Landcorp Farming Limited

Transcription

1 Landcorp Farming Limited Research Report November 2013

2 Table of Contents 1 Executive Summary... 2 Company Background 2 Earnings Outlook 2 Key Assumptions 2 Valuation 3 Movement from 2011 DCF Valuation 3 Value of Landcorp s Ordinary Share Capital 4 2 Company... 5 Background 5 Industry Outlook 6 Historical Financial Information 12 Company Outlook 13 3 Assumptions Economic Assumptions 15 Sector Assumptions 15 Prices Assumed in Forecasts 18 Company Specific Assumptions 19 Capital Expenditure 21 4 Financial Statements Financial Performance 23 Financial Position 24 Cash Flows 25 5 Discounted Cash Flow Valuation Forecast Cash Flow 26 Terminal Value 26 Cost of Capital 26 DCF Valuation 27 Sensitivity Analysis 28 Movement from 2011 DCF Valuation 29 6 Alternative Approaches Appendix A : Disclaimer Declarations 32 Qualifications 32 Independence 32 Disclaimer and Restrictions on Scope of Our Work 32 Limitation of Liability 33 Appendix B : Glossary i

3 1 Executive Summary Company Background Landcorp Farming Limited (Landcorp or the Company) is a State Owned Enterprise primarily involved in pastoral farming of over 375,000 hectares of owned and leased land in New Zealand. The Company predominantly produces lamb, beef and milk solids for sale in global markets. After a period of favourable trading conditions underpinned by high commodity prices, the Company s earnings deteriorated in FY13 due to the impact on livestock production of a sustained and widespread drought throughout much of New Zealand and a sharp reduction in lamb prices. In the short term, meat and dairy prices are expected to return to and remain at elevated levels supported by growth in Chinese demand. In the longer term, the outlook for commodity prices is uncertain and will be influenced by: Climatic events impacting supply; Growing demand for protein as a result of income growth and broadening of consumption across an emerging middle class in Asian countries; and Constraints on the availability of arable land and resources necessary to enable production to keep pace with projected growth in demand. The Company also develops and sells land for purposes other than farming and holds land which has been set aside for public policy purposes by the Crown. Earnings Outlook The following factors are expected to impact the Company s financial performance in the near term: The flow on effects of the FY13 drought is expected to impact livestock production in FY14. Nevertheless, Landcorp management consider that experience from previous dry seasons and actions taken by the Company during the drought have resulted in a greater level of resilience in its operations and the Company is well placed entering FY14. Landcorp is forecasting to significantly increase milk production through its joint venture arrangements with Shanghai Pengxin and Wairakei Pastoral. The Company is committed to developing 13 to 16 new dairy units on approximately 8,000 ha of Wairakei Pastoral land over the next five years. Key Assumptions We have prepared a valuation of Landcorp s equity using the Discounted Cash Flow (DCF) valuation approach and: A 10 year cash flow projection using forecasts for: Livestock and milk production prepared using information from the Ministry of Primary Industries (MPI), Agrifax and other published sources; and Production volume, operating costs and capital expenditure forecasts based on guidance provided by Landcorp management. Executive Summary 2

4 $m Valuation A discount rate based on an estimate of the Company s Weighted Average Cost of Capital (WACC). Table 1 presents the equity value for Landcorp calculated using the DCF valuation approach with the base case cash flow forecast. Table 1: DCF Valuation $m Enterprise Value 1,021 Net Debt (237) Protected Land 119 Redeemable Preference Shares (118) Equity Value 785 Multiple of FY14 EV/EBITDA 18.7x Movement from 2011 DCF Valuation The base case equity value calculated using the DCF approach in our 2011 report was $700 million. Figure 1 presents the movement in Equity Value from the DCF valuation prepared in 2011 to the 2013 value. Figure 1: Movement in Landcorp Equity Value since Executive Summary 3

