Tuesday, 17 July 2012

Joining the dots

Twas the announcement by Gunns on 1st July that further write-downs of its forestry assets were needed in the current environment that has shed a little more light on the problems confronting the Tasmanian forest industry.

The announcement gives a little more context to the going concern deliberations currently occupying the minds of both Gunns’ and FT’s Directors.

This time last year Gunns was contemplating the year ahead:

The Company has completed a number of transactions to focus its operations. There are a number of significant transactions remaining to be closed in the course of the current year. These include teh the sale of our MIS loan book, completion of the Green Triangle forest estate sale and the financial closure of the Bell Bay pulp mill equity investment”.

None of the significant transactions referred to above were completed during the year.

The Board contemplated life without the possible completion of the transactions and concluded it was still reasonable to continue to adopt the going concern basis when preparing the financial statements. This was best described in a Note contained in last year’s financial statements.

“Should the ability of the consolidated entity to realise sufficient cash flows from trading operations, secure additional lines of finance or the sale of assets be restricted, the consolidated entity will actively pursue alternative funding arrangements and institute additional measures to preserve cash. These may include (but are not limited to) further sales of assets (refer Note40 – Events subsequent to balance date), working capital reductions, accessing capital markets and further restrictions of operating and non-essential capital expenditures.

The Directors have also considered the ability of the consolidated entity to obtain alternative sources of debt finance or refinance senior debt at or before its maturity date of January 2012. The ability and timing of the consolidated entity to secure long term debt financing beyond that date cannot presently be determined with certainty; however management and Directors are confident that new banking arrangements on mutually agreeable terms and conditions will be established prior to the maturity date of the existing facilities.

After making enquiries and considering uncertainties described above, the Directors have a reasonable expectation that the consolidated entity will have adequate resources to continue to operate and meet its obligations as they fall due for the foreseeable future. For these reasons the Directors continue to adopt the going concern basis in preparing the Consolidated  Financial Report.”

The Directors dodged a bullet in January 2012 when banks agreed to extend loans until December 2012. It wasn’t a completely charitable gesture by the banks as Gunns had to agree to pay a further bank fee of $30 million.

It is always a little difficult to ascertain the size of Gunns forest estate here in Tasmania partly because of the different measures bandied about eg area under management vs area owned freehold vs area with plantations owned by Gunns vs net plantable areas.

Overall Gunns manages plantations of 341,000 hectares. Of these 53,000 hectares are softwoods, almost all in the Green Triangle (ex Auspine). Most of the Green Triangle softwood trees have been sold and Gunns have been trying to sell the land for ages (see above).

That leaves 288,000 hectares of hardwood plantations under management.

Approximately 130,000 hectares of MIS plantations were taken over by Gunns from Great Southern. All are owned by MIS growers on leased land and all except about 9,000 hectares are located on the mainland, mainly in the Green Triangle and in the South West of WA.

That leaves approximately 167,000 hectares of managed hardwood plantations in Tasmania. Two thirds are managed on behalf of MIS growers with the remaining one third growing trees owned by Gunns, some in a joint venture arrangement with third parties.

Hence only about 100,000 hectares of hardwood plantations in Tasmania are growing on Gunns’ land, with about half belonging to MIS growers. The balance of Gunns’ managed plantations almost all belonging to MIS growers is on land leased from third parties.

This means only about 50,000 hectares are Gunns’ trees on Gunns’ land.

Gunns only owns a total of about 200,000 hectares of freehold land in Tasmania, but 92,000 hectares is classed as non-wood production areas mainly native forests withdrawn from production or areas unsuitable.

There have been few plantations established in the last 5 years. With the youngest plantation being 4 to 5 years old it is possible to assess eventual yields to within 10% for the short rotation crops. The value of these trees is currently affected by depressed pulpwood prices which in turn reflects the value of the underlying land.

The biggest current uncertainty when trying to assess the value of plantation land is what will happen once the crop is harvested. There was a time when it was blandly assumed that more MIS investors would easily be found to finance second rotations. But no longer.

It’s got to the stage where if a landlord may become responsible for post harvest replanting and/or cleanup the huge depressive effect on plantation land values may well mean the land has close to a nil value from an investment viewpoint.

What will be weighing on the minds of shareholders being asked to contribute another $400 million on top of the $500 million contributed in the last 4 years, almost all of which has vanished, is what is the value of the freehold land owned by Gunns or more specifically, who will pay the replanting/cleanup costs—- Gunns or the existing growers.

If it’s the former then the land with third party crops has probably a nil value, the land with Gunns’ own crops may have some value (much is the stunted plantations at Surrey Hills behind Burnie), and the native forest plantations are worth maybe $1,000 per hectare on a good day with a fair breeze.

