VicForests heading downhill fast

 It is difficult to understand how VicForests’ can describe its latest loss of $4.7 million as ‘a sound result’.

A closer look at the VicForests’ Annual Report for 2020/21 suggests a different description may be warranted.  Forest revenue of $85 million was similar to the previous year, but after production costs of $70 million the stumpage value of harvested timber was the lowest ever at 17.9 per cent of revenue or $15.3 million, which was scarcely enough to cover roading and regeneration costs of $13.5 million, let alone employee costs of $19 million and overheads of $12 million. A lifeline of $21 million from the Government was needed for VicForests to continue as a going concern.

VicForests’ operations fell well short of being financially sustainable. It’s been that way for the past five years at least. Forest revenue from the sale of publicly-owned trees has been insufficient to cover costs. Native forests, which comprise the majority of VicForests’ net assets, have been provided free by the Crown. No dividend has been paid in the last five years. Land is not transferred, only the right to harvest stipulated areas of native forests over certain periods.

The transfers of trees from the Crown are recorded in Vic Forests’ books at a value equal to the anticipated net proceeds when the timber is sold. Net proceeds allow for harvesting costs but exclude regeneration costs. Provided estimated costs are reasonably accurate and similar to actual costs, cash proceeds will be equal to the estimated value of the timber. Once the value of a felled coupe is written off as an expense the amounts will cancel out and profits will be close to zero.

Therefore, whilst profits will be zero or thereabouts, VicForests doesn’t pay for the timber and so will have cash equal to the net proceeds, being the value of the logged coupe, from which to pay regeneration costs.

Not only have the net proceeds from logging gifted forests been insufficient to regenerate coupes as required, VicForests’ financial statements obscure the reality that the value of regenerated coupes is less than the amount that is spent on regeneration.

There’s a basic overarching accounting principle that applies to all businesses which is particularly relevant to VicForests. If capital spending is unlikely to increase a firm’s asset base, the capital amounts should be expensed immediately. Had VicForests expensed regeneration costs when incurred over the past five years, as it should have according to this principle, the ensuing headline losses would have clearly reflected the economic unsustainability of native forest logging.

This year 2020/21 has seen a change in accounting policy whereby regeneration costs are immediately expensed rather than treated as additions to the asset base.  

The corollary is to include regeneration costs when calculating the net proceeds from logging. This would wipe out the value of native forests currently on VicForests’ balance sheet. In fact, it would become a negative amount. Instead of an asset representing future net proceeds which conveniently excludes the mandatory costs of regeneration, there would be a liability account, a provision for future harvest losses. It would then be crystal clear to a reader that VicForests had negative equity which will need cash injections from government to continue as a going concern. In effect VicForests boosts its balance sheet by bringing to account future income without including all future costs.  It’s a con. Directors of listed companies claiming sustainability when their figures suggest otherwise run a huge risk. It doesn’t appear to concern VicForests directors. They can always claim adherence to an arcane accounting standard even if it leads to a misleading set of financial statements.

VicForests’ recent operations are best assessed by referring to earnings before interest, tax, depreciation and amortisation, which accountants call EBITDA. The EBITDA is then adjusted by the amount of government grants to give a figure for the cash earnings of the business before government assistance. Prior years’ profits have been adjusted to include regeneration costs as expenses rather than as capital amounts which overstate VicForests’ balance sheet.

In the following chart the blue line shows the headline profit figure, and the orange line shows VicForests’ revised EBITDA figure representing net earnings (including amounts spent on regeneration) before interest, tax and government grants and before any book entries such as depreciation, amortisation and adjustments of the value of trees. On this latter point it is worth noting VicForests reduced its headline loss figure in 2020/21 by revaluing standing timber by $10 million at the same time as it wrote back its growing pile of logs in storage by $2 million. It’s odd for standing timber to increase in value at the same time as the value of harvested timber suffers a fall, particularly when harvest costs are increasing.  The revaluation of standing timber conveniently reduced its headline loss by 70 per cent.  As noted above to boost profits by bringing to account more future income is a con if one doesn’t account for all future costs.

The EBITDA figure ignores all book entries and focuses on cash earnings. It is therefore a more relevant measure of VicForests’ profitability than the headline figures trotted out in the Annual Reports. 

         

            

The 2020/21 cash loss of $30.5 million was funded by $21 million of government assistance and a $10 million run down in VicForests’ bank account. Like Mother Hubbard’s cupboard the bank account is now bare. There’s $2 million still to be spent on regeneration and another $5.6 million will be needed to carry out programs for which grants were received but spent elsewhere.

There’s little doubt as to the trajectory of VicForests’ earnings. The figures show an inexorable downhill slide.

Will it survive another nine years to 2030 when native forest harvesting is due to end? It will need a lot more government assistance. In the past five years government assistance has totalled $97 million. Cash deficits before assistance in the same period have amounted to $96 million.

VicForests’ Annual Report referred to problems caused by ‘opponents of sustainable native timber harvesting’. It is not clear what was meant. There hasn’t been any sustainable native timber harvesting by Vic Forests for at least five years. Perhaps it was a typo. Perhaps it was meant to refer to ‘opponents of unsustainable native forest harvesting’. That would make more sense.

 

 (this note was prepared to assist Friends of Leadbeater's Possum Inc in its campaign to preserve the threatened habitat of this endangered species)