Regular Beef Central contributor, accountancy and rural property valuation professional Michael Vail, delves into pastoral valuations for investment purposes of a Walk in Walk Out going concern (with “all things necessary”) grazing enterprise in arid and semi-arid zones of Australia.
Pastoral valuations (and the prices paid), in general, have been an irrational nonsense for 30 plus years, with very hefty premiums being paid over and above a fair investment value.
Consequently, there has been an income and capital disconnect, from an investment viewpoint, of some degrees of magnitude.
This very unhealthy state of affairs is mainly due to really bad advice being given to investors. Think the ‘bigger-fool’ theory (where the buyer pays too much, yet hopes a bigger-fool will come along to extricate her from folly). And then (most importantly) there is the mis-application of the Beast Area Valuation (BAV) industry, ‘Rule-of-Thumb’ methodology, which is being applied on a BARE (of Stock and Plant) basis, when it was always a Walk-In-Walk-Out (WIWO), going concern (with ‘all things necessary’) ‘as-is-where-is’ approach, for a fully developed property, and to be principally used as an ‘index’.
This has been happening, in my opinion, since around the end of the ‘70’s beef-slump, circa 1978.
An example at this time, will be illustrative:
- Assume a property of some #65,000 acres, in the Central-West of Queensland, around Blackall, is ‘For Sale’; WIWO, as a going concern (with ‘all things necessary’).
- The long-term carrying capacity through a 10-year cycle (in an area known for roughly ‘7 good years in 10’) is around #4,000-head; implying a Sustainable Stocking Rate (SSR) of 1 Beast:16 Acres.
- The Net Farm Gate Price (NFGP), as if it were a ‘paddock sale’, is assumed to be around $950 per head (in real terms).
- The average value per animal sold is assumed around $1100 per head
- The BAV is assumed at around $2400 per Beast Area; an expectation.
- Discounted Risk, Leverage & Inflation Adjusted Valuation (DRLIAV) method:
- Dollars per unit area (DUA) = (Net Farm Gate Price (FGP)).(Sustainable Stocking Rate (SSR))-0.83
- DUA = ($950).(16)-0.83
- DUA = $95.13 per Acre
- An extended total, or Enterprise Value (EV), of $6.184-million WIWO.
- Less: Stock-on-Hand: $4.4-million (#4,000-head @ $1,100 each)
- Less: Plant & Equipment: $0.2-million (an assumption)
- Equals: Land & Improvements: 1.584-million (or $24.36 per Acre) BARE
The WIWO value per Acre is $96.00 per Acre; and the BARE basis value per Acre is $25.00 (as it would be idiotic to assume any valuation exercise is accurate).
- Beast Area Valuation (BAV) method (as currently applied, on a BARE basis):
- DUA = BAV divided by SSR
- DUA = $2,400 / 16
- DUA = $150.00 per Acre BARE
- An extended Value of $9.6-million BARE
- To which must then be added the further investment outlay of $4.6-million for Stock and Plant to make it a going concern.
- An EV of $14.2-million WIWO (or $218.46 per acre)
- Or ‘True’ implied BAVWIWO of $3,550 per Beast Area.
- A premium paid of $8.016-million (or 130%) on a WIWO basis.
- A premium of $8.016-million (or 506%) on a BARE basis.
For over 20 years, I worked very closely (in fact, ‘hands-on’), with animal production, on the land, and have practiced professionally in the fields of applied finance and investment for over 20 years also; with the last five, since 2009, as a specialist in this space.
‘…By any measure the disconnect between price asked and intrinsic value is extraordinary’
By any measure of return on investment (ROI), the disconnect between price asked (and paid), and intrinsic (or ‘Full’) value during that time (with evidence of compound gains to the land portion only, exceeding 20.0pc per Annum since 1971), is extraordinary! Not withstanding the assistance provided by the ‘floor’ in prices offered by the Wool Reserve Price Scheme (1971 to 1992).
