BUSINESS
AFGRI is a leading South African services business offering a wide range of physical and intellectual inputs to farmers, agri-processors and users of agricultural products. AFGRI also owns animal feed and seed processing businesses which leverage its critical mass and core skills to reduce the cyclicality of earnings related to an agricultural commodity business.
The business of the group is structured into the following main pillars:
AFGRI Financial & Logistics Services:
- Handling & Storage, with 64 silo complexes and 4 million tons of capacity countrywide (representing nearly a third of South Africa's total silo capacity of 14 million tons)
- AFGRI Logistics, a fourth party supplier of logistic services, as well as fleet management and owner-driver solutions
- Trading, one of the three leading grain traders in South Africa
- Financial Services, providing loans and seasonal accounts, as well as insurance (though the largest crop insurance broker in South Africa).
AFGRI Producer Services:
- Retail & Equipment, with over 80 retail outlets supplying requisites and equipment to farming communities across the country, under the AFGRI Retail and FarmCity brands
- Primary Inputs, supplying fertiliser, chemicals, fuel and seed to farmers
- Tsunami, which sources and formulates cost-effective agri chemicals for distribution by agents
- Partmaster, a national supplier of agricultural wear parts
- AFGRI Golf, which specialises in golf course and industrial turf equipment
- AFGRI Tobacco, a buyer and primary processor of tobacco for both the local and international markets
- Agri Onderdele, a supplier of tractor parts.
AFGRI Products:
- Animal Protein
- Animal Feeds
- Daybreak Group
- Scinetic
- Foods
- Nedan Oil & CSP
- Citrifruit Products
- Direct Inputs
AFGRI International:
This pillar comprises the group's operations in Australia (mainly equipment supply) and Zambia (a smaller replica of the South Africa operations).
BEE
AFGRI Operations is 26,8% owned by a broad-based BEE consortium, The Agri Sizwe Empowerment Trust, which has two representatives on the Board of Directors. The relationship between AFGRI and the Agri Sizwe Empowerment Trust has settled down to a steady working relationship, based on a shared vision of building a world-class agricultural services group that meets the needs of the entire agricultural supply chain, including that of emerging farmers.
AGRICULTURAL ECONOMIC BACKGROUND
While manufacturing and services are enjoying virtually unprecedented growth, the same is not true for agriculture, which contracted by 13,1% in 2006. This was the worst performance by the sector in over 10 years, according to independent economic analysts RLJP. If agriculture is stripped out of the picture, overall economic growth for the domestic economy would have been in the region of 5,5% last year, as opposed to the 5% actually achieved.
The main reasons for this poor performance were the much smaller than expected maize crop in 2006, coupled with weaker maize prices. Maize is the primary crop in South Africa, and the fortunes of maize farmers have a powerful bearing on agriculture as a whole.
Market disturbances in the maize sector
The maize crop for the 2005/6 planting season shrank by nearly half to 6,3 million tons, down from 11,45 million tons in the previous season. The reasons for this are easily summarised: global over-supply in the 2004/5 season coupled with the strength of the rand drove the farm-gate price of maize down to a low of roughly R600 a ton, well off the previous high of about R1 800 a ton. Conditions were further aggravated by the late harvest. Few farmers were able to make profits at R600 a ton (the average price for 2005 was R725 a ton), so the following season they switched to alternative crops or simply let their fields lie fallow. Farmers reduced plantings in 2006 in an effort to force prices higher, which they successfully did: prices for 2006 averaged R1 237 a ton.
This recovery in maize prices encouraged farmers to increase maize plantings for the current season, and initial estimates for the year put the expected crop size at 7,75 million tons. However, following several months of drought in the key maize growing areas of the country, crop estimates have since been pared back to 6,9 million tons, and may be further revised as the growing season progresses. This is only slightly higher than the previous season's crop, though the average price realised should exceed that of the previous season. Maize prices on Safex jumped above R1 700 a ton in the early part of 2007, but have since moderated to around R1 500 a ton. While the increased price will go some way to offsetting the lower crop yields, the loss of more than one million tons of maize to drought represents a substantial loss of revenue for farmers, and hefty payments on crop insurance.
Given the current low stock levels and reduced crop estimates for maize and wheat, South Africa will again have to make up the domestic supply shortfall through imports. Maize imports are expected to reach up to 1.5 million tons this coming season, versus 0.098 million tons last season. Wheat imports could reach 1.3 million tons, up from 1.1 million tons last season, while protein imports are likely to be slightly higher than last season's 0.6 million tons.
