Seven Ugly Gaunt Cows That Could Swallow South Canterbury Finance

See also:

Fonterra Payout Increase Buys Time for South Canterbury Finance

Share Market to South Canterbury Finance: Not Interested!

Pharaoh said to Joseph, “In my dream I was standing on the bank of the Nile, when out of the river there came up seven cows, fat and sleek, and they grazed among the reeds. After them, seven other cows came up—scrawny and very ugly and lean. I had never seen such ugly cows in all the land of Egypt. The lean, ugly cows ate up the seven fat cows that came up first. But even after they ate them, no one could tell that they had done so; they looked just as ugly as before. Then I woke up." ...
Then Joseph said to Pharaoh, “The seven good cows are seven years ... The seven lean, ugly cows that came up afterward are seven years ... Seven years of great abundance are coming throughout the land of Egypt, but seven years of famine will follow them. Then all the abundance in Egypt will be forgotten, and the famine will ravage the land. The abundance in the land will not be remembered, because the famine that follows it will be so severe. (Genesis 41, NIV)

The good times in an industry don't last forever, and South Canterbury Finance would do well, or would have done well, to hear and heed the dream of Pharaoh, and not stake its survival on the fortunes of fat dairy cows.



Just how much exposure does troubled financier South Canterbury Finance have to the dairy sector? The answer is probably a lot more than you might think, and a lot more than a prudent financial institution should have. Here's a list of the known and likely exposures:

1. Dairy Holdings Ltd, SCF holds 33.59% of the company, which has assets of $666m, liabilities of $408m, revenue of 78m, made a loss of $66m, and SCF's share has a carrying value of 76m (source: note 15 of the annual report), and therefore makes up about 72% of the firm's common equity of just $106m as at 30 June 2009. And yes that is one big dairy farm investment, and yes, its mightily indebted and making mighty big losses.
   
2. 'South Island Farm Holdings Ltd, a company which is under the control of a company director, has issued 67.2m preference shares at $1 per share, to South Canterbury Finance Ltd. On 1 July 2009 6.8m ordinary shares at $1 per share were acquired by South Canterbury Finance' (source: note 25 of the annual report). Several concerns here: it appears that SCF was unwilling to make this company an associate company, which would involve disclosure of its financial position and performance as with Dairy Holdings Ltd, so they invested equity in the form of preferred shares instead (however, the ordinary share investment post balance date makes South Island Farm Holdings Ltd. an associate company after that). It would appear that the company is such a bad financial situation that it needed very substantial equity injection that Hubbard was unable to provide, and wanted to hide this situation from investors and raided SCF's cash reserves to invest in preferred shares instead. Although its assets, liabilities, revenues and profits are not disclosed in the most recent financial report, however, given that it is in the same business as Dairy Holdings Ltd., it probably has similar debt gearing levels and makes similarly large losses on equity. So, the total equity investment in this farm is $74m, 70% of SCF's common equity of $106m as at 30 June. Total equity exposure so far is therefore $146m, so far is therefore farms is 138% of common equity. Holy cow! But wait, there's more!
   
3. 'Rural Lending
   South Canterbury Finance has had a long standing presence in the New Zealand rural lending market as a result of the background of its Chairman, Directors, and executive team, and their respective relationships with the rural sector. The General Manager of Rural Lending further enhances this presence and assists the Company to build on its existing relationships within the rural sector.
   As at 30 June 2009, the Charging Group’s rural loan portfolio stood at approximately $178.15 million and covers a number of loan types from term loans for land use changes through to seasonal funding arrangements and all forms of rural activities from sheep and beef to dairy farming. As at 30 June 2009, South Canterbury Finance had approximately 246 rural loans with an average loan settlement value of approximately $664,800,
   with two rural loans in excess of $10 million each. As at 30 June 2009, total impairment provisions relating to the Company’s rural portfolio were approximately $3.9 million, being approximately 2.2% of the rural portfolio and 0.2% of the Charging Group’s total net receivables. As at 30 June 2009, approximately $144 million or approximately 81% of South Canterbury Finance’s Rural sector loans were secured by first ranking charges and approximately $34 million (or approximately 19%) by second ranking charges.
   As a result of the continual growth in the rural sector in New Zealand and the corresponding growth in demand for funding, South Canterbury Finance sees this sector as continuing to offer key lending opportunities.' (Prospectus 60, registered 20 Oct. 2009, p 8)
   

So, there you have it. $146m in direct equity dairy exposures, $34 million in second ranking security rural exposures, and $144m in first ranking security rural exposures, Total dairy and rural exposure: $324m.

The dairy sector is already characterised by very high asset prices and low to negative returns, even with elevated dairy product prices. Should the dairy product price suffer some down times, asset prices could fall by more than 50%, and SCF would lose hundreds of millions of dollars. It should also be noted that SCF intends to sell its dairy farm holdings (good idea, do it now!), but they are large enough, together with Crafer farms (also on the market, loaded with $200m of debt) to raise concern about depressing the prices or triggering an asset price crash. Today's post is enough to show how the whole company's survival depends on the fortunes of a single industry.

The rating agencies, investors, and the crown should be concerned about this.