Tuesday, 10 August 2010

MIS an abject failure

It’s like standing in St Peter’s Square awaiting the first wisps of fumata bianca from the Sistine Chapel. The selected stakeholders continue to mull over our fate but are not telling us anything.

What are they discussing?

Sure they’re talking about changes to the logging of native forests. But are they charting a future course for the entire industry?

If so it is incumbent upon them to fully understand why the industry is beset with its current problems. I hope they’re following the various post mortems to help them understand what’s happened and which bits are viable.

The list of the fallen reads like a war memorial. Timbercorp in Liquidation, Great Southern likewise , FEA in Administration, Willmott Forests under suspension, Elders in difficulties.

It’s easy to conclude that the MIS model is dead. Like Monty Python’s parrot. Dead.

But maybe Michael Palin, the pet shop owner, is right “No no he’s not dead, he’s, he’s restin’! Remarkable bird, the Norwegian Blue, idn’it, ay? Beautiful plumage!”

Maybe MISs are just resting.

The National Association of Forest Industries’ chief executive Allan Hansard thinks so. He is calling for more government incentives for investment in plantations.

“It could be tax arrangements, it could be grants,” Mr Hansard said.

This is in addition to the $100 million requested by harvest contractors.

Plus the $100 million already showered on the industry via the RFA.

Assistance to establish plantations, assistance to harvest. Any more ? Maybe some assistance to process? Some assistance to transport from remote locations like Strahan? Some of that Food Bowl water would be handy to assist those inappropriately sited plantations in the South East. They must be thirsty this winter.

Terry Edwards from Tasmania’s Forest Industries Association says local contractors have been hit hard by a “perfect storm” of events, including the global downturn, a strong Australian dollar, and campaigns by environmentalists.

He omitted to mention the unsustainable structure of the industry that he helped create.

Take FEA for instance.

“A sustainable business model sets FEA apart” was the headline in the last edition of FEA’s newsletter Canopy in late 2009.

“FEA has a sound and sustainable business model as a vertically integrated forestry and forest products company. We generate revenue from all aspects of the forestry and forest products value chain from seedling to sawn timber” said CEO Andrew White

Revenue maybe, but not profits.

There are times when spruiking one’s own Company is tantamount to misleading shareholders, for it was barely a few months later that FEA’s Receiver Tim Norman showed little hesitation in declaring “FEA’s business model was fundamentally reliant on annual MIS product sales to fund ongoing operations”.

The Receiver was criticised by, amongst others, TCA’s Barry Chipman “…..a great Tasmanian company brought undone by callous international and so-called Australian banks (alluding to ANZ and CBA).... the restructure plan was delivered on time and provided for large reductions in current debt levels”

Not so according to Mr Norman.

“They were unable to submit a restructure plan that showed a return of the business to a viable position that was able to address the significant operating cash outflows forecast over the next few years.”

“Eventually one needs to face the reality that if the business model could not be restructured, funding continued cash deficits through asset sales and stretching creditor payments was not in the interest of any class of creditor, including the MIS Investors, or the FEA shareholders.”

Without the support of its bankers, FEA became technically insolvent and was forced to appoint an Administrator. The banks immediately appointed a Receiver to look after their interests and at the first meeting of creditors attempted to remove the Administrator and appoint their nominee instead. This move failed and the Administrator will remain in charge at least until the second meeting of creditors is held when it will be decided to return the Company to the control of the Directors (unlikely), continue under Administration with a Deed of Arrangement (possible), or put the Company in Liquidation ( most likely).

Any information from an Administrator is useful in trying to understand the problems confronting a Company under his control. He has broader responsibilities to creditors, investors and shareholders, to investigate the Company’s affairs and recommend alternatives for the future and accordingly his reports to investors and creditors are bare boned sober explanations devoid of the glossy nonsense that pervade many Company reports.