The higher grain prices alluded to above are putting upward pressure on meat prices, since grain is the largest input cost for cattle farmers. The same is true of broilers and pork. Grain and meat constitute around 9.5% of the total consumer price basket and around 45% of the total consumer food price basket, which contributed almost two percentage points to the 6% year-on-year consumer price inflation in February 2007. Cattle farmers may respond in one of two ways to rising grain costs: they will attempt to pass these costs on to consumers or, unable to sustain the high feed prices, increase the slaughtering of cattle. The resultant increase in meat supply to the market would have the effect of pushing down meat prices. Research by Standard Bank suggests there is a relatively high correlation between meat prices and consumer spending on durable goods. This demonstrates that meat prices are only raised during times when consumer spending is buoyant. While the spectre of food inflation looms large, there are grounds to believe the pass-through effect at the retail and manufacturing levels will be lagged and partial.
Impact of ethanol demand on the maize market
Given the sharp reduction in plantings in 2006, it was inevitable that maize prices would recover as the laws of supply and demand took hold. Domestic prices were helped by firmer international trends: International corn prices have virtually doubled to around $4 a bushel over the last two years, due largely to the increase in demand from ethanol producers. Corn (maize) growers in the US intend to plant 90.5 million acres of corn in 2007, up 15% from 2006 and 11% higher than 2005. The US Department of Agriculture (USDA) announced in March 2007 that continuing high demand for corn, fuelled by increasing ethanol production, will keep corn prices at historic levels for the foreseeable future. Stronger prices have prompted US farmers to increase corn plantings at the expense of traditional crops such as cotton. This trend is further encouraged by generous - and controversial - subsidies and tariff protection enjoyed by US farmers. As The Wall Street Journal recently noted, surging corn prices are driving up the cost of food globally and hurting those most vulnerable - the poor. This is because corn is a vital input for pork and chicken farmers, to name just two.
As far as AFGRI is concerned, higher maize prices are a mixed blessing: they encourage higher plantings by farmers, and - weather permitting - this increases demand for our Handling & Storage facilities. But as already mentioned, the recent drought has had a devastating effect in some parts of the country, and the size of the expected crop this season will be substantially below initial projections. Higher maize prices hurt other parts of our business, notably broilers, where maize is the key feedstock.
Local maize prices take their cue from the international market, where prices are trending sharply higher due to ethanol demand. The weakening in the rand since May 2006 has further impacted local maize prices and we are unlikely to see prices return to the lows of around R700 seen just over a year ago.
South Africa cannot escape the global trend towards ethanol as a fuel additive, and maize farmers are understandably keen to develop alternative markets for their output.
This presents a major opportunity for AFGRI. The first ethanol production facility is due to be built in Bothaville, heartland of the South African maize industry, by a newly formed entity called Ethanol Africa (which has plans for eight such facilities). Legislation is pending in South Africa relating to a mandatory E10 blend in the local fuel industry. The fuel E10 is made of 10% denatured (unfit to drink) ethanol blended with 90% gasoline. Ethanol production will therefore become a substantial part of the country's grain business going forward, and this new market for grains should encourage steadily higher plantings by farmers in years to come. AFGRI will benefit in terms of stronger demand for its products and services: handling and storage, sales of equipment and farming inputs (fuel, fertiliser, etc.) and financial services. The Group is exploring a number of options to further capitalise on what will become a permanent feature of the grain market in the future.
Maize futures prices on Safex - firmer prices here to stay?
(Click on image to enlarge)
Source: Share Friend Executive
As the accompanying graphs show, the area planted to maize in South Africa has been declining in recent years as the yield per hectare has been increasing. Improved seed technology and farming methods have produced a near doubling in yields in the last few years, resulting - the recent supply shortfall notwithstanding - in steadily expanding maize surpluses (ie. surplus to domestic needs). The scale of surpluses is expected to continue rising, hence the strong interest in ethanol production as a new market outlet for farmers.
