PGW - PGG Wrightson

[Balance]

Any thoughts on whether the OIO will allow a full takeover of PGW ?

PGW is already overseas owned. It will simply be a transfer of ownership from one foreign shareholder to another. Main issue I believe is whether the new owner is a fit and proper owner.

[Snoopy]

Any thoughts on whether the OIO will allow a full takeover of PGW ?

I don't think that just because you can see BAIC holdings increasing their stake that implies they are on a takeover path. You have to think like a Chinese person, not a westerner. The Chinese understand 'long term'. BAIC would I am sure be quite prepared to sit there as a 20% shareholder for ten or twenty years. The Chinese also like partnerships with the west., like the 50/50 ownership deal they did with Silver Fern Farms. They are used to this at home where for a long while Western companies setting up in China had to set up a joint venture with a Chinese business partner. I think PGW would suffer if it became fully Chinese owned with farmers switching to the co-ops to do their business. At least as it is now, PGW still has a semblance of NZ ownership. As a marketing ingredient going forwards, I think the 100+ years of being a New Zealand company is key.

SNOOPY

[Snoopy]

As I predicted, the PGW pension plan continues to career out of balance. The ten year picture is shown below.

In the table below, I am effectively looking at the pension schemes as a 'black box' and observing the cashflow that comes in and out. The information in this table can be found in the respective annual reports under the header "Defined Benefit Asset/Liability" (e.g. Note 20 in AR2017).

PGW Pension Plan(s) External Cashflows

Financial Year	Pension Plan Deficit EOFY	PGW Contribution {A}	Members Contribution {B}	Total Contribution {A}+{B}	Benefit Paid {C}	Net Cash Movement {A}+{B}-{C}
2010	-$18.206m	$3.127m	$1.651m	$4.778m	($5.631m)	($0.853m)
2011	-$16.970m	$3.622m	$1.378m	$5.000m	($4.980m)	$1.398m
2012	-$26.264m	$2.727m	$1.363m	$4.090m	($3.819m)	$0.271m
2013	-$20.819m	$1.402m	$1.364m	$2.766m	($6.412m)	($3.646m)
2014	-$13.528m	$1.427m	$1.337m	$2.764m	($4.709m)	($1.945m)
2015	-$14.665m	$1.301m	$1.300m	$2.601m	($5.304m)	($2.703m)
2016	-$20.715m	$1.204m	$1.254m	$2.458m	($3.482m)	($1.024m)
2017	-$12.271m	$5.920m	$1.199m	$7.119m	($6.010m)	$1.109m
2018	-$7.722m	$3.011m	$1.170m	$4.181m	($8.914m)	($4.773m)
2019	-$5.883m	$8.455m	$1.268m	$9.723m	($14.044m)	($4.321m)
2020	-$9.838m	$0.692m	$0.832m	$1.524m	($5.301m)	($3.777m)

At least the long term cash drain behind the scenes (the PGW contribution) has shored up the pension plan at long last -right?

Unfortunately not, because the ten year government bond rate, a key driver in calculating the required pension fund asset position since the balance date of 30th June 2019 has declined from 1.57% in AR2019 to 0.91% in FY2020. The pain hasn't stopped either because as of today, nearly two months on from the balance date, the ten year cash rate is down to just 0.67%!

Very importantly, the earnings capacity of the company has approximately halved due to the sale of the seeds division. In this drought year in particular, earnings have collapsed to just $5m. That means the pension scheme deficit of $9.838m (approximately $10m) will need two years of PGW profits to be diverted to close the funding gap. The effective position of the pension plan for PGW shareholders, and even pension plan beneficiaries, must now be of significant concern. Yet in June 2019, the Group announced that they had brought the Plan to an 'actuarial equilibrium position', because they have their own calculation standards that are better than IFRS standards (apparently).

I finally got the chance to listen to the AGM audio file and noted the details of the comments and subsequent discussion on the company pension scheme. The discount rate of just 0.91% (representing the 10 year government stock rate at balance date) was blamed for the $9.838m 'Pension Scheme balance blowout' deficit figure. Under the IFRS standards, the rules require the use of the ten year NZ government discount rate to determine the present value of future returns. Under the alternative Financial Market Authority (FMA) standards, the deficit figure was less than a quarter of that reported - or less than $2.5m.