FEA’s Administrator has reported to Grower/investors on their tree crops. FEA undertook 17 MIS Projects from 1993 to 2009 covering 72,000 hectares, roughly half in Tasmania with most of the balance located in NSW and Queensland. Initially most land was owned by the FEA Group but increasingly land was leased from third parties for sub letting to investors. Overall about one third of investors’ trees are on land leased from third parties.

The 1993 Project has been harvested and produced returns better than expected, with a MAI (mean annual increment, a measure of recoverable harvest volume) of 29 tonnes per hectare. But it was only 44 hectares in total. The return to investors was just over 7% after tax. This is the only Project where yields are expected to exceed the figure suggested in the PDS, the offer document to investors.

The 1994 crop is currently being harvested and it is likely the 1995 crop will be harvested forthwith, and both will be completed by the end of the 2010 calendar year. Yields are expected to be below forecasts, a MAI of 23.5 tonnes per hectare for 1994 and 17.6 for 1995, compared to a forecast MAI of 28 tonnes per hectare. Investors in the 1994 Project will get their money back (just) but there will be a deficit for the 1995 Project.

With the Projects from 1996 to 2001 the Administrator is recommending fast tracking thinning and harvesting to be completed by 2013.None of the Projects is on track to achieve its targeted MAI. All of these projects will require contributions from Growers as the FEA Group has no cash, there will be expenses to pay including lease payments to third parties and even the rent on land owned by the FEA Group will need to be paid in cash as that land is currently under the control of the Receiver as he attempts to force the wind up of the Projects so that the land can be sold and the proceeds paid to the banks. In the opinion of the Administrator delaying harvesting is likely to result in lower returns to growers.

None of the 1996 to 2001 Projects is likely to give investors a return of their original investment. The largest of these Projects is the 1999 Project when $51 million was raised from investors to plant almost 11,000 hectares, 70% of it here in Tasmania, including large chunks of grazing/cropping land at Preolenna, Trowutta and other farming districts. The MAI at the planned rotation age of 13 years is 18.8 tonnes per hectare. Fast tracking harvesting will return an estimated $37 million to growers, a shortfall of $14 million. Delaying harvesting will require greater contributions from investors that are likely to exceed the proceeds from the additional harvest volumes.

The worst performing Project has been the 2001 Project of 1,300 hectares, 90% of it in Tasmania which cost investors $7 million but which will only return $2.7 million if fast tracked. Delaying the harvest will prolong the pain and probably reduce the net return to investors.

The Administrator has also reported on each of the less mature Projects, from 2003 to 2009, a total of 56,000 hectares. He has yet to form a view as to whether the Projects are viable although he suspects they will. To what extent is unknown at this stage. He has given growers an estimate of the contribution required from them for 2011 to keep the Projects afloat, the weighted average amount being $469 per hectare or $26 million in total. Note this is just the figure for 2011.Amounts will be required each year until harvest. Of the $25 million for 2011, $16 million will be required for rent, $5 million for plantation maintenance, $3 million for overheads and $2 million for insurance.

If a MAI is only 20 tonnes per hectare and the stumpage price $23 per tonne, say, then the MAI in $ terms is only $460. Given the risks involved an investor may be nervous about outlaying $469 to stay in the game. He would be expecting slightly better odds. A good manager could certainly trim the costs but an Administrator is not the best placed person to do this. Costs will reduce, as a general rule over the rotation particularly maintenance costs.

The rent due includes payments to third parties as well as payments within the FEA Group that is now required by the banks as mortgagors. Even before the Receivers were appointed when internal lease payments were just book entries, the Group still had to find enough to make payments on the bank loans used to acquire the land.

So it is fanciful in the extreme to think that the annual 2003 to 2009 Project costs could have been met out of cash flow from an unprofitable sawmill. All Projects were predicated on a deferred lease and management fee arrangement meaning that Growers had no obligation to fund expenses annually. They paid an upfront fee of about $7,000 per hectare, but then no more until harvest time. The only way FEA could have survived is if MIS money kept flowing in the door. This was never going to happen. Even without “a perfect storm” it would have dried up because the grower returns have been insufficient. Woefully so.