5 The increase in the 2013 equity value, calculated using the DCF approach, compared to 2011 is primarily due to the forecast increase in earnings arising from Landcorp s investment in dairy production through its joint venture arrangements with Shanghai Pengxin and Wairakei Pastoral. Value of Landcorp s Ordinary Share Capital Landcorp values its land and buildings, forests, livestock and financial instruments at fair market value at each reporting date. The reported value of Landcorp s Net Tangible Assets (NTA) as at 30 e 2013 is $1,032 million (excluding Protected Land), which represents the aggregate value that could be realised from the sale of the individual assets less debt. Consistent with our 2011 report, there is a significant gap between the DCF valuation and the NTA value. The reasons for this gap include: The DCF valuation approach is based on a cash flow forecast assuming a single scenario for use of the land owned and leased by the Company. There may be upside to the DCF valuation for the option value of alternative uses for the land which may yield higher returns. Historical cash returns for Landcorp (and the comparable listed companies) are lower than the Weighted Average Cost of Capital ( WACC ) estimated for the Company. This suggests that investors in the farming industry may be willing to accept lower cash returns than implied by a WACC calculated using the Capital Asset Pricing Model. The gap between the DCF valuation and Landcorp s NTA demonstrates the challenges in applying the DCF approach to value rural land-based businesses. The value of Landcorp is directly related to the aggregate value of its underlying assets (i.e. rural land). The DCF approach does not capture all the value that investors may attribute to the underlying assets. In light of this, we consider that the value of Landcorp s NTA at 30 e 2013 of $1.3 billion is an appropriate basis for the commercial value of Landcorp s ordinary share capital. Executive Summary 4

6 2 Company Background Landcorp is a State Owned Enterprise primarily involved in pastoral farming of over 375,000 hectares (ha) of owned and leased land in New Zealand. The Company receives revenue from the sale of livestock (lamb, beef and deer) and milk solids. Table 2 presents a summary of the Company s historical productive land and annual production. Table 2: Summary of Landcorp Production Units FY09 FY10 FY11 FY12 FY13 Productive land Ha 177, , , , ,388 Milk solids Tonne 11,210 11,504 12,500 13,357 12,761 Sheep meat Tonne 10,130 9,369 9,008 10,176 10,307 Beef Tonne 11,162 10,268 8,309 9,715 11,154 Venison Tonne 2,275 2,060 2,144 2,258 2,335 Wool Tonne 2,717 2,723 2,760 2,294 2,732 Timber Tonne 102,458 80, , , ,415 Source: Landcorp financial statements In addition, the Company has two significant farming joint ventures: In May 2013, Landcorp commenced a joint venture agreement with Shanghai Pengxin Group (Shanghai Pengxin). Under the agreement, Shanghai Pengxin contributes approximately 8,000 ha of land it owns in the Waikato area (the former Crafar farms) and Landcorp contributes 18,000 dairy cattle and manages the farms. Landcorp s relationship with Shanghai Pengxin is part of a broader strategy the Company has for developing its trade with China. Landcorp has a joint venture agreement with Wairakei Pastoral Ltd (Wairakei Pastoral), the owner of approximately 25,000 ha of forestry land located near Taupo. Landcorp currently leases approximately 3,200 ha of land from Wairakei Pastoral which it has developed for dairy use. The Company intends to significantly increase the size of its operations on Wairakei Pastoral land in the next five years. In addition to its farming operations, Landcorp has the following operating subsidiaries: Landcorp Estates Limited, which develops and sells land, either directly or in conjunction with other property developers, for purposes other than farming; and Landcorp Holdings Limited, which owns nine properties on behalf of the Crown that are set aside for public policy purposes under a Protected Land Agreement with the Crown. The properties are managed and operated by Landcorp. The Crown has acquired Redeemable Preference Shares in Landcorp as consideration for the properties set aside under the agreement. Company 5

