Even before the seismic upheaval caused by the Australian Government’s ban on live cattle exports to Indonesia in June 2011, the northern beef industry was showing the classic signs of a sector with deeper, underlying structural problems.

All industries are at some stage subject to a tipping point, often brought about by an unexpected external shock, but what changed the dynamic in the northern beef industry and put it at risk? 

Traditionally producers had done reasonably well, but like most sectors of Australian agriculture, they were subject to the vagaries of drought and commodity prices. Scale was often large but this did not necessarily translate into high financial wealth.

However, a dramatic increase in land prices over the last decade turned many long-established operators into paper millionaires; saw the entry into the market of the price-distorting management investment schemes; and attracted the interest of overseas investment funds. New live trade markets combined with a dramatic increase in per hectare productivity helped to buoy the outlook.

Rapid advances in technology and a marked improvement in business performance; strong capital growth and ballooning property prices, fuelled by the ready availability of debt; a sudden, unforeseen external shock to the market and the threat of crisis for the unprepared – this was an all too familiar scenario for many businesses in the lead up to the GFC and one now familiar to northern beef operators. 

A recent survey by the Queensland Rural Adjustment Authority estimates average debt per cattle enterprise is now $1.4 million, having grown by 20 percent in the last two years alone. The same study estimates debt per beast has risen from $240 to $647 in the last decade. Crucially there has been no discernible increase in the long-term average income over the same period.

But more recently, property values have begun falling. Herron Todd White reports that of the 30 northern properties listed on the market in 2011, only eight sold and 22 remained on the market at March 2012.

The challenge now facing northern beef producers is to manage high debt-servicing costs and the need for greater short-term working capital support, through a period of low and uncertain incomes. How will those that survive and prosper need to adapt to take advantage of the world’s ever-growing demand for high quality protein?

Those finding themselves in financial difficulty need to be proactive as they restructure and test the viability of their businesses. It will be important for operators to recognise that the future of their business must be based on working within debt levels that reflect the economic earning capacity of the business.

Live export ban not the core problem

As serious as it has been, the disruption to the live export trade is not the problem itself. The main problem for the northern beef industry has been an overreliance on the live trade and the change in the financial structure of many businesses dependent upon it. This has severely impacted their ability to adapt. 

When the Australian Government placed a ban on live export of cattle to Indonesia, overnight a trade that had exported 520,987 live cattle in 2010, ceased. Serious damage was done to an export market that was already starting to show signs of strain as Indonesia sought to restrict live cattle weights to 350 kilograms and looked to support its own domestic cattle industry.

This sudden shock occurred after a prolonged period in which debt levels increased on the back of higher per hectare productivity; simplified production systems; a growing live export market that did not require cattle to be shipped long distances across Australia; and the siren call that the Asian demand for high quality protein would only increase. 

These developments inevitably led to increased competition for land and the attendant steep rise in northern rural property prices.

Agriculture, however, is no different to many other capital intensive industries.  The oil on the fire that has seen northern cattle property prices follow the dramatic rises in other parts of the property sector has been the ready availability of debt financing.  

Purchasers have often been able to borrow the entire acquisition price through the utilisation (and hence dilution) of existing equity in their own property. This has exacerbated a problem not uncommon in many other areas of agriculture where operators have been able to maximise borrowings against the value of an asset without reference to its true economic earning capacity. 

The focus was on capital gain. In an overheated property market this has resulted in leverage levels that will severely test the sustainability of many enterprises, leaving both borrowers and financiers exposed when property values fall, and true underlying profitability is insufficient to service existing debt.

Now faced with falling property prices, high gearing and uncertain income, many northern cattle enterprises are being forced to re-examine their business plans and operational viability. 

Historically, much lower gearing and the availability of equity helped businesses support operational change or cope with extended periods of drought or low prices. A change in financial structure across much of the industry, towards a much higher reliance on debt financing has meant this option is no longer available.

This issue is not new, however, and the problem has been looming for some time. Fuelled by dramatic rises in property values (30pc year on year between 2002 and 2008), often debt-funded, businesses have become even more susceptible to uncontrollable external factors. 

The highly contentious ban on the live export of cattle to Indonesia was in reality not the root cause of today’s problems, but rather the straw that in many cases broke the camel’s back. 

The challenge

Many claim the live trade to Indonesia is now in terminal decline and that this will have a profound effect on the northern cattle industry. Others consider such talk is premature. 

Alternatives such as the opening of a new abattoir near Darwin to service the northern beef industry are now being progressed. However, it is not likely to provide an immediate alternative for enterprises producing sub-350kg weaners for the Indonesian live trade.

With no short-term viable alternative to live trade, many businesses will see current financial year performance dramatically impacted, with little potential improvement for the year to come.

The isolation of many of these enterprises means it is not financially viable to transport weaner cattle to a slaughter works or feedlots further south. Adaption of their operations to service new markets will take time and involve additional working capital that is just not available to a number of the more highly geared. 

The fall in land values has not only added pressure to financing arrangements through a dramatic rise in loan to property value ratios, but has reduced the options available to producers to generate cash through the sale of all or part of their properties.

Unfortunately for some the only solution will be an exit from the industry through a sale of their property at true market price, which may or may not realise sufficient to return some equity to the operators. 

However, for most the solution has to be a shared response developed in conjunction with their financiers. 

Any plan will need to address short-term cash requirements and should demonstrate long-term viability under realistic trading assumptions. Importantly, it will need to provide evidence of operational flexibility and the ability to adapt to changing markets. Commitment to one major market or customer can only be sustainable if there is a meaningful and feasible plan B.

There remain many extremely competent and profitable operators in the industry who are well placed to take advantage of the world’s increasing demand for Australia’s high quality beef.  Such producers can be identified by a range of operational and financial factors including:

• Detailed budgeting, forecasting and business planning to identify the true drivers of business profitability
• A focus on overall enterprise profit and the recovery of overheads rather than just on herd productivity 
• A lower level of gearing and avoidance of over reliance on debt funding
• Continuous innovation through new and/or improved production practices.
• An absence of over-reliance on a particular market and an ability to adapt as markets change
• Scale of operation
• A focus on breeder herd performance and continued genetic improvement within the herd

The very features that these operators exhibit are those that businesses struggling within the industry at present will need to focus on, if they too are to survive the short-term crisis and position themselves for long-term security and success.

* McGrathNicol is an independent advisory firm specialising in Corporate Advisory, Forensic, Transaction Services and Corporate Recovery. It provides a range of services to companies experiencing financial distress and has a particular focus and expertise in the agribusiness sector.