The level of rents required to be paid attracted a comment from the Administrator. External lease payments were set at market rates at the beginning of the lease term. A rate of 8% of land value is believed to be the initial figure, and indexed at CPI thereafter. This is an attractive rent figure for rural land.

The rent on the internal leases within the FEA Group is based on the weighted average of the external leases. So as the external leases were indexed from a starting point of market value, so were the internal leases. The growers’ share of the pie was under increasing threat each year of the lease. MAIs had to meet expectations and stumpage prices increase, but alas neither occurred.

The Administrator floated the possibility of pooling the 2003 to 2009 Projects into one Project and dropping some of the properties with external leases, which would have the effect of reducing overall lease costs, continuing to run with annual grower contributions and trying to stage a managed exit over a number of years. The difficulty is always getting everyone to agree and then hoping the agreement is honoured. Too many breaches will bring down the house of cards.

The Administrator also made an interesting comment about the NSW and Queensland Projects, “where markets do not currently exist proximate to them”. There is a need to find markets so as to save transport costs which are currently “prohibitive” if sold to Brisbane or Newcastle.

FEA planted 35,000 hectares without definite markets in mind. One reads of court cases where small plantations of prohibited plants are grown is remote locations with more forethought.

It’s little different in Tasmania. There has never been much of a Plan. The back of a table napkin maybe, but not a Plan that had been rigorously developed. FFIC have recently told us that “sawing trials have concluded that E.nitens plantation stock is unsuitable for, and uneconomical as, a source of wood for appearance grade sawn products. This is because of the considerable degrade associated with the seasoning process (in particular, surface checking and unrecovered collapse). … Unless these challenges (associated with processing plantation timber) are overcome, a large proportion of the current Tasmanian hardwood production industry is unlikely to be able to profitably or sustainably process plantation sourced logs into high grade products.”

For a previously well regarded forestry company like FEA it is surprising to discover the large gulf between spin and reality.

The evidence from FEA lends little support to the views of a Gunns’ functionary 2 years ago in support of MIS schemes. “Well from our perspective we see positive benefits for investors … bringing funds in general from urban areas back into regional and rural areas. Providing employment for people establishing, maintaining and adding value to these plantations … . we also see great value for land owners … . we provide choices to those land owners. … it’s a diversification of farm income which provides them some great security and to other landowners it provides some choices if they wanted to exit the farming arena”.

And also the view of the Minister for Resources. In a letter dated 21st September 2005 Mr Green said: “The Tasmanian forestry sector is critical to the future of the State as well as the economic success of many rural and regional communities. This is why the Tasmanian Government is encouraging regional communities to actively seek innovative new investments and alternative land uses, such as plantation forestry, as a means of creating employment, retaining young people and maintaining the economic, community and environmental values of a region … The forestry sector provides real opportunities for rural and regional communities”.

There is now enough evidence from Liquidators and Administrators, from the horses’ mouths, to say that MISs as presently constituted and conducted have been an abject failure and have no place in the future of Tasmania’s forest industry. I note Mr Hansard from NAFI has raised the possibility of grants rather than tax incentives. I wonder if this is being discussed at the Roundtable? With the pulp mill already under a cloud, it’s prospects won’t be enhanced if there aren’t any bunnies to fund more plantations. The absence of any substantial plantings for 2010 and 2011 won’t assist the age profile of trees required to provide a steady stream of chips for the mill.

Even Professor Felmingham seems to be softening his views towards industry assistance. Talking about the most important issue in Tasmania today, the matter of where AFL teams play, he pointed out that Government funding can have negative effects.

“The more you sponsor a place, the more you deprive it of a long-term future”, he said. “You just don’t determine things politically”.

He could well have been discussing MIS schemes.


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