Management and ownership

In August 2010, Olam International Limited (Olam), a leading global supply chain manager and processor of agricultural products and food ingredients, made a full takeover offer that resulted in Olam increasing its shareholding in the Company from 18% to 78%. Following this initial takeover, three directors from the incumbent Board – Murray Flett, Craig Norgate and Keith Smith – retired at the annual shareholders’ meeting in October 2010. Four directors nominated by Olam – Ravi Kumar, Richard Haire, David Beca and myself – were appointed to the Board at the 2010 annual shareholders’ meeting. The new directors have brought a broad range of skills to the Board from their experience in managing agricultural commodity businesses internationally.

Prior to Olam’s takeover offer in August 2010, the Board had decided to terminate the management contract held by a subsidiary of PGG Wrightson Limited and internalise the management of the Company. Following Olam’s initial takeover, the management contract was terminated and the Company paid a termination fee of NZD 4.6m (equivalent to USD 3.4m), and paid the remaining outstanding amounts due to PGG Wrightson, including previously incurred performance fees, management fees and re-charged expenses.

The Company then established its own internal management team. Alastair de Raadt was appointed Chief Executive Officer on a short-term contract to 31 January 2011, based in Uruguay. At the end of that contract, Managing Director / Chief Executive Officer David Beca was appointed from 1 February 2011. David brings extensive experience and skills in dairy farming and livestock production in New Zealand, Australia and South Africa, and is based in Uruguay to apply his expertise to the day-to-day management of the Company.

The Company’s Chief Financial Officer (CFO), Andrew Clark, elected not to relocate to Uruguay, where the CFO role was to be based. Andrew left the Company in late February 2011 and Silvina Crosa was appointed CFO. Silvina had been CFO of PGG Wrightson Uruguay, and has also had a major involvement in the Company since its inception in 2006. She has an MBA from American University in Washington DC and strong experience in commerce and banking.

In January 2011, the Board appointed me as Chairman, replacing John Parker who had been Chairman since December 2009 and an independent director since the Company’s inception. John resigned as director, effective in January 2011.

The departing directors and executives all made significant contributions to NZ Farming Systems Uruguay and the current Board offers them its thanks for their contribution to the Company.

In April 2011, Olam made a second full takeover offer that resulted in Olam increasing its shareholding in the Company from 78% to 86%. There remains a small but significant New Zealand based minority shareholding to benefit from the strong business platform established following Olam’s involvement in, and funding of, the Company, and we are confident that the Company is now progressing well towards implementing a profitable pasture-based dairy farming model in Uruguay.

Strategic Review and Funding

Shortly after the completion of Olam’s initial takeover offer in 2010, the Company’s business plan was reviewed by the new Board. As a result of the review, significant changes in the strategy and day-to-day operations of the Company were made. The Board adopted a series of key strategies and changes arising out of the review. In summary, these were a:

    - Substantial increase in the use of concentrates in the diet of milking cows.
    - Maximisation of pasture growth through increased fertiliser use and increased irrigation.
    - Rapid increase in milk production due to increases in the size of the milking herd and the production level per cow on account of the changed feeding regime. The intention is to accomplish full dairy development on farms, with the number of owned dairy sheds lifting to 48-49 by spring 2012 and milking area increasing to approximately 16,000 hectares.

In conjunction with the strategic review, Olam provided the Company a short-term loan facility of up to USD 50m. Funds under the facility were drawn as required to repay the outstanding balances owing to PGG Wrightson, to fund capital expenditure and to provide working capital. This Olam loan was further extended in June 2011 to USD 85m to repay Banco Santander’s share of the syndicated loan, and to further support on-going development. The original USD 50m Olam loan and the extension to USD 85m were taken following the granting of waivers from NZX. The loan facility allows the Company to pursue its development plans and on-going operations without funding constraints. To date, USD 70m has been drawn on the shareholder loan from Olam. Under the current terms, the Olam loan is repayable on 31 December 2011. During the year the Company also partially repaid the Uruguayan bonds that are on issue. The total still owed to bondholders is USD 25.7m.

