Tuesday, 26 October 2010

Gunns: The next chapter

The Truth and Reconciliation Roadshow continued last week with a presentation by Gunns’ CEO to a conference run by investment bank UBS, coincidentally a Gunns’ shareholder.

The changes from the presentation which accompanied the release of Gunns’ preliminary 2010 financials in mid August were subtle and revealing of the future chosen path.

John Gay’s business model was then described as being “a conglomerate of long life low yielding assets…..(consisting of) many businesses….. excessive levels of encumbered assets .....excessive debt levels to earnings,..... (where) potential investors do not understand the business.”

The latest presentation includes further criticisms of the old model. Mr L’Estrange confirmed that Gunns was “cash negative” and was bedevilled by “aging inefficient assets”.

Cash negativity is a fairly serious condition. If it persists disaster usually awaits. Aging inefficient assets make the problem worse.

Forget about a social license. Gunns needs cash and a more ‘efficient’ portfolio of assets.

In August the new look Gunns was to comprise a division devoted to ‘hardwood and softwood’ sawmilling.

This has now been revised to ‘softwood processing’ only. No mention of hardwood sawmilling. Literally, this means an exit from all hardwood sawmilling not just native forest sawmilling.

Normally a CEO when spruiking his Company will attempt to explain and justify the latest P&L Statement. UBS has been critical in the past of the book entries of Dickensian proportions that have been used to prepare Gunns’ financial accounts. Hence Greg didn’t dwell on Gunns’ appalling 2010 results. He was on a hiding to nothing. He simply said “if your investment focus is purely about this year’s trading, GNS is not your stock”.

Never a truer word has been uttered.

The latest presentation concentrates on the balance sheet and the opportunities that may ensue. The net operating assets (before bank loans of $660 million) are listed for each of 8 segments.

These are:
1. Forest products (woodchipping) $109 million.
2. Hardwood sawmilling $179 million.
3. Softwood sawmilling $144 million.
4. Softwood plantations $250 million.
5. MIS $413 million.
6. Wine/walnuts $45 million.
7. Other $32 million.
8. Pulp $1,165 million.

A total of $2,337 million. More details can be found on page 9 of http://www.asx.com.au/asx/statistics/displayAnnouncement.do?display=pdf&idsId=01110388

Now to have a closer look at the suite of assets.

1. The woodchipping side of the business contains $57 million of land, some aging woodchipping plant and not much else.

2. Hardwood sawmilling contains $119 million of inventory and a bit of land and plant for a total of $179 million.

3. Of the $144 million net operating assets for softwood sawmilling, almost half, $60 million, are intangibles relating to goodwill/trademarks when Auspine was acquired. Of the rest $31 million is inventory and $57 million buildings and plant. A bit thin.

4. Softwood plantations contain $222 million of land. And $88 million of trees which are on the market. But then it will require $40 million to acquire the sawmill and the 290,000 tonne pa resource from FEA. The trees to be sold are believed to be in SA. Gunns will probably use the proceeds to fund the FEA purchase.

5. MIS management is Gunns’ second largest segment in $ terms, a total of $413 million. The management relates to existing schemes. Further schemes are not contemplated at this stage. Loans of $237 million are due from MIS investors, and a further $140 million is an estimate of the value of future commissions due at harvest time from MIS proceeds. Gunns conveniently omits future MIS expenses from the financials, the legacy costs which help sink Great Southern. These expenses are only given a cursory mention as a contingent liability in the Notes. Before the Great Southern deal Gunns managed 106,000 hectares of its own MIS plantations. The Great Southern deal added a further 130,000 hectares (only 7,400 hectares in Tasmania). Gunns only paid $6 million in a competitive tender situation to acquire the Responsible Entity rights to 9 Great Southern Project. This enabled it to immediately bring to account $67 million of future earnings. Other tenderers must have mispriced the asset. So much for the Efficient Market Hypothesis. Maybe Gunns are overstating their windfall? The book entry provided a timely boost to Gunns’ sagging Balance Sheet. The future commissions could be worth as little as threepence halfpenny if the travails of Timbercorp and Great Southern are any guide. And the loans to MIS punters have sold for as little as 30 cents in the $ in the past.

6. The wine assets have been sold for $33 million and the walnut assets will soon follow.

7. The ‘other’ of $32 million is minor. It includes the construction business which will be transferred to Hazell Bros.

8. The remaining 50% of Gunns’ net operating assets will form part of the pulp mill business which will be “vended into the project”. Sold to another entity?

Before looking at the ‘pulp’ assets just a few comments on the remaining 7 segments.

There’s nothing of sufficient quality that will cause investors to queue. And there’s nothing with security value to attract bankers.
After the walnuts go, the next most realisable asset is the hardwood sawmilling inventory of $119 million but this presumably will occur as Gunns’ planned structure includes softwood processing only. To sell it so soon after the ITC Timber acquisition last November is a little puzzling and possibly indicates the seriousness of Gunns’ current predicament. That acquisition was designed to take advantage of synergies with Gunns’ existing hardwood sawmilling operations. And in 2010 it seemed to work, as it appeared to be the only part of the business with positive cash flow.

