September 2008: The financial crisis

1) A crisis spreading even to New Zealand

The significant deterioration of wholesale financing markets is currently spreading to New Zealand. As a debtor nation we are in the process of tightening our belts. Our current account deficit has already fallen from 10% to around 6% of GDP and will need to fall further as there are few enough lenders out there willing to finance NZ borrowers. The NZ urban sector, which expanded massively in recent years on the back of a high dollar, cheap imports and free credit, is contracting. The NZD has moved sharply lower (from USD 0.80 at its peak to USD 0.67 at time of writing) and interest rates are falling. Both these developments are good for our export oriented, debt financed farming sector and I anticipate that agricultural cash flows in NZ should improve as a result. However, and this is very significant for our new fund, it now appears that the prices paid for farmland, despite these improvements, will fall.

2) Why is it likely that prices of NZ farmland will now fall?

There are two reasons:

The first is that banks are cutting back on lending. It is rumoured that two of the four largest agricultural lending banks have quietly decided in the past few days not to advance ANY new farm financing loans. This extraordinary move (I guess the last time this happened in NZ was in the Great Depression) is not primarily because farming is doing badly. Rather it is because these banks need to improve their balance sheets; to either raise capital or lower assets. And for these Australian owned banks one of the easiest ways to improve those ratios is to cease (new) lending in a couple of off-shore islands called New Zealand.

The second reason prices of farmland in NZ looks likely to soften is that, although red meat commodity prices are moving up as predicted in last month’s Newsletter, dairy commodity prices have fallen sharply in the past six weeks. We have seen a sharp fall to (a still satisfactory) price of around USD 3,000 per ton of skim milk powder from remarkably elevated prices that peaked at around USD 5,000 i.e. international dairy commodity prices are down around 40% down in USD terms. Though the pain has been cushioned for NZ farmers by the fall of the NZD against the USD the kiwis are still about 10% worse off from last season to this (prices were not at USD 5,000 last year…that is a more recent peak). The fact Fonterra, the giant farmer-owned NZ dairy co-op that is involved in 50% of the international trade in dairy products, has been forced to write down 70% of the value of their investment in San Lu, a scandal-affected Chinese milk distributor, has not helped. Fonterra have lowered their forecast pay-out for the 08-09 season from the $7.90 per kg of milk solids they paid last year to a forecast of $6.60 per kg. NZD 6.60 is still a very good pay-out for farmers whose costs in most cases hover around $4 per kg (enabling them to generate operating profits of NZD 2,000 to 3,000 per ha – still a substantial yield). However some of the more over-leveraged dairy farmers could well find themselves needing to sell their farms in coming months. We are already seeing some properties coming to market in an effort to beat the rush.

3) How does these negative factors for the price of land affect our strategy?

Across all sectors, for those people fortunate enough to have free capital available, capital preservation is currently the key objective. The current environment is one in which the right strategy is to cut costs, to simplify businesses, to locate a bank that is solid and to hold your cash there in a bank account or term deposit.

It is true that agricultural returns look like they will do ok, and farm prices look like they will fall, however there is no hurry to invest. In a time of crisis attractive investments can be had by (those few) players who have cash to spend. We aim to be one of those investors.

In keeping with this strategy we have pulled out of the purchase of the dry-land property mentioned in the last Newsletter. Te Moata Station, our first purchase, is reasonably well positioned as its current output (red meat) is turning up (prices for red meat remain 40% higher than the same time last year). We have had good spring growing conditions up there on the west coast of the North Island and the stock values (purchased in winter on a drought market) are now trading up nicely. I am confident that Te Moata is going to perform well in cash flow terms. Could we purchase the same property cheaper in a few months? Quite possibly, given the bank lending situation and the possibility there may be forced sellers (at the present time the market in land has ground to a complete halt – nobody is buying or selling). However I don’t believe a fall in the land value of Te Moata would offset the rise in value of the stock and returns from sale of produce.

We are looking closely at carbon sink opportunities at Te Moata and elsewhere now that New Zealand has passed (in mid-September) its Emissions Trading Scheme legislation – the first in the world to include both Green House Gas emissions from ruminant animals and the carbon sequestration value of forestry. Our strategy on Carbon Sequestration will be the subject of a subsequent newsletter but the basic summary is that trees can sequester remarkably high quantities of carbon (30+ tonnes of Carbon per ha per year on good land), that good operators in this space are likely to make high returns, but that at the same time we need to tread carefully as this is a new and therefore risky market.

In summary, other than working hard on our sheep, beef and tree strategies at Te Moata, Craigmore Resources will now go into a “capital preservation” mode. We will wait for yields to rise, and only commit capital to particularly high-quality projects. We expect that some of these are going to become available at attractive valuations.

I am confident that the medium and long term case for improvement in the terms of trade of food and other products of the land remains intact. It follows that, provided we invest wisely, investments in productive capacity of land will out-perform “average” investments in coming years.

Until October I wish you all well in this very challenging environment (and would be glad to get your views on any matter raised).

IWMI – Water – the Forgotten Crisis click here to download pdf (69.3KB)

Forbes Elworthy