Historical land under maize cultivation
(Click on image to enlarge)
Maize yield per hectare in South Africa
(Click on image to enlarge)
Historical and projected annual maize surplus
(Click on image to enlarge)
Source: Ethanol Africa
FINANCIAL RESULTS FOR YEAR TO FEBRUARY 2007
HIGHLIGHTS
- TURNOVER FROM CONTINUING OPERATIONS UP 21,4%
- DILUTED HEPS UP 62,6% ON PRIOR YEAR
- GROUP DILUTED EARNINGS PER SHARE UP 42,8%
- HEADLINE EARNINGS FROM CONTINUING OPERATIONS UP 60%
- NET CASH POSITION IMPROVED BY 202%
- ACQUISITION OF DAYBREAK BROILER BUSINESS
- EXCELLENT RESULTS FROM PRIMARY INPUTS, RETAIL, PROTEIN AND FINANCIAL SERVICES
- DISPOSAL OF UNDER-PERFORMING COTTON GINNING BUSINESS
- 44% REDUCTION IN PROFIT FROM LOGISTICS DUE TO SMALLER MAIZE CROP
- AUSTRALIAN BUSINESS TRADED PROFITABLY, DESPITE THE REGION SUFFERING THE WORST DROUGHT IN RECORDED HISTORY
The strong improvement in financial performance was largely the result of a more buoyant agricultural climate driven primarily by improved commodity prices, and the ongoing focus on cost reduction and improvement in supply chain efficiencies.
A notable feature of the results was the 22% increase in turnover from the Primary Inputs and Retail businesses, and a 27% increase in turnover from Financial Services. Two years ago the Group embarked on a programme to reduce fixed overheads and optimise supply chain efficiencies (particularly procurement). The full benefits of this programme were evident in the 2007 financial results, when these businesses achieved a R160 million improvement in profitability.
All areas of the business performed well, with the exception of Logistics (profit was down 44% due primarily to the smaller maize crop) and International. The Australian business traded profitably despite Australia suffering its worst drought in recorded history, and trading results from the Zambian business were down due to structural and personnel difficulties, which has since been resolved. The Zambian business has since been restructured and is now breaking even, with expectations of an improved result in the coming financial year.
The results were lifted by the prior year disposal of the loss-making Clark Cotton business. This aligns with the Group's strategy of exiting businesses that destroy value, and investing in those that create value for shareholders.
Other noteworthy features of the results for continuing operations were:
- Headline earning per share grew by 62,6% to 60,5 cents
- Earnings per share was up by 42,8% to 55,7 cents (2006: 39 cents).
- Turnover from continuing operations was up 21,4% to R6,12 billion (2006: R5 billion restated)
- Operating profit for continuing operations improved 33,7% to R672 million (2006: R502 million).
- Profit before tax for continuing operations was up 67% to R413 million (2006: 247 million)
- The tax charge for the year was R69 million, up from R24 million the previous year
- Net profit after tax from continuing operations was R344 million, a 54% improvement on the R223 million achieved the prior year.
- Headline profit from continuing operations (before tax and after finance costs) improved by R138 million, or 60%, for the financial year.
- There was a 202% improvement in the net cash position, helped by to a R333 million improvement in working capital.
- A total dividend of 30 cents was declared for the 2007 financial year, up 54% from the 19,5 cents normal dividend paid in 2006 (after excluding 10,73 cents a share special distribution in that year).
DIVISIONAL PERFORMANCE
AFGRI Producer Services
It was an excellent year for Producer Services, with turnover up 22% to R3,8 billion, helped by a 1% improvement in gross margins translating into a R114 million turnaround in business profitability, from a loss of R59 million the previous year to a profit of R55 million.
Producer Services reported a sharp improvement in business profitability, assisted by a R60 million reduction in stock and inventory, and a turnaround in the financial fortunes of FarmCity in Pretoria from the previous year's loss to sustainable profit. Equipment sales were much improved, and October 2006 was a record month for tractor sales, contributing to an overall increase in market share of 9% for the year. AFGRI provides equipment to farmers through its John Deere dealership.
Overall, Producer Services benefited from higher volumes, improved gross margin and cost reduction programmes. Business volumes benefited from a 50% increase in maize plantings during the year, notwithstanding the subsequent drought which has reduced maize crop estimates for the current growing season.
Retail comprises a network of roughly 80 stores countrywide trading under the AFGRI brand, servicing the equipment and supply needs of farmers. A relatively new retail concept, FarmCity, was launched nearly two years ago to cater to the peri-urban consumer with a range of outdoor and sporting goods, alongside the traditional farming requisites. The existing two FarmCity stores - in Pretoria and Pietermaritzburg - have been augmented by a third in Ruimsig, Roodepoort, with several more planned over the medium term.
This division, which includes a network of workshops and mobile units, offers equipment repair and maintenance services to farmers. This network was rationalised during the year to reduce fixed overheads and deliver a more cost-effective service. The focus during the coming year is to roll out a network of 13 world class John Deere workshops and mobile units. This is in addition to the network of workshops already in existing in KwaZulu-Natal.