Prior to receiving the April 2011 takeover notice from Olam, the Board had been considering raising additional capital through a rights issue to all existing shareholders. The capital raising was intended to repay the Olam loan and fund the updated business plan capital expenditure to enable completion of development. The Board’s consideration of capital raising options was put on hold on receipt of the second takeover offer from Olam pending the outcome of the takeover. Now the takeover offer has been completed, options for funding are again being considered, with the Board’s expectation that the options will be put before shareholders in the next few months. The primary objective of the Board and management is to use funding to drive the Company to achieve the goal of successfully implementing a profitable pasture-based dairy farming model in Uruguay.

Results

The annual results for the year ended 30 June 2011 show that the Company incurred a loss of USD 8.7m. For the previous year (2010), the loss was USD 7.9m. This 2011 result includes Loss Before Interest and Finance Costs of USD 4.3m compared to a loss of USD 2.8m in 2010. Revenue (excluding Change in Fair Value of Livestock) increased by 90.8% from USD 22.5m in 2010 to USD 43.0m in 2011 primarily due to an increase in milk production from 68m litres to 105m litres, and an increase in average milk price from USD 28.3 cents/litre to USD 38.1 cents/litre.

Change in Fair Value of Livestock increased from USD 8.1m in 2010 to USD 21.0m in 2011. In addition to Births and Deaths, this included USD 5.5m of category changes (USD 1.7 in 2010), USD 8.1m in herd improvement (USD NIL in 2010), and USD 7.5m in fair value adjustment (USD 6.2m in 2010). Category changes relate to evolution of livestock into older/heavier categories. Herd improvement relates to the increase in concentrate feeding levels implemented during the year, which resulted in a significant lift in milk production, pregnancy rates and body condition in 2011, and is expected to lead to further lifts in milk production and pregnancy rates in 2012. Fair value adjustment relates to changes in livestock values between the start and end of the year.

Total Revenue including Change in Fair Value of Livestock increased by 108.5%, from USD 30.7m in 2010 to USD 64.0m in 2011.

There has been an increase in total farm valuation of 6% when compared with last year (2010). The total value of Property, Plant & Equipment moved from USD 161.7m on 1 July 2010 up to USD 173.9m at 30 June 2011. Within this the value of farm land, buildings and improvement moved from USD 142.9m on 1 July 2010 up to USD 151.1m at 30 June 2011.

Operating performance

As noted above, there has been an increase in milk production from 68m litres to 105m litres during the year to 30 June 2011, and an increase in average milk price from US 28.3 cents/litre to US 38.1 cents/litre. Milk production is expected to increase to 190m to 200m litres in 2012, while average milk prices are expected to be US 37 cents per litre in 2012.

Livestock numbers increased during the year from 56,153 at the start of the year to 62,483 at the end of the year. This increase came from a combination of purchases of livestock to contribute to the population of the 7 new dairies that are coming on line in spring 2011, plus increasing numbers of livestock resulting from a natural increase in the herd. This represents an increase in total livestock valuation of 65% over the valuation in 2010, including an 11% increase in numbers.

Farm Operating Expenses increased from USD 20.9m in 2010 to USD 47.0m in 2011. The largest contributor to this increase was an increase in concentrate feed costs which lifted from USD 3.4m in 2010 to USD 18.5m in 2011. A substantial contributor to this increase was the decision to increase concentrate feeding rates to the milking cows on an ongoing basis. The change in feed regime is expected however to lead to on-going milk production gains, improvements in pregnancy rates and in young stock weight gain. The Company’s increased milk production during the year reflects this expectation. Other major contributors to the increased expenses were the drought conditions experienced across Uruguay (especially in the central regions where the drought lasted six months) and an increase in all purchased feed prices in Uruguay.