7 Industry Outlook The farming industry in New Zealand primarily produces protein in the form of lamb, beef and milk solids for sale in global markets. The financial performance of the industry is impacted by a number of macro factors, including uncertain economic conditions, volatile commodity prices (caused by weather events or other disruptions to supply and changes in demand) and the strength of the New Zealand dollar in recent years. Economic Conditions Table 3 below presents historical and forecast GDP growth rates for New Zealand s major trading partners. Table 3: Historical and Forecast GDP Growth Rates YoY % 2011(A) 2012(A) 2013(A) 2014(F) 2015(F) 2016(F) USA UK Europe 1.7 (0.3) (0.1) China New Zealand Source: Economist Intelligence Unit 2013 While modest growth is forecast for the US and New Zealand economies, uncertain economic conditions persist in Europe and to the lesser extent the UK. Historically, the UK and Europe are key markets for New Zealand meat (primarily lamb) exports. China is now a significant trading partner with New Zealand. Exports to China now account for over 20% of dairy and 15% of meat exports by value 1. The rate of Chinese GDP growth is forecast to ease from current high levels. It is not clear what impact, if any, this will have on the rate of growth of New Zealand s export trade with China. Commodity Prices Figure 2 below presents the Meat, Skin and Wool series from the ANZ Commodity Price Index to August Figure 3 presents data for the Meat, Skin and Wool series for the period since the date of our last report (November 2011) on the Company. 1 ANZ Commodity Price Index, ANZ Banking Group, 2 October Company 6

8 Nov 11 Dec 11 Jan 12 Feb 12 Mar 12 Apr 12 May Jul 12 Aug 12 Sep 12 Oct 12 Nov 12 Dec 12 Jan 13 Feb 13 Mar 13 Apr 13 May Jul 13 Aug 13 Index Value (Base 100 Jan 1986) Jan 86 Jan 87 Jan 88 Jan 89 Jan 90 Jan 91 Jan 92 Jan 93 Jan 94 Jan 95 Jan 96 Jan 97 Jan 98 Jan 99 Jan 00 Jan 01 Jan 02 Jan 03 Jan 04 Jan 05 Jan 06 Jan 07 Jan 08 Jan 09 Jan 10 Jan 11 Jan 12 Jan 13 Index Value (Base 100 Jan 1986) Figure 2 Meat, Skin and Wool Series of the ANZ Commodity Index Meat, skins & wool (World Price) Meat, skins & wool (NZD) Figure 3 Meat, Skin and Wool Series since November Meat, skins & wool (World Price) Meat, skins & wool (NZD) Company 7

9 Jan 86 Jan 87 Jan 88 Jan 89 Jan 90 Jan 91 Jan 92 Jan 93 Jan 94 Jan 95 Jan 96 Jan 97 Jan 98 Jan 99 Jan 00 Jan 01 Jan 02 Jan 03 Jan 04 Jan 05 Jan 06 Jan 07 Jan 08 Jan 09 Jan 10 Jan 11 Jan 12 Jan 13 Index Value (Base 100 Jan 1986) Figure 2 and Figure 3 demonstrate that: The Meat, Skins and Wool series of the price index has eased from record highs in However, the index suggests that prices remain at high levels relative to historical prices. In the two year period since our last report, the Meat, Skins and Wool series of the price index has declined by 6.9%. The New Zealand dollar Meat, Skins and Wool series has grown at a Compound Annual Growth Rate (CAGR) of 1.5% since the index commenced in Figure 4 presents the Dairy series from the ANZ Commodity Price Index to August 2013 and Figure 5 presents the price index data for the period since our last report. Figure 4 Dairy Series of the ANZ Commodity Index Dairy (World Price) Dairy (NZD) Company 8