Finally then, we see an admission that the pension fund is 'not quite' in actuarial FMA balance. Granted a deficit figure of $2.5m would not -to me- be a cause of major concern. But is that FMA deficit figure really more accurate than the IFRS deficit figure?

The Chairman noted that the board is onto the issue and he himself questions the performance of the scheme regularly. The Chairman acknowledges that higher returns are becoming more difficult to obtain too. But he also says that the board are at 'arms length' from the trustees that run the scheme, (and I say rightly so to that). He keeps exhorting the trustees to 'do better'. Yet after hearing that, I do wonder if the board understand the mechanics of running such a scheme?

The 'end of year' composition of the 'Defined Benefit Scheme' may be found in AR2020 under Note 18:

Asset Class	Percentage Holding
Equities	58%
Fixed Interest	29%
Cash	13%

I would break the boards mantra of 'better returns' into three sub questions:

Q1/ How do you get better returns from the cash piece of your portfolio?
A1/ You can't

Q2/ How do you get better returns on your fixed interest piece of your portfolio?
A2/ Invest in higher risk funding where those borrowing the money are charged a higher interest rate, but have a higher chance of default. I would question whether that is a wise course of action for investing pension money though.

Q3/ How do you get better returns on your fixed interest piece of your portfolio?
A3/ Try stock picking. Invest like Buffett in companies with 'beaten down valuations', and take advantage of takeover situations by 'buying ' as soon as a takeover is announced. However, I think PGW has tried to be clever like this in the past and has now moved to an 'index fund' rather than a 'stock picking' mentality. While an index fund should give a good 'market return', how do you convert that to an 'above average' market return? The answer, given the nature of an index fund, is that you can't.

As of 5th December, the ten year government bond rate is now 0.54% (down from 0.91% at balance date), and the NZX50 is up 5% in the same time frame. But fixed interest term rates have fallen significantly. I can't see that these changes will have improved the income position of the pension scheme since balance date.

I have had a prevailing view expressed to me that interest rates will stay low for the next couple of years and then go higher. But will they? Isn't such a low 10 year government bond rate an expression of a 'wider prevailing view' that interest rates will stay low for a long time? What happens if interest rates stay this low for twenty years, not two?

In summary, I am not convinced that the PGW pension scheme will be able to close any valuation gap for their 200 scheme members under the current scheme rules. ' Look for things to blow out further by 30-06-2021' is my prediction.

SNOOPY

[Snoopy]

The problem with estimating an 'interest rate equivalent paid' for the PGW debt is that company debt is quite seasonal. Shareholders were presented with a picture of this in Figure 6.1 on page 34 of the "PGG Wrightson Independent Report, (outlining the case for divesting the seed division, and dated October 2018). Disclosure to this level of detail is not available in the annual report. But we can make a 'triangulated approximation' to the variability of the debt via three data points that are in the annual and half year reports:

1/&2/ End of year net debt position of the current year and the previous year AND
3/ The half year net debt position in between.

From AR2019 p8

"PGW negotiated and entered into new bank facilities in July 2019.....It is pleasing to note that very competitive terms have been struck for these banking arrangements"

This interest rate renegotiation makes all of my indicative interest rate calculations up to now, including calculations based around AR2019, historical. However, exactly what 'very competitive terms' means has not been revealed. One thing we can assume is that PGW is now paying a lower interest rate compared to what they have done in the recent past. So let's dive back into last years PGW history and try to figure out what is the figure they were paying that, by way of comparison, makes the new terms so good.

Distorting the end of FY2019 capital picture is the gain on the sale of the seeds business on 1st May 2019 of $134.281m. If this gain had not happened, the debt position of the company at EOFY balance date would be very different. We don't know exactly the position of the company just before the seed sales proceeds came through. But I am guessing it was something like I have outlined in the table below:

	30th April FY2019	EOHY2019	EOFY2018	EOHY2018	EOFY2017
Cash	$0m	$3.884m	$10.926m	$24.247m	$9.403m
less Short Term Debt	$2.680m (*)	$79.635m	$30.806m	$91.215m	$26.719m
less Long Term Debt	$134.281m	$130.000m	$149.205m	$130.634m	$110.925m
equals Total	$136.961m	$205.751m	$169.085m	$197.602m	$128.241m
Half Year Increment		+$36.666m		+$69.361m

(*) This figure from EOFY is used as an estimate of the short term loan balance two months earlier.