Usually ‘Value’ is shown graphically, by a generally gently, upward-sloping, long-term trend-line, with cyclical ‘Price’ oscillating around it; to reflect issues around supply and demand for agricultural land, and the commodities of food and fibre (i.e. meat/grain, and wool/cotton) produced from it.
Evidence shows there has been many mean reversions during the 40-year period 1971 to 2011, yet the compound returns have been sustainably astronomical, at around 20.0pc per Annum; and on a BARE basis.
What is going on?
In the rural/pastoral zones, of arid and semi-arid Australia, a grazing enterprise, and the product from it, is defined by the land upon which it resides; and should not be separated from it.
By contrast, a suburban factory is located upon the land, and could be situated almost anywhere. In these cases, businesses do not need to own or be ‘linked’ to the land, and may therefore merely reside upon the land; leasing to the extent required.
On the other hand, pastoral land and the quality of its resources, will either add a premium, or discount, to the produce from it; and therefore the long-term value of the operating enterprise.
In this way, the value of a pastoral zone grazing property, WIWO, as a going concern (with ‘all things necessary’), is the Enterprise Value (EV) of the Total Assets (less any Surplus Assets) in an ‘all-equity’ model; including the land, and the Improvements thereon.
Like equity, land is a ‘residual’ value; meaning ‘that which is left-over’.
BAV is a circular, incestuous formulae, which might be used for a valuation sleight of hand, and possibly a fraud upon the industry
BAV is to be used as an ‘index’, and may be used for ‘price discovery’. Unfortunately, it is a circular, incestuous formulae; which might be (and currently is) used for a valuation sleight-of-hand, and possibly a fraud upon the industry.
If it was used properly, as a WIWO concept, BAV would currently be between $1500 and $1700 per beast area; the above example leads to a BAV of around $1546 ($6.184-million / #4,000-head).
BAV may also be used for price discovery of the implied Dollars per Unit of Area (DUA); for that particular property of roughly $96.63 ($1,546/16), say $97.00 per Acre WIWO.
Research conducted by the author has shown that BAV (as currently applied) has NIL risk or inflation adjustment over time. Once any debt is introduced, and such debt is assumed at around 20pc, a Livestock Valuation Multiple (LVM) may be derived, and the BAV formula modified to give an industry ‘rule-of-thumb’ method of valuation which is ‘about-right’, as the economically feasible investment value, or the ‘price-to-pay-no-more-than’; knowing that for each dollar paid above this number, the Investor may exponentially increase the risk of business failure.
The essence here to understand, is that all ‘risk’ is cumulative; and in the pastoral space, the operator does not just endure business and financial risk, but also the extreme ‘Black-Swan’ event, or ‘fat-tail’ risk, of climate variability (as denoted by ‘7 good years in 10’).
In some 10-year cycles, it is not unusual to see a net-sum-game of $NIL as far as EBIT (average) is concerned.
The Livestock Valuation Multiplier (LVM), where debt will oscillate around 20pc Debt to Assets (and a maximum for very short periods of up to 40pc Debt to Assets), is 1.8-times.
Therefore, a modified BAV formula, which adjusts for all risk in this space is:
DUA = ((NFGP).(1.8)) / SSR
To apply our previous assumptions:
(($950).(1.8)) / 16 = $106.88 per Acre = DUA (WIWO)
Say $107.00 per Acre WIWO
An extended Enterprise Value of $6.955-million WIWO
Working backwards, using the DRLIAV method:-
$107 = $1,100 (?)-0.83
log (107 / 1,000) = -0.83 (log (?))
-2.330237 / -0.83 = log (?)
2.807514 = log (?)
? = 1-beast: 16.6-Acres, as the Sustainable Stocking Rate (SSR).
Conclusion: ‘About-Right’ value is shown. (We said 1:16 above.)
A further example is “Tilbury” (31,386-Acres), a well-known cattle breeding and fattening property at Blackall. This property was recently (7th October, 2014) sold for $5.3-million (or $168.86 per Acre).
The DRLIAV method valuation would be:-
($950).(25-Acres)-0.83 = $65.68 per Acre WIWO
An extended Value of $2.06-million WIWO.