10 Nov 11 Dec 11 Jan 12 Feb 12 Mar 12 Apr 12 May Jul 12 Aug 12 Sep 12 Oct 12 Nov 12 Dec 12 Jan 13 Feb 13 Mar 13 Apr 13 May Jul 13 Aug 13 Index Value (Base 100 Jan 1986) Figure 5 Dairy Series since November Dairy (World Price) Dairy (NZD) The figures show that: The World Price Dairy series of the price index reached an all time high of 414 in 2013 and remains at a high level. The New Zealand Dollar series of the price index shows that increases in world dairy prices have been tempered by appreciation of the New Zealand dollar against other currencies. In the two year period since our last report, the Dairy series of the price index has increased by 27%. This is consistent with the movement of the price for Whole Milk Powder contracts traded on Global Dairy Trade which has increased by 31% over the two year period. The New Zealand dollar Dairy series of the price index has grown at a CAGR of 4.0% since the index commenced in Much of the growth in this series of the price index has occurred since Over the long term, commodity prices should trend to the long run marginal cost of production. However, in the short term commodities prices are subject to large swings due to supply disruptions, fluctuating demand and regulatory intervention (i.e. quota/tariffs). These factors make it difficult to forecast commodity prices with any degree of accuracy. Exchange Rates The New Zealand farming industry is exposed to fluctuations in the value of the New Zealand dollar (NZD) against the currencies of its major trading partners, particularly the EUR and GDP (lamb exports) and the USD (beef exports to the US and beef, lamb and dairy exports to Asia). Figure 6 presents the historical value of the New Zealand dollar relative to the USD, GBP and EUR and Figure 7 presents this data for period since our last report. Company 9

11 Nov 2011 Dec 2011 Jan 2012 Feb 2012 Mar 2012 Apr 2012 May Jul 2012 Aug 2012 Sep 2012 Oct 2012 Nov 2012 Dec 2012 Jan 2013 Feb 2013 Mar 2013 Apr 2013 May Jul 2013 Aug 2013 NZD / Trading Partner Currency Jan 1999 Jul 1999 Jan 2000 Jul 2000 Jan 2001 Jul 2001 Jan 2002 Jul 2002 Jan 2003 Jul 2003 Jan 2004 Jul 2004 Jan 2005 Jul 2005 Jan 2006 Jul 2006 Jan 2007 Jul 2007 Jan 2008 Jul 2008 Jan 2009 Jul 2009 Jan 2010 Jul 2010 Jan 2011 Jul 2011 Jan 2012 Jul 2012 Jan 2013 Jul 2013 NZD / Trading Partner Currency Figure 6 Historical Exchange Rates NZD/USD NZD/GBP NZD/EUR Linear (NZD/USD) Linear (NZD/GBP) Linear (NZD/EUR) Figure 7 Historical Exchange Rates since November NZD/USD NZD/GBP NZD/EUR Figure 6 and Figure 7 demonstrate that: The NZD remains at high levels relative to the USD, GBP and EUR compared to medium to longer term exchange rates. Company 10

12 The NZD has remained relatively stable against the USD, GBP and EUR over the two year period since our last report. The strength of the NZD against the USD has a direct impact on the returns on beef and dairy exports (and lamb to a lesser degree). As well as sales to the US itself, the US dollar is the dominant pricing currency in a number of Asian markets. The recent increases in commodity prices have been moderated in New Zealand dollar terms by the relative strength of the New Zealand dollar. In our 2011 report we presented an analysis of historical prices that showed an inverse correlation between dairy prices and the exchange rate. This relationship suggests that changes in international dairy prices are moderated to some extent by movements in the value of the New Zealand dollar. Outlook In the short term, meat and dairy prices are expected to remain at elevated levels underpinned by growth in Chinese demand. In the longer term, the outlook for commodity prices is uncertain and will be influenced by: Climatic events impacting supply; Growing demand for protein as a result of income growth and broadening of consumption across an emerging middle class in Asian countries; and Constraints on the availability of arable land and resources, including in some areas water, necessary to enable production to keep pace with projected growth in demand. The New Zealand dollar remains at high levels relative to the major trading currencies (USD, GBP and EUR). At the date of this report, there is nothing to suggest that this situation will change in the near term. Company 11