For the purposes of calculating an 'average loan balance', I feel it is best to consider the financial year split into three time periods:

P1/ An intiial six months, WITH
P2/ an ensuing four months FOLLOWED BY
P3/ a final two months.

The calculation of the average loan balance over these three time periods, using a linear interpolation model, is as follows:

P1/ ($169.085m + $205.751m)/2 = $187.418m
P2/ ($205.751m + $136.961m)/2 = $171.856m
P3/ $0m (debt repaid)

The time proportional average debt of these three periods added together is as follows:

( 6 x P1 + 4 x P2 + 2 xP3 ) / 12 = ( 6x$187.419m + 4x$171.856m) / 12 = $150.994m

The Annual Report declared net interest bill for the year has been split into interest expense allocated to 'Seed and Grain' ($4.481m) and PGWRR ($6.067m), for a total of ($10.548m). This equates to an implied net interest rate for PGW over FY2019 of:

$10.548m / $150.994m = 7.0%

CEO Stephen Guerin has negotiated the new banking facilities so that there is an incremental seasonal funding amounts to $70m. Considering the business has now been roughly 'half sized', this seems a lot, although I guess it is prudent to allow for less than ideal weather circumstances. The reduction in interest rate paid also announced must be meaningful for Stephen Guerin to crow about it. A 10% reduction might be more in line with what is happening in the markets as a matter of course. I am picking Stephen has got a 20% reduction. That would take PGW net interest rates down to: 0.8 x 7% = 5.6% for FY2020.

Stephen Guerin crowed about the great refinancing deal he got for shareholders for the just finished financial year. But now the year is wound up, how well did he actually do?

	EOFY2020	EOHY2020	14h August 2019	EOFY2019	30th April FY2019	EOHY2019	EOFY2018	EOHY2018	EOFY2017
Cash	$16.868m	$0.682m	$0m	$210.491m	$0m	$3.884m	$10.926m	$24.247m	$9.403m
less Short Term Debt	$30.000m	$40.000m	$2.680m (2)	$2.680m	$2.680m (1)	$79.635m	$30.806m	$91.215m	$26.719m
less Long Term Debt	$20.000m	$20.000m	$23.509m	$0m	$134.281m	$130.000m	$149.205m	$130.634m	$110.925m
equals Total Debt	$33.132m	$59.318m	$26.189m	($207.811m)	$136.961m	$205.751m	$169.085m	$197.602m	$128.241m
Half Year Increment		+ $33.129m (3)				+$36.666m		+$69.361m

Notes

1/ 1st May 2019 was the settlement date for the sale of the seed division. This short term debt figure just before the payment was made is from EOFY2019 (used as an estimate of the short term loan balance two months earlier).
2/ 14th August 2019 was the seed division sale capital repayment date to shareholders. This short term debt figure just before the payment was made is from EOFY2019 (used as an estimate of the short term loan balance six weeks later).
3/ Half year debt increment after capital repayment (Comparison with previous full year position not meaningful).

For the purposes of calculating an 'average loan balance' over FY2020, I feel it is best to consider the financial year split into three time periods:

P1/ An intiial one and one half months, WITH
P2/ an ensuing four and one half months FOLLOWED BY
P3/ a final six months.

The calculation of the average loan balance over these three time periods, using a linear interpolation model, is as follows:

P1/ $0m (no debt)
P2/ ($26.189m + $59.318m)/2 = $42.754m
P3/ ($59.318m + $33.132m)/2 = $46.225m

The time proportional average debt of these three periods added together is as follows:

(1.5 x P1 + 4.5 x P2 + 6 x P3 ) / 12 = ( 0 + 4,5x$42,754m + 6x$46.225m) / 12 = $39.145m

The "Net Interest and Finance costs" over FY2020 sum to $5.032m (AR2020 p35). This implies an effective interest rate of:

$5.032m / $39.145m = 12.9%

That seems very high, more than double what I predicted, and in no way bears out Stephen Guerin's claim of a very competitive interest rate deal that he has negotiated. So how to explain what has gone wrong?