The modified BAV would be:-
(($950).(1.8)) / 25 = $68.40 per Acre WIWO
An extended Value of $2.15-million WIWO.
Assuming an average value around $67.00 per Acre WIWO above, and the actual sale price, which I believe was BARE basis, this disparity is incredible!
How may smart young bushmen and women get involved, and bring their skills ‘home’, when premiums over rationality, and on this scale, are being paid?
The new owner(s) must have plenty of money, NIL debt, and a very rosy view of the future.
Further, if the average long-term SSR of this pulled, scrub-soil Gidyea (30pc) and Desert/Forest (70pc) improved pasture property (which was one of the first pulled in Qld to sow Buffle-Grass around 1953) is around 1 Beast: 25 Acres, then the implied NFGP expected by the Investor, and looking through a 10-year cycle, is around $2,442 per head.
An increase of around 100.0pc from current values, for a similar article sold.
When the market took from 1973 ‘til 1983 to reach parity with the 1972 highs of $1.00 per Kg (or $0.40 per Lb.) ‘on-the-hoof’, and the general auction market today, hovering around $1.80 per Kg. (where it fell from $2.20 highs), it seems a big ask.
Is it a case of the ‘Bigger Fool’ theory? As Buying/Investing, is about future expectations, and it has to get better eventually. Right?
Maybe it will be somehow ‘different this time’; with the Chinese FTA coming…
A further point to note is, if the NFGP is around 20.0pc of the retail amount (and should be about 1/3rd), this implies the butcher-shop value of a beast will rise by nearly 50.0pc!
Is this possible? Only time will tell …
- The new DRLIAV method for Pastoral Zone valuation is ‘about-right’ at:-
- (NFGP).(SSR)-0.83 = DUA
- If using Discounted Cash Flow (DCF) as a secondary ‘check-test’ method (which may give a nonsense answer due to ‘lumpiness’ of income, and the excessive years of negative cash-flow in a pastoral setting), the appropriate discount rate to apply, is greater than 22.0% per Annum (Compound).
- A Zero Coupon Perpetual Bond formula may be your guide to a similar profile and risky investment (assuming an ‘all-Equity model):-
- NPV = EBIT . (1 + (1 / Discount Rate)) – Original Cost
- The ‘decision-rule’ for NPV projects is to, “invest in positive NPV projects”. If the investor is indifferent, regarding whether to invest or not, where NPV = Zero, then rearrange the formula, and solve for Original Cost; or the indicative ‘price-to-pay-no-more-than’.
- NPV = Zero = EBIT . (1 + (1 / r)) – Original Cost
- Original Cost = EBIT . (1 + (1 / r))
- If EBIT = $1,250,000 &
- If the discount rate, ‘r’ = 22.0%
- OC = $1,250,000 . (1 + 4.545455-Times)
- OC = $1,250,000 . (5.55-Times)
- OC = $6.938-million WIWO
- Making it about performance, not size; and size becomes irrelevant to a degree, once operational scale is reached a point above economic ‘break-even’).
- Meaning, if any grazing enterprise could average an EBIT of $1.25-million, in real terms, over the vagaries’ of a 10-year cycle, then it was deserving of this Value.
- Revenue (a ‘pure’, unadulterated economic and accounting concept) multiples (assume ‘all-Equity’) equivalent to a Price Earnings Ratio (PER) of 16-times Net Profit After Tax (NPAT) for a listed entity on the ASX, is 2.8-Times. For a private business, with private knowledge, where there may not be so much transparency, this multiple reduces to around 1.8-Times Revenue, as maximum price to pay.
- The rural/pastoral multiplier for debt is 5.3-Times EBIT (‘all-Equity’ model), and around 4.6-Times EBIT, where debt may be no more than 40% Debt to Assets.
- The risk modified BAV formula becomes:-
- (SSR) . (DUA) = BAV = ((NFGP) . (LVM))
- ((NFGP) . (1.8 LVM)) / SSR = DUA WIWO
- A sustainable, and economically feasible value, where debt will be used, and ‘risk’ measures applied.