13 Historical Financial Information Table 4 presents a summary of the historical financial performance for Landcorp: Table 4 Summary Financial Performance Statement of Financial Performance FY09(A) FY10(A) FY11(A) FY12(A) FY13(A) $000 $000 $000 $000 $000 Revenue Livestock gross profit 98,464 83, , ,323 89,060 Milk solids income 54,164 70,193 94,615 82,989 75,820 Wool gross profit 6,020 5,914 10,888 10,163 7,609 Forest & other produce income 1,096 2,735 5,215 1,908 3,610 Other income , Total Revenue 160, , , , ,720 Operating Expenses Farm working 68,970 62,885 73,999 82,526 81,947 Personnel 41,501 42,054 44,203 45,393 45,577 Repairs & maintenance 11,239 10,869 11, ,904 Other 20,532 20,109 23,794 24,376 26,337 Total Operating Expenses 142, , , , ,765 EBITDA 18,095 27,034 66,068 45,333 10,955 EBITDA Margin 11% 17% 30% 22% 6% Depreciation 12,235 12,557 12,461 13,280 13,592 EBIT 5,860 14,477 53,607 32,053 (2,637) EBIT Margin 4% 9% 24% 15% -1% Interest Expense (12,741) (11,366) (10,404) (10,238) (10,801) Gain (Loss) on sale of Land 3,819 8,721 10, Other Income (Expense) 13,738 6,902 (966) 5,198 26,397 Profit Before Tax 10,676 18,734 52,551 27,013 13,168 Income Tax Expense/ (Benefit) (12,567) 3,468 12,789 (8,312) (1,325) Fair Value Adjustments (12,913) (21,107) 74,830 (44,739) (32,560) Net Profit After Tax 10,330 (5,841) 114,592 (9,414) (18,067) Net Profit Margin 6% -4% 52% -4% -10% Source: Landcorp financial statements We make the following observations: A combination of high commodity prices and favourable weather conditions throughout FY11 and much of FY12 were positive for Landcorp s earnings. The Company experienced a sharp deterioration in earnings in FY13 as a result of: Sustained and widespread drought throughout the North Island and much of the South Island that resulted in lower livestock and dairy production and an increase in supplementary feed costs. A sharp reduction in lamb prices mid-way through FY12 and a general easing of beef and dairy prices in FY13. The reduction in market prices resulted in lower farm gate revenue and write-downs of livestock values. The proportion of revenue from the sale of milk solids has increased due to the combined impact of rising dairy prices and increases in the level of dairy production. Landcorp s milk production has increased by approximately 15% over the last five years. Company 12

14 Table 5 presents a summary of the historical financial position of Landcorp: Table 5: Summary Financial Position Statement of Financial Position FY09(A) FY10(A) FY11(A) FY12(A) FY13(A) $000 $000 $000 $000 $000 Current Assets Cash on Hand Inventory 12,500 10,918 9,659 10,095 11,913 Debtors 20,840 28,168 44,501 22,495 38,641 Livestock 218, , , , ,812 Forest 8,648 10,746 16,807 16,225 18,958 Property Held for Sale 38,922 37,634 25,419 87,782 82,865 Total Current Assets 298, , , , ,189 Non-current Assets Fixed Assets 43,433 41,586 40,885 43,367 45,444 Land 1,144, ,231 1,058,426 1,033,557 1,052,548 Protected Land 117, , , , ,358 Other Assets 47,051 48,592 49,584 54,381 69,748 Deferred Tax Asset 17,812 17,127 2,387 10,029 9,591 Total Non-current Assets 1,369,758 1,222,014 1,269,048 1,259,930 1,296,689 TOTAL ASSETS 1,668,748 1,521,949 1,662,973 1,662,884 1,694,878 Current Liabilities Overdraft Creditors 22,957 16,464 19,591 18,507 14,531 Other creditors 6,628 7,829 8,337 8,560 8,161 Total Current Liabilities 29,585 24,293 27,928 27,067 23,398 Non-current Liabilities Debt 189, , , , ,398 Total Non-current Liabilities 189, , , , ,398 TOTAL LIABILITIES 218, , , , ,796 NET ASSETS 1,450,057 1,337,579 1,469,382 1,449,724 1,435,082 Source: Landcorp financial statements We make the following observations: The recent decline in the carrying value of livestock is largely due to an easing of market prices in FY12 and FY13 and a reduction in stock levels as a result of the drought in FY13. This decline masks an increase in the size of the dairy herd following the addition of approximately 18,000 heads (approximately $25 million value) relating to the joint venture with Shanghai Pengxin. Protected land relates to nine properties owned by Landcorp Holdings Ltd that are subject to a Protected Land Agreement with the Crown. This land is held by the Company for public policy reasons. Property held for sale is intended to be sold in the next 12 months and includes farm land with a market value assessed at approximately $70 million. Debt has increased by approximately $50 million in FY13. Funds from borrowings (and from property sales) are being used to fund the acquisition of livestock and infrastructure for the joint venture with Shanghai Pengxin. Company Outlook The following factors will impact the Company s financial performance in the near term: The flow on effect of the FY13 drought in FY14 is expected to result in: A lower than normal level of stock carried over into the FY14 season. Company 13