SNOOPY

[Snoopy]

For the purposes of calculating an 'average loan balance' over FY2020, I feel it is best to consider the financial year split into three time periods:

P1/ An intiial one and one half months, WITH
P2/ an ensuing four and one half months FOLLOWED BY
P3/ a final six months.

The calculation of the average loan balance over these three time periods, using a linear interpolation model, is as follows:

P1/ $0m (no debt)
P2/ ($26.189m + $59.318m)/2 = $42.754m
P3/ ($59.318m + $33.132m)/2 = $46.225m

The time proportional average debt of these three periods added together is as follows:

(1.5 x P1 + 4.5 x P2 + 6 x P3 ) / 12 = ( 0 + 4,5x$42,754m + 6x$46.225m) / 12 = $39.145m

The "Net Interest and Finance costs" over FY2020 sum to $5.032m (AR2020 p35). This implies an effective interest rate of:

$5.032m / $39.145m = 12.9%

That seems very high, more than double what I predicted, and in no way bears out Stephen Guerin's claim of a very competitive interest rate deal that he has negotiated. So how to explain what has gone wrong?

There are a couple of good reasons why the effective interest rate I have calculated will be higher than whatever terms CEO Guerin has negotiated with his bankers.

1/ PGW is a seasonal business. Our Chairman in his AGM address talked about a 'Seasonal Build up of Working Capital' from the end of year balance sheet position. I am modelling the seasonal debt peak to be 31st December (the publication date of the half yearly accounts). But the Chairman has said the actual peak is in February/March. This means the average quantum money borrowed will be greater than I have calculated. That means the dollar value of net interest payments will be spread over a larger debt base. And that means the real indicative interest rate paid by PGW will be lower. So if I knew all this, why did I not correct for it? PGW does not publish their accounts on the day of 'peak debt'. So any correction would only be a guess. My philosophy in these situations is to declare that my interest calculation is too high and let others decide on what correction to make for that, if any.

2/ I often take out foreign exchange corrections. Foreign exchange items form part of the annual interest charges. These have to be declared to reflect what would happen if those underlying foreign exchange contracts were discontinued over our one year operating window. However, there is no intention to ever realise these contracts until they have run their course. And often these year to year fluctuations balance out.

In this case the interest bill should be adjusted by (AR2020 p49): $0.502m - ($0.324m) = $0.178m (reduction in interest bill),

3/ IFRS16 introduces an 'interest on lease liabilities' into the overall annual interest charge. Lease liabilities are an accounting construct introduced with IFRS16,. Interest on these lease liabilities have no interest charge equivalent in previous year's accounts. Instead there is a roughly equivalent higher level of operating expenses in pre-IFRS accounts. The transfer of what was an 'operating expense' to an 'interest charge on lease liabilities' is nothing to do with any underlying bank loan for PGW. So my inkling is to remove the 'interest on lease liabilities' charge from the interest bill.

In this case the interest bill reduces by (AR2020 p49): $4.183m (reduction in interest bill)

Summary: The net effect of these changes is to reduce the indicative interest bill to:

$5.032m - ($0.178m + $4.183m) = $0.671m

That translates to an indicative loan interest rate of:

$0.671m / $39.145m = 1.7%

That figure seems astonishingly low, and Steve Guerin has performed a negotiating miracle if that is the underlying corporate interest rate he has negotiated. What is more my reference point 1/ above would suggest this estimate is on the high side. They say if something is too good to be true it isn't true. With the lowest fixed residential mortgage borrowing rate available being 1.99%, that 1.7% figure does seem to good to be true. Anyone like to volunteer where I might have gone wrong in my calculation?

SNOOPY

[Snoopy]

https://thespinoff.co.nz/business/23...ger-than-ever/

$1 billion more in food exports despite pandemic.