Possibly only $150 million to $200 million in total for the land plus say $100 million for its own plantations, a far cry from the $600 million book value.

That is why Gunns admitted to the ASX on 1st July that it will have to revalue its assets as at 30th June. It is unlikely that the book value of its softwood sawmills will escape unscathed from any revaluation.

It is facing serious going concern problems, investors have baulked at putting in more funds.

It looked for a while that shareholders might opt for one more spin of the wheel, to consolidate the land and trees into one ownership structure, but the numbers are so unfavourable it starting to look like a case of good money chasing bad.

Forestry Tasmania FT will also need to write down the value of its hardwood plantations. It too will need to assess its going concern situation. The $78 million from the sale of its 50% share of the softwood JV suggested liquidity problems were solved for a year or two, and a continuation of its three year prayer mat vigil might solve longer term going concern issues.

This is what FT’s Directors said in their Report, dated 15th August almost 12 months ago on the matter of its going concern status when preparing the annual financial statements.

Forestry Tasmania’s operating result, together with the ongoing uncertainty around the Tasmanian Forests Intergovernmental Agreement and the Statement of Principles and their possible impact on the business, have caused the Directors to review the appropriateness of continuing to prepare the accounts on a going concern basis. The current trading outlook presents significant challenges in terms of sales volume and pricing and in these circumstances there are material uncertainties over future trading results and cash flows. In addition, the effect on the business of the Agreement and Principles is yet to be finalised but it is possible that they will lead to a significant reduction in the resource available for harvest and sale.

Also relevant is that the State Government has commenced a strategic review of Forestry Tasmania. The outcome of this review may or may not increase the uncertainties surrounding Forestry Tasmania’s operations.

The Directors have concluded from this that the combination of these circumstances represents a material uncertainty on the operations of the business.

However, the Directors note that:

• there are signs of improved demand for forest products, pricing is improving and Forestry Tasmania has reduced its costs significantly;

• measures have been instituted to preserve cash, additional sources of finance have been secured and other initiatives are being considered including asset sales;

• it is likely that assistance will be received in restructuring operations and the balance sheet;

• appropriate enquiries of the relevant ministers have been made and, bearing in mind the uncertainties described above, the Directors have concluded that the Group and the Organisation will receive ongoing support and adequate resources to continue in operational existence for the foreseeable future.

Taking into account all the above factors the Directors have concluded that it is appropriate to continue to adopt the going concern basis in preparing the financial report.

FT displayed its usual unjustified optimism with regard to improved demand and lower costs but at least the Directors appeared to consider the possibility that further Government assistance/compensation, in addition to the more than $220 million granted since corporatisation 17 years ago, might be necessary to satisfy going concern requirements.

In December 2011 the unlikely tag team of Messrs Gutwein and Booth quizzed FT at an Estimates hearing. Mr Gordon from FT responded at one point:

“So we said, ‘Okay, let us model a scenario where the future looks like the volumes in the IGA.’ We then ran a series of scenarios to sell the softwood joint venture and we assumed that we would get our reserve price for it or keep the softwood joint venture. We also looked at a series of other scenarios about when we could harvest our plantation assets. Again that depends on basically whether they end up being sliced, peeled or sawn. Under those scenarios FT has an operating profit and retained earnings sufficient to retain cash in the business, pay tax and a dividend for each of the next 25 years.

We also included the very significant reductions in operating costs that we have done in the last three years, from 540 staff to 340-something today. We have factored in the other savings we have made in terms of roading costs and a whole range of other things. When you take into account substantially reduced income, as we have modelled, compared with cutting 300 000 cubic meters of sawlog we are still in a position where we can return a profit, a dividend, pay taxes and maintain a cash balance necessary to have some capacity for investment in new activities and to pay our way.”

That looks awfully like an implicit denial from Mr Gordon that he was not a modern day Capt Edward Smith heading towards an iceberg in the North Atlantic and that really, everything was under control. To repeat “...........we are still in a position where we can return a profit, a dividend, pay taxes and maintain a cash balance necessary to have some capacity for investment in new activities and to pay our way.”

Barely six months later following the Government belated appointment of URS as a Strategic Reviewer it appears that FT is facing chronic cash flow difficulties with Treasury advising Leg Co members of a cash flow shortfall of $35 million for 2012/13. Hence the appropriation of $35 million in the Budget and a total of $110 million over the Forward Estimates period, was needed just in case FT was to keep trading for a further 4 years without any changes to its errant ways.