15 Lower livestock reproduction rates (particularly for lamb production as fewer ewes will be mated and there will be lower percentages for those that are). Lower dairy production due to the poorer condition of the herd. Nevertheless, Landcorp management consider that experience from previous dry seasons and actions taken by the Company during the drought have resulted in a greater level of resilience in its operations and the Company is generally well placed entering FY14. The Company has entered into fixed price contracts for the supply of lamb, most notably its agreement with Silver Fern Farms for the supply of lamb to Tesco, a major UK supermarket operator. In FY13, fixed price agreements were in place for approximately 70% of the Company s prime lamb production. Landcorp is now looking to enter into fixed price contracts for beef and venison production. Fixed price arrangements provide greater revenue certainty for the Company. Landcorp is forecasting to significantly increase milk production through its joint venture arrangements with Shanghai Pengxin and Wairakei Pastoral. The Company is committed to developing 7 new dairy units on approximately 8,000 ha of Wairakei Pastoral land over the next three years. Company 14

16 3 Assumptions Landcorp has prepared financial projections for the three year period to FY16. We have used Landcorp s financial projections as the basis for the cash flow projection in our DCF valuation, subject to the adjustments noted below. Economic Assumptions Table 6 presents the economic assumptions used in our cash flow forecast for the Company. Table 6: Economic Assumptions FY11(A) FY12(A) FY13(E) FY14(F) FY15(F) FY16(F) FY17(F) FY18(F) CPI 4.5% 1.6% 0.9% 1.6% 2.1% 2.1% 2.3% 2.4% NZD/USD NZD/GBP NZD/EUR Source: NZIER Quarterly Predictions September 2013, MPI Situation Outlook for Primary Industries 2013 We have used NZIER s quarterly predictions for the Consumer Price Index (CPI) over the period to FY18(F). Thereafter we assume annual CPI growth of 2.4%. We have used commodity price forecasts prepared by the Ministry of Primary Industries (discussed further below). Table 6 also presents the exchange rate assumptions implicit in MPI s price forecasts. We assume that fair market value of underlying land increases at a rate of 2% per year. Sector Assumptions Table 7 presents historical and forecast prices for deer, lamb, beef and milk solids published by MPI in e We compare MPI s forecast prices to and prices used in Landcorp s financial projections in the discussion below. Table 7: MAF Price Forecasts $/Kg FY10(A) FY11(A) FY12(A) FY13(E) FY14(F) FY15(F) FY16(F) FY17(F) AP Stag Lamb Schedule Prime Beef Schedule Milk Solids Source: MPI Situation Outlook for Primary Industries Situation and Outlook for Primary Industries 2013, Ministry of Primary Industries, e Assumptions 15