The balance of the softwood plantation with a book value of $88 million is “subject to current sale process”. This sale certainly raises the question of why Gunns bothered to purchase Auspine, barely 3 years ago. The gross assets totalled $500 million. But it has since sold three quarters of the trees and is about to sell the rest, has closed down one mill and about to close another. The only tangible asset remaining will be $222 million worth of land growing other people’s trees.

Gunns’ strategy, incidentally, is to “capture full value from the assets on the balance sheet and create a new future”. Just in case you’re wondering.

Unless one is a paranoid conspiracy theorist it’s a little difficult to see any Green or Geoff Cousins’ role in Gunns’ Auspine debacle. It appears to be an example of Gunns’ decision making during the Gay years.

The need for cash is what’s driving Gunns. A social license is ancillary. Gunns knows by how much it needs to reduce debt come December 2011 before major loans are renegotiated. That’s why it’s quitting hardwood sawmilling. So it can sell the sawmilling inventory. Take a look at the other aging inefficient assets in the first 7 segments. There’s not much else of any value. This limits borrowings, even if there was cash flow to support borrowings, which there isn’t.

Selling assets to reduce debt invariably falls short of expectations. The sale of assets prior to June 2010 did nothing to reduce debt. Gunns simply used any spare cash to survive.

Withdrawing from native forest sawmilling has been portrayed as a noble goodwill gesture designed to promote an end to years of division. But a sceptic reading the financials could well conclude that there was no other option. Directors had no alternative pursuant to their statutory responsibilities and fiduciary duties.

Paying compensation for the alleged noble gesture will indeed create a dangerous precedence.

There are suggestions that Forestry Tasmania will take over the Triabunna facilities. That’s unlikely to produce cash. It will simply be offset against amounts owed by Gunns to FT. Which won’t help FT either ‘cos like Gunns it needs cash. Unless it dips further into the jar of TCFA grants?

The ‘pulp’ net operating assets of $1,165 million contains $585 million of land and forest roads, $241 million of plantation trees and $320 million of buildings plant and equipment, the largest component being $205 million spent on the mill to date.

It is likely that most of Gunns’ current debt of $660 million will need to shift with the ‘pulp’ assets. Which is hardly likely to impress joint venture partners or prospective lenders to the project.

Gunns owns about 65,000 hectares of hardwood plantations in Tasmania, mostly on its land. There are a further 106,000 hectares of Gunns MIS schemes, again mostly on its land, and a further 7,400 hectares of Great Southern’s plantations here in Tasmania which Gunns are now ‘managing’. The latter are of dubious quality if the 800 hectare Temma plantation is any guide. Cattle still enthusiastically graze the property. Agroforestry is not normally practised with such young trees. There are extensive areas where the tree population is similar to that of the Sahara Desert. My ute will be available for the afternoon when cartage to the mill door is required.

There are also private plantations and FEA has about 35,000 hectares of MIS plantations in Tasmania. The fate of the latter hasn’t been decided but fast tracking harvest operations is likely to occur, before the land is sold by the bankers.

A pulp mill of the size contemplated will probably need a plantation resource of almost 200,000 hectares. It always a little difficult to work out the size of the hardwood plantation resource, its location, age, current volume, estimated volume at harvest time and importantly who owns the crop. This has changed markedly since Gunns’ first pulp mill proposal. Maturing crops have disappeared at a faster rate than replacement crops now that MISs have dried up. Current MIS investors are likely to continue to exit at harvest time. They will need to be bribed to stay. Or ‘offered compensation’ may be the more polite phrase. Both Gunns and Elders have been reported as saying half of the current national estate of 800,000 to 900,000 hectares won’t be replanted.

Even if the pulp mill doesn’t proceed a full audit of the available plantations estate is required if peace talks are to be advanced.

Gunns dilemma is quite simple. When financiers are taking a detailed look at the financials they can’t help but notice that borrowings haven’t reduced since loans were taken out to purchase assets from Boral and North Forests. These assets are now a crappy pile of junk. Sure, there’s a bit of land but most of that is leased to tax recalcitrants to grow slow growing trees which if protected from interfering cattle may produce sufficient at harvest time to cover harvesting and transport costs. And then they’ll probably exit the industry with their share,85% to 95%, of whatever remains. Who’s going to replant? More Government assistance?

Hopefully the next chapter will see a new era for native forest sawmillers, smaller more nimble players free at last from the over arching dominance of the industry’s major player which is now a business with aging inefficient assets, excessive levels of encumbered assets, excessive debt levels to earnings, cash flow negative and increasingly dependent on a highly unstable plantation industry yet to evolve beyond failed MISs.


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