AFGRI Tobacco is a new business within the Group, and is a buyer and primary processor of tobacco for local and international markets, particularly the Far East. AFGRI has long been involved in financing tobacco farmers, but recently extended its involvement to the primary processing of tobacco for sale to the local and international markets. The Group has acquired an interest in a modern processing plant at Rustenburg, providing a strong foothold into this market. This is in the long-term interests of tobacco farmers and buyers, as AFGRI has assisted in consolidating the primary tobacco industry by instituting buy-back contracts with farmers, who now receive much better tobacco prices than was previously the case.
Prospects
Notwithstanding the lower-than-expected maize crop for 2006/7, a sustained increase in the maize price as was evident over the last 12 months has infused the farming community with greater confidence going forward. Offtake from ethanol producers will become an important feature of the maize market in the years to come, providing a solid underpinning to what has hitherto been a fickle and uncertain market for producers. A key area of focus for the current financial year is supply chain optimisation and cost containment. Plans are in place for expansion of the retail network, and AFGRI Tobacco will be expanded to Zambia. We are therefore confident of achieving real growth in Producer Services in the year ahead.
AFGRI Products
It was an excellent year for AFGRI Products with a 24% increase in turnover and 91% in operating profit. The 24% growth in turnover to R1,8 billion for the year was boosted by the inclusion of Daybreak. Excluding Daybreak, turnover is on the same level as the prior year.
Operating profit grew 91% to R143,6 million. Excluding Daybreak, operating profit was up 36%.
A highlight of the year was the exceptional performance from Animal Feeds, which posted its best performance ever.
The acquisition of the Daybreak broiler business vindicates the decision to re-enter this market, following the sale of AFGRI's 50% share in the Earlybird broiler business over a year ago due to contractual constraints. Daybreak has turned out to be an excellent and well-timed acquisition. It is a well managed operation comprising abattoir facilities near Springs, east of Johannesburg, and the hatching facilities near Bela-Bela (Warmbaths), north of Johannesburg. The company has capacity to produce 800 000 broilers a week, and the focus of attention in the coming year will be to expand production to meet growing market demand. The acquisition of the Daybreak broiler business during the previous financial year provides a vital new product outlet for Animal Feeds.
Daybreak's performance was assisted by a strong domestic market, where demand for broilers is growing at an average 5% a year. Daybreak contributed R346,7 million to turnover and R41,4 million to profit before internal interest and tax.
The Animal Feeds business comprises six manufacturing facilities at Kinross, Paterson in the Eastern Cape, Klipheuwel in the Western Cape, Bethlehem, Eloff and Isando, with a total production capacity of 1.2 million tons a year, making it one of the three largest animal feed operations in South Africa. The newly commissioned Paterson and Klipheuwel facilities are now performing to expectation.
Because maize is a key input in the Animal Feed and broiler businesses, higher maize prices will exert pressure on margins in the year ahead, though AFGRI has taken steps to protect margins through more effective procurement and supply chain management.
Tsunami had a good year, with sales of fertiliser, chemicals and fuel rising strongly on the back of the higher maize plantings. Seed had a more difficult year, though this has been addressed by refocusing this business.
The Foods division recorded a R5 million turnaround in performance during the year, following restructuring and a more critical focus on stock management and margins. Citrifruit is performing to budget, and Nedan Oil Mills posted a much improved performance. Nedan supplies plant oils and soya-based products from a manufacturing plant in Potgietersrus. Citrifruit supplies lemon oil to a major international soft drinks manufacturer, as well as lemon and grapefruit concentrate and lemon peel to various other customers.
Prospects
The increase in grain commodity prices over 2006 will result in margin pressure in the Animal Protein and Foods businesses. The main challenge faced is to manage the procurement of raw materials to be competitive in the market. AFGRI Products will utilise the expertise of AFGRI Trading to ensure competitive raw material procurement.
In the coming year the division will focus on the expansion of Daybreak, either organically or by acquisition, as well as the consolidation of the Nedan and CSP plants. Further areas of focus include the introduction of new maize genetics to the market and the entry of Tsunami into the Western Cape.