- If an ‘all-Equity’ model will be used, and therefore financial risk eliminated, the LVM may change from 1.8-times, to up to 2.0-times.
- If only business risk remained, a LVM of 2.5 would be OK; and still less than ‘full’ value, at an LVM of 2.8-times.
I hope this helps, and adds to the debate.
Happy to be proved wrong, and open to comment.
Thank you for taking the time to read this article.
The author Michael J. Vail, M App Fin, M Prop Val, F Fin, CTA, FCPA, is a director of TRE PONTE Corporate in Brisbane . He can be contacted by email by clicking here
For a more in depth exploration of this topic, click here to view the thesis Mr Vail recently authored to achieve a Masters in Property Valuation, titled “What is the ‘True’, Going Concern Value of a Pastoral Zone, Grazing Enterprise Investment in Australia: and, Why Beast Area Valuation (BAV) is Wrong?”
“Well said”, to Kevin and Peter, for their comments above. The buyer sets the tone; the funding facilitates it.
I go back to one of the core principles of valuation, compare apples with apples and oranges with oranges.
1. Therefore when analysing a WIWO sale and applying $x to the beast (derived from market evidence), the same $x must then be applied to the beast when doing a wiwo valuation.
2. BAV is a check or rule of thumb, it must never be a primary valuation approach. It is the case for some that they become dangerous with a little bit of know how!
3. Supply and demand dictate market value. Over the past decade or so pre 2008, the demand side of the equation has been highly stimulated by a run of good seasons (plenty of grass and water), improving beef price and most significantly, readily available finance by aggressive money selling to the rural sector at high loan to value ratios and even interest only loans for extended period making repayments affordable and compelling purchasers to borrow more. Therefore a finite supply against a TURBO BOOSTED demand caused a snowballing effect of property value appreciations and ultimately a bubble.
4. The bubble has well and truly burst and in most areas depreciated by about 50% which on a time line puts them at about 2000 to 2005 value levels.
5. Typically the difference between high priced and low priced pastoral property is profitability, which in most cases is due to the cost of production, rather than the price of the commodity. After selling beef or wool, the net revenue amount will dictate what a prudent purchaser is generally prepared to pay for the land.
6. Historically (up to about 2000) throughout northern Australia, the Beast Area Value (BAV) closely reflected the value of animal turned off from the area that the animal needed to either produce an offspring or grow beef. For example, in Cape York, to maintain breeder condition, early weaning is norm and due to the deficient nature of the land, weaners are trucked to better country for growing etc. Therefore pre 2000, the price for such a turnoff was from $100 to $300 and such was the BAV. On the Mitchell Grass Downs, growing and fattening enabled producing annual turnoff’s of about $500 to $1,000 and hence the land had a similar BAV.
7. Another factor to sharp property value appreciation is the extra purchaser competition from investment funds where the capital is not derived from profitable agricultural enterprise but other means including investors, super funds, tax minimisation schemes etc. Their buying power was/is far stronger than the local farmer who has to generate surplus capital from profitable agriculture or waited for long term capital value appreciation (equity).
In summary, it is my experience that the pastoral sector has a fairly unsophisticated approach to pricing property. Often its merely a basic understanding of what’s being sold or for sale in the district and for how much. These comparisons are often a hit and miss approach including comparing wiwo and bare property prices (comparing apples and oranges instead of apples with apples or oranges with oranges). Also the auction process in a rising market where there is strong demand will in most cases lead to property value appreciation and when fuelled by aggressive lending, you get record property value appreciations with no economic foundation. There are now many examples where the chooks have come home to roost and where cattle producers were broke the day they signed the loan docs. A review of rural lending practices is critical to create a stable rather than volatile sector. All rural lending should be limited to 50% LVR’s and interest only loans should be for disaster mitigation and not asset acquisition!!
Supply & demand will ultimately be the factor that determines the price paid for properties.