The trends evident above (increasing milk production and revenue, and increasing expenses) are expected to continue in the 2012 year. Under normal seasonal conditions (no drought) and given the herd improvements outlined above, revenue is expected to increase at a significantly faster rate than expenses. For 2012 this is presently forecast to result in both positive earnings before interest and tax (EBIT) and a net profit after tax, with further improvements in financial performance forecast for 2013 and beyond.

Earnings per share is a loss of USD 3.56 cents compared to a loss of USD 3.24 cents in 2010.

With secure funding, the Company intends to continue with the development of its farms to their full dairy potential. Over the next two years this will result in a further 18-19 milking sheds being developed for a total of 48-49 owned milking sheds on approximately 16,000 hectares of dairy land, and a total of around 7,000 hectares of dairy land being irrigated. It will also include additional electricity infrastructure that is currently underway.

Total capital expenditure in the Company’s business plan is expected to be approximately USD 68m for the year, around USD 15m higher than under the previous business plan, due to inclusion of a number of productivity-related capital expenditure items such as a feed mill, in-shed feeding systems, feed pads and storage pads, additional machinery, and irrigation cost increases.

My expectation is that the changes made during the year, and future actions planned by the Board and management, will build on the improvement we are starting to see in the performance of the Company.

Farm development

Farm development has been progressing to schedule with the intent to complete all structural improvements by spring 2012. One further milking shed was commissioned in 2011, and another 7 are being commissioned this spring, bringing the total to 39. It is intended to commission the balance of 11-12 milking sheds by September 2012. A further 11 pivots were commissioned in 2011, and work on additional irrigation as well as the high tension electricity line in the centre of Uruguay is in progress with this expected to be completed before the coming summer. Once completed these developments will reduce the cost of feed and reduce the drought risk. Capital and/or cropping fertiliser was applied on all areas of the farm that were identified as requiring this through soil testing.

Farm Sales

The sale of Don Pepe farm (2,373 hectares) that was agreed in the previous financial year was completed in October 2010 for USD 7.1m (USD 6.9m net of commissions). Farm valuation (including improvements and revaluations) was USD 6.9m.

The Los Naranjos farm (945 hectares) was conditionally contracted for sale for USD 4.9m (USD 4.7m net of commissions). Farm valuation (including improvements and revaluations) was USD 3.9m.

As at September 2011, the Company has no active plans to sell any further farms.

Uruguayan economy

The Uruguayan economy has continued to strengthen. Expectations for growth in Gross Domestic Product are running at around 6.7% for the 2011 calendar year and 4.9%for 2012. Unemployment has been at record lows of around 6.2% and inflation is running at approximately 7.5%.

The Uruguayan Peso has been stable, at just under 19 to the US Dollar. In December 2010 credit rating agency Moodys improved its Uruguayan debt credit rating from Ba3 to Ba1, which is one grade below investment grade. In July 2011, both Fitch and Standard & Poor’s also lifted their Uruguayan debt credit rating to one grade below investment grade.

Outlook

Milk production has continued to lift well since the end of June 2011. Milk prices are relatively strong, although the price in August 2011 dropped 10% with the removal of the winter premium. The August milk price was approximately US 41 cents per litre, equivalent to NZD 7.15 per kilogram of milksolids at a NZD:USD exchange rate of 82 cents. We expect on-going volatility in milk prices with some continuing downside risk.

Feed prices are currently 20% to 25% above the budgeted price in the Company’s business plan, although buying feed in advance has given us some improvement over spot prices. Despite this, we anticipate a negative impact from high feed prices over the coming year.

Recent early spring weather has been favourable and pasture growth has been excellent.

Although there is price volatility in both the revenue and expense areas, we are confident that the Company has the right strategy and is developing its capabilities to deliver on the business plan.

On behalf of the Board of NZ Farming Systems Uruguay.

 

Vivek Verma

Chairman

Applying New Zealand farming expertise in South America

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