Logistics Services
This business unit comprises:
- Handling & Storage, with 64 silo complexes and 4 million tons of capacity countrywide (representing nearly a third of South Africa's total silo capacity of 14 million tons)
- AFGRI Logistics, a fourth party supplier of logistic services, as well as fleet management and owner-driver solutions
- Trading, one of the three leading grain traders in South Africa
Handling & Storage posted a 22% drop in turnover and a 43% drop in profit before interest and tax due to the smaller maize crop, and aggressive strategies by competitors offering alternative storage mechanisms. The carry-over stock at the beginning of the financial year was higher than normal as a result of excess grain left over from the previous bumper crop. As mentioned earlier, this resulted in a drop in maize prices, and many farmers switched to more profitable crops the following season. Though maize planting were substantially higher at the start of the current growing season, the subsequent drought is likely to result in a crop only marginally higher than last year. There is some expectation that the current crop will be delivered to the silos earlier than normal, which would positively impact the business.
The introduction of electronic silo certificates as a service enhancement to customers is beginning to yield positive results, and a new tariff structure has been launched to strengthen our competitive position in the market. The benefits of this new tariff structure will become evident in the current financial year.
A new strategy has been launched, together with AFGRI Trading, to capture a larger share of end users' storage business. Handling & Storage's adherence to food safety regulations has set the benchmark for the industry. The business has invested in state-of-the-art IT and stock management systems to further improve its competitive position. Another focus for the year ahead is geographical diversification, a process which has already been started.
Logistics reported a 7% increase in turnover and a 83% reduction in profit before interest and tax for the year, due to difficult market conditions and competitive pricing on coal transport. Logistics will continue its diversification into the coal market, prompted in part by the ongoing withdrawal of Spoornet's service delivery to the agricultural market. Transport contractors are moving into various segments of the logistics chain, such as warehousing, broking and commodity trading, which intensifies competition in this market. Another problem is the relative shortage of road transport capacity during certain periods of the year, particularly on the Reef-Durban route.
A highlight of the year was the acquisition of the Rotran coal contract. The product offering to the market will be expanded to offer more than just coal transport and strategic alliances will be critical in the year ahead.
The Trading business performed admirably in a difficult year, posting an increase of 21% in sales despite the lower maize plantings. Profit before tax, interest and exchange rate advantages increased by 5%, which must be seen in the context of the smaller maize crop and the halving in carry-over stocks over the last growing season. Margins were under pressure during the year, though this was ameliorated by the strong growth in sales. Grain imports are expected to increase substantially during the current year, which will impact the Trading business's volumes.
Financial Services
AFGRI Advances posted a 69% increase in turnover and profits increased by 64%. Turnover in this business was helped by a steady growth (11%) in the debtors' book, as well as a healthy stream of advisory fee. Operating conditions remained buoyant for most of the year, though the changing interest rate environment required a more conservative approach to credit assessments. Farmers generally received much better prices for their crops than the previous years, which contributed to the improved financial result. Obtaining funding in a higher interest rate environment remains a challenge, but this was successfully overcome by focusing on specific areas of the total book and then sourcing funding on that basis. The business's large exposure to grain was addressed through the creation of a new entity in the Western Cape to increase exposure to soft commodities, and this will remain a focus throughout the current year. A new credit card brand was established during the past year, which will assist in the business's growth strategy.
AFGRI Insurance grew turnover by 15,8%, helped by improved income from each of Short-Term, Hail and Input Cost insurance, and Credit Life. Crop Insurance benefited from the dramatic increase in hectares planted to maize during the year. Commercial Short-Term income increased over the prior year due to better management and a good team effort. Due to a write-off during the prior year, those numbers might not represent a true picture of achieved revenue.
Prospects for Logistics and Financial Services
Am improved performance is expected from Handling & Storage due to a somewhat larger maize crop and strategies now in place to secure a larger share of this market. This includes the new tariff structure, the convenience of electronic silo certificates, and plans for geographical diversification.
Demand for financial services is likely to remain buoyant as agricultural conditions normalise. Financial Services has identified a need for a focused agricultural and commodity finance entity to provide direct funding solutions to the agricultural sector. This will make the business less dependent on wholesale banking, allowing it to compete with the banking industry. Also under exploration is the possibility of acquiring a third party debtor book.
AFGRI Insurance is looking to augment its established customer base by strengthening its presence in selected areas, and through acquisitions.
Treasury's focus for the coming year is enhancing its systems with a view to better managing foreign exchange risk, while expanding its product offering to the rest of the Group.
The emphasis in the year ahead will be on more efficient procurement and improved management of supply chain logistics to mitigate the effects of higher maize prices in those parts of the business that are sensitive to escalating prices. |