But the most bizarre reaction was from the rusted on FT supporters who overlooked the fact that at worst Mr Gordon had misled Parliament and at best had raised serious doubts about his transition from driving a Pulp Mill Taskforce Bus to driving a GBE with all the attendant fiduciary responsibilities to shareholders, creditors and employees, and instead decided if opprobrium should attach to anyone it should attach to Mr McKim for daring to suggest that business as usual at FT was not an option.

Mr McKim’s was hardly a radical view. In fact the Auditor General went further when he was particularly scathing about FT’s inadequacies in a draft report on FT’s performance in April 2009. He said “without stronger financial performance, investment in roads and plantations over the past 15 years will not yield future benefits to Forestry and arguably should be expensed rather than capitalised. On that basis, it can be argued that ordinary operations from 1994 to 2008 have yielded little profit.”

In other words if all the compensation money received so far, over $220 million, won’t yield future benefits, then why entrust FT with any more?

The pro forestry cheerleaders are almost at the stage where they’re acting as double agents, by further undermining the industry with their consummate lack of understanding of the loss of equity from the industry over the last few years and the distortion of the contribution of the industry to the State economy.

We keep hearing that forestry is an $800 million pa industry, or if a really large number is required, the level of economic activity is $1 billion plus.

But these are all measures of what is essentially turnover, apparently derived by adding intermediate outputs with final outputs to get a grossly inflated figure for the contribution of the industry, camouflaging the loss of capital essential for any industry to thrive which in turn inevitably casts a pall over the future industry as envisaged by the spruikers.

Four years ago Gunns’ balance sheet revealed its net worth or equity position at about $1 billion. Since then shareholders have contributed a further $500 million but the company has probably a zero value given the lack of enthusiasm by instos to contribute more and given that more asset write downs are now occurring. That’s a loss of capital of $1.5 billion.

Let’s be quite clear about this, loss of equity doesn’t happen when assets are sold and loans repaid, it happens when assets are worth less than book value and when operating losses persist.

Four years ago FT’s equity was $550 million, last year it was $146 million. Today, with a revaluation of its remaining hardwood plantations and continuing losses, FT could go close to registering a zero equity position———a little bit of working capital, a few trees, a few roads on land it doesn’t own offset by an unfunded superannuation liability which at last count was $122 million.

Between Gunns and FT the loss of capital over the last 4 years is almost $2 billion.

That this is not of sufficient concern to warrant a comment from the spruikers is simply mindboggling.

A lot of comments on FT focus on the operating profit. Sure it’s been a bit negative, but these are tough times, but forestry is still a $800 million industry, blah, blah, we’ve heard it lots of times. But the entire capital base has gone, at least from major players like Gunns, FT and FEA.

I recall FT’s current Chairman saying to an Estimates Hearing just over 3 years ago:

“Much has been made of the …. loss recorded by Forestry Tasmania, and it is worth explaining in layman’s terms how that figure came about when the operational profit was $8.5 million. In any business accounting, accountants calculate the value of the physical assets held in that business……. it is my view that this valuation number is a somewhat theoretical number. In financial terms, a better measure of how we are travelling is the operating profit or loss.”

I wonder if the Chairman would make the same comment now that all FT’s equity has disappeared.

It is troubling that a GBE Chairman finds presenting a meaningful balance sheet a little theoretical.

The corollary is if valuing trees is theoretical, on what basis investors are supposed to use if they are to consider an investment in the forest industry. If they don’t go through a similar exercise by estimating likely future proceeds and costs and trying to assess whether an investment is worthwhile then what are they supposed to do, flip a coin?

Therein lies the crux of the problem. Plantation land has lost value, expected future returns are unattractive. Hardly any investment for the last five years and unlikely to suddenly resume. We await the outcome of the IGA deliberations as they concern native forests, but meanwhile the plantation industry too is as good as dead. Capital and equity has vanished. Without it an industry will find it difficult to grow.

It’s a microcosm of what’s happening everywhere. If overseas Governments weren’t already insolvent, rescuing insolvent banks which needed to be recapitalised following plummeting asset values, soon fixed that.

The IGA process might be flawed and unrepresentative but there won’t be anything better.

The Libs cling to the mistaken idea that the industry will survive and will trade out of its problems, seemingly oblivious to the eroded balance sheets that pervade the industry. Their potholed Road to Recovery dependent on diverting FT appropriations will become impassable if FT needs more funds.

Threats to tear up the agreement are lamentably short sighted, especially when no alternative blueprint is presented except maybe a belief in the confidence fairy.

Without capital the task will need more than a magic wand.

It’s time stopped we deluding ourselves and moved on.


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