Global and local volatility has meant that the world we live in has never been as dynamic as it is now, and we still cannot be sure what the ‘new normal’ is. But we can take stock of what we know now and use it to best position ourselves for the world of tomorrow.
The purpose of this article is not to rehash the challenges KwaZulu-Natal (KZN) farmers have faced, such as flooding, looting, supply-chain disruption, margin squeezes, but rather to take a step back and assess where we are currently and map out some future solutions to the predicaments we face.
When one reflects on both the sugarcane and macadamia industries, it becomes clear how the laws of supply and demand, and the law of excess profits attract new capital and investment. These basic economic principles may take time to play out but are fundamental to the basics of economics and asset allocation.
Let us map out some of the challenges we face in the context of the above. For years the sugarcane sector had been a stable industry with a predictable supply – aside from droughts – and price, thanks to industry structures. Over the 11 years that I have been at Nedbank, we’ve witnessed the slow diversification out of monocropping sugarcane into macadamia. Over the past seven years, the pace of this transition into macadamias has quickened in KZN, as evidenced in the chart below:
The need to diversify is being driven by several factors, which include the following:
· Diversification from monocropping.
· Alignment of crop production with geographical potential.
· Vertical integration without the ability to grow through economies of scale, thus optimising return per hectare through high-value crops.
· Rand hedge with revenue stream in US dollars and other foreign currencies.
What has become evident, however, is that some of the diversification is driven by the perception of excess profits to be made without the layering of management and geographical suitability, and rather seeing diversification as a silver bullet to a current situation the farmer faces.
The table below illustrates the compound annual growth rate (CAGR) in price over the 10 years from January 2009 to December 2018. It illustrates the approximate US$/kg macadamia kernel price, approximate R/kg macadamia kernel price and finally the sugarcane price.
Over this period, it is evident that, from a price perspective, this worked well as a rand hedge and even outperformed on a US dollar basis versus the sugarcane industry.
Since the dates above there has been a correction in the macadamia industry pricing, but the sugarcane CAGR remains much the same.
This information speaks only to price, but we know margins in macadamias have, and still do, outperform sugarcane.
There is no doubt that early adopters have benefited from this diversification from both a balance sheet (increasing land and macadamia tree age) and income statement perspective (cash flow as trees have come into production and the increasing macadamia price until recently).
From a financier’s perspective, this diversification has been simple to assess because of the stable source of income in sugarcane, against which to structure macadamia capital expenditure (CAPEX) and loans, allowing for flexibility of loan tenure and capital moratoriums.
However, given the status of the sugarcane industry with large carry overs, mill stoppages, business rescue, etc, cash flows have become exposed and are putting some of the more recent expansions under pressure.
The remaining question in both industries is whether the changes are structural or short term in nature and, given the world we live in, the answer to this question is not simple, which makes long-term planning more challenging.
One must understand there is no perfect answer to the future outcome, as every investment is made on a unique set of criteria with some farmers looking for asset growth, others for diversification, while others look at it from a pure basis of return on investment and others by using diversification to optimise their current tax situation.
History has taught us numerous lessons about agriculture . These lessons include the following:
· The sector is extremely robust and farmers are experts at adapting to evolving macro and micro situations.
· Cycles in agriculture are very long and must be considered for any short- to medium-term investment changes.
· There are usually strong balance sheets in the background and banks as senior debt financiers are generally well secured.
· Historically, during similar periods, farmers tend to focus on their cost base and rationalising their business. which benefits them over the long term.
In summary, we have seen sugarcane farmers diversify into macadamia, based on certain industry and cash flow assumptions. The current challenges in the sugarcane industry have exposed this CAPEX from a cash flow perspective, which has been further compounded by the short-term drop in the macadamia price.
With this in mind, we offer some advice on assessing current business structures. Keep the following in mind:
1 Communication is key:
(a) This applies to all stakeholders in the respective sectors. If there is uncertainty or mixed messages across a sector, the decision process becomes less clear and increases the likelihood of stakeholders to err on the side of caution.
(b) Communication between farmers and their financiers is especially important, as we elaborate in point 2 below.
2 Be proactive:
(a) Ensure there is an open and honest line of communication between you and your financial partners.
(b) It is much easier for your financier to seek a solution to a problem before it occurs than to fix the problem retrospectively, which has significant consequences to both the bank and the farmer.
3 Revisit your financial structure:
(a) Match financing to the correct time horizon.
(b) Where capex has been funded out of cash flow, which now sits in an elevated overdraft or has been funded out of cash, it would be worth evaluating this to determine if cash can be brought back into the business via ‘refunding’ this capex through new loans that are structured to the type of investment undertaken.
(c) Are your repayments aligned with your revenue streams?
(d) Look at the balance sheet but focus on cash flow as this is key.
(i) Is your current debt structure correct?
(ii) After reviewing this, does your business produce enough earnings before interest, taxes, depreciation and amortisation (EBITDA) using long-term assumptions to service debt at comfortable levels, especially given the current knowledge we have of the market?
(e) If your business only works by putting all your debt back over maximum term, thus stretching all lending parameters, one has to ask if this is the correct decision.
4 Look at non-core assets:
(a) Are there off-farm investments that can be liquidated to either inject cash flow over the short term or allow your financier to realign their debt at lower levels with lighter monthly cash-flow requirements?
Nedbank has put investment in the agricultural sector at the core of its strategy and is committed to providing farmers, agribusinesses, entrepreneurs and organisations with the expertise and financial acumen they need to thrive in complex times.
Duggan is Nedbank’s Regional Agricultural Manager for KwaZulu-Natal.