Elders put an emergency recapitalisation plan to shareholders. Existing and new investors were asked to contribute $550m of fresh capital in order to repay the banks and put the debt-laden company on a ‘sustainable footing’. They voted in favour of the plan, but they should have kept their money in their pockets.
Today the stock market values the whole company at $170m and, despite knocking a large hole in its debt obligations, questions are, once again, being asked about its long-term solvency. In hindsight, the equity wasn’t worth anything when investors stumped up their hard-earned cash last year. The banks are happy – they’ve got half their money back and will get most of the rest back even if Elders does go under – but for ordinary equity investors the whole saga has been nothing short of a disaster (the current share price is 38 cents, versus an equivalent price of $15 just two years ago).
There’s not much left of the Elders that was. CEO Malcolm Jackman has been doing his best to cut the business down to size and focus on what it has done best for more than 100 years; servicing Australia’s agriculture sector. He sold its insurance business to QBE Insurance, 60% of Elders Rural Bank to Bendigo and Adelaide Bank, ITC Timber to Gunns, Forest Enterprises entered administration, making divestment unnecessary and Elders disposed of its stake in listed cattle company AACo. That only leaves its large forestry operation, a small stake in the bank, its automotive parts business that is also up for sale and the original agricultural supplies and livestock trading business, Elders Rural Services.
The rationalisation made for an interesting turnaround opportunity. The underlying Elders brand is a strong one, the core business looked sound and I thought other investors were extrapolating an abnormally bad decade for the rural sector. After the latest profit downgrade, it’s quite clear that the problems are deeper than anticipated.
The issue now is that the ‘core’ business is failing to deliver the goods, and some of the excuses being made beg belief. The rural services business is going to make substantially less this year than it made last year, despite farming conditions being vastly superior. Full-year revenue is now forecast to be substantially less than anticipated just a few months ago, and management is blaming a ‘much greater willingness by growers to use cheaper generic product over branded items’.
That a large percentage of farmers are switching to generic glyphosate products as a cheaper alternative to Roundup is a fact (just ask Roundup distributor Nufarm’s sharholders – the share price has more than halved in the past six months). But I knew this trend was well underway more than 6 months ago, and I haven’t hitched a boom spray in 15 years. Which means Elders’ management also knew the trend was well underway when they made their forecasts. The real issue, and a more concerning one, that Elders is probably losing market share to competitors such as Landmark (owned by AWB).
The other problem area is Elders’ forestry division (ironically, the one business making more money than expected is the automotive parts business, which is ‘non-core’). Management had this business pencilled in for $15m of Managed Investment Scheme (MIS) sales this year. It now seems sales will be closer to zero and one would have to question what those few hardy souls taking the leap are thinking. For the past 15 years, the MIS sector has done nothing but transfer wealth from retirees and doctors looking for a tax deduction to promoters, financial planners and farmers who sold their land for inflated prices. The only reason the charade lasted so long was that it took at least 10 years for the first projects to be harvested and investors to realise that they’d been dudded. Great Southern Plantations paid its early investors three times the actual proceeds from their projects in an attempt to keep the abysmal returns quiet for a few years.
Elders’ forestry products have always been superior to those offered by its now-defunct competitors Great Southern and Timbercorp, but is it really a surprise that there’s no interest in the sector?
At 38 cents per share, the potential rewards for today’s buyer of Elders shares are high (some relatively realistic assumptions indicate the possibility of a four- or five-fold return). The business still owns a lot of land, a lot of trees and a rural distribution network that, in the right hands, could be worth a lot of money. It’s also often the times when everyone has given up that the best opportunities arise. But this company has delivered disappointment after disappointment, and it’s hard to imagine there aren’t more to come.
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Forager Funds is a boutique fund manager specialising in a value investing approach. We offer an ASX listed Australian Shares Fund as well as an International Shares Fund both aimed at delivering returns for long term investors.