Bad news for farmers is never good for PGW. But my ears pricked up this when I heard a news story about some of those combine harvester drivers from Europe being unable to get a spot in our quarantine hotels until February. Too late! Certain crops will be unharvestable by that stage. And one 'crop' that will be affected is silage and other stock feed. PGW sells supplemental feed. So we might find that these combine harvester drivers being locked out is actually positive for PGW over FY2021.

SNOOPY

[dibble]

Bad news for farmers is never good for PGW. But my ears pricked up this when I heard a news story about some of those combine harvester drivers from Europe being unable to get a spot in our quarantine hotels until February. Too late! Certain crops will be unharvestable by that stage. And one 'crop' that will be affected is silage and other stock feed. PGW sells supplemental feed. So we might find that these combine harvester drivers being locked out is actually positive for PGW over FY2021.

SNOOPY

Seems unhelpful to repeatedly blame immigration policy for lack of harvester drivers. Farm machinery isnt a doddle but, like anything mechanical, you get some confidence then just take it a bit slowly to start.
Perhaps farmers could think a little wider and put more effort into training a few locals who can already drive a tractor rather than continually whine about having to leave the crop to rot. All harvester drivers have to start somewhere, they've had many months to plan. If they are really simply moaning about a lack of cheap (if it is cheap?), ununionised labour then let it be called that.

[BlackPeter]

Seems unhelpful to repeatedly blame immigration policy for lack of harvester drivers. Farm machinery isnt a doddle but, like anything mechanical, you get some confidence then just take it a bit slowly to start.
Perhaps farmers could think a little wider and put more effort into training a few locals who can already drive a tractor rather than continually whine about having to leave the crop to rot. All harvester drivers have to start somewhere, they've had many months to plan. If they are really simply moaning about a lack of cheap (if it is cheap?), ununionised labour then let it be called that.

I hear that unemployed pilots make great harvester operators (well, after a bit of training - its like flying a new type of plane ....). Plenty of them around ...

[iceman]

I hear that unemployed pilots make great harvester operators (well, after a bit of training - its like flying a new type of plane ....). Plenty of them around ...

I had a coffee with an engineer friend yesterday. He was telling me about a couple of ex Air NZ pilots now driving tractors on farms. Very good operators but he said they spend too much time on pre take-off checks before they head out into the fields :-)

[Somebody Else]

They say if something is too good to be true it isn't true. With the lowest fixed residential mortgage borrowing rate available being 1.99%, that 1.7% figure does seem to good to be true. Anyone like to volunteer where I might have gone wrong in my calculation?

SNOOPY

Where to start? Note 5 on page 49 of the annual report seems a good place. In calculating your $671k you have included the interest income that PGW gets from charging overdue account fees to their customers. I'm not sure why you would bother calculating that number given they tell you they paid line fees of $683k and interest of $923k for a borrowing cost of $1.6m.

Applying $1.6m to your borrowing figure of $39.145m gives an interest rate of 4.1%. That seems a bit much, so there is likely a problem with the debt number. The first thing that stands out is that you included the $16.868m cash balance in your average debt calculation for the length of your P3 period. That seems like a big concession and likely makes your debt number $8.5m or so low ($16.868m x 6 months).

You could always try and reverse engineer the number by breaking it into components though this can be muddied up if PGW use interest rate swaps or other hedging tools. The facility looks to have a line fee component and an interest component, which will be a base rate + a margin. The line fee should be easy as it applies to the whole facility, so $683k / ($50m + $70m) = 0.57%.

The interest rate will be harder as it only applies to drawn funds, which is why you need the average funds drawn number you tried to calculate. $923k of interest over say $45m of average borrowings = 2.2%. Might be a little high but the base rate will be one of the BKBM numbers (grab whichever one you like from the Reserve Bank, but for the PGW financial year will likely average 1%) meaning the margin is maybe 1.2%. Thats probably reasonable so maybe $45m is the right number. $1.6m of borrowing cost over $45m = 3.6%. Thats higher than your residential mortgage rate, but they have line fees on undrawn facility headroom that a residential mortgage holder doesn't have.