17 Lamb The UK and European markets are traditionally the most significant for sales of New Zealand lamb. The spike in the lamb schedule price in FY11 and FY12 came to an abrupt end when UK and European lamb prices declined significantly in the second half of FY12 and remained at lower levels throughout FY13. A modest increase in the lamb price is forecast for FY14 as supply is expected to contract due to lower lambing percentages following the FY13 drought. Reduced UK and European demand is expected to temper the price for higher value lamb cuts. However, increased Chinese demand for lower and mid priced cuts is expected to support increases in the lamb price over time. Landcorp is forecasting a higher lamb price than MPI s forecast price. Landcorp s scale of production means it is better placed to negotiate prices with meat processors relative to smaller scale farming operations that are subject to schedule prices. Beef The US market is the largest market for New Zealand beef exports, accounting for 47% of New Zealand beef volume. Domestic US beef supply has been constrained due to persistent drought conditions, resulting in higher than normal beef prices. The New Zealand dollar export beef price is forecast to remain at high levels, tempered in the near term by appreciation of the New Zealand dollar against the USD. Landcorp s forecast beef price is broadly consistent with MPI s forecasts. Venison The price for venison is influenced by European demand (Germans are the largest consumers of venison globally and consume approximately 30% of New Zealand exports) and the restaurant trade, which is where a large proportion of venison is consumed in other parts of the world. In the near term, New Zealand dollar export prices are forecast to ease as tight economic conditions in Europe impact demand and the New Zealand dollar remains high. MPI is forecasting modest improvement in the venison price over time as the exchange rate depreciates against the Euro and economic conditions improve in Europe. Milk Solids Table 8 presents a comparison of published forecasts for the milk solid price. Table 8 Comparison of Forecasts for the Milk Solids Price $/KgMS FY14(F) FY15(F) FY16(F) FY17(F) MPI Agrifax Fonterra Synlait Westland Assumptions 16

18 We make the following observations: On 24 September 2013, Fonterra Co-operative Group Ltd (Fonterra) announced an increase in its forecast milk price to $8.30/kg ms for the FY14 season. Agrifax are forecasting a decline in the price for milk solids over the three year period to FY16. Agrifax reports 3 that the price for milk solids have never remained at such elevated levels for such a long period of time and that current high prices have resulted in customers in markets other than China looking for alternatives to Whole Milk Powder products. The price of NZX Dairy futures (not shown on the table) also indicates expectations of an easing of dairy prices. Apart from FY14 (where Landcorp s milk price forecast is more conservative), the Company s forecast price for milk solids is broadly consistent with Agrifax s forecast. Expectations of continued Chinese demand appear to support a high milk price in the near term. However, in the longer term increases in global production and a forecast easing in the rate of Chinese economic growth suggest that there may be downside risk to the price for milk solids. 3 Dairy Report, Agrifax, September 2013 Assumptions 17

19 $/kgms $/kg Prices Assumed in Forecasts The forecast product prices used in the DCF valuation are presented in Figure 8 and Figure 9. Historical prices are included for comparative purposes. Figure 8 Forecast Deer, Lamb and Beef Prices Deer Lamb Beef Figure 9 Forecast Dairy Price Milk solids Assumptions 18

20 Tonnes produced We have used MPI s forecast prices for venison, lamb and beef over the three year period to FY16. Beyond FY16 we have prepared scenarios where prices change by the long term CAGR of 1.5% (refer to the Meat, Skin and Wool Series of the ANZ Commodity Index presented in Figure 2). Our forecast prices for venison and beef in the high scenario are subject to a price cap of $8.00/kg and $4.75/kg respectively. We have assumed Fonterra s forecast milk sold price for FY14 and Agrifax s price forecast for the remaining period to FY16. After FY16, we assume a price for milk solids that is in the range of $6.00/kg ms to $8.00/kg ms. In Section 4 we present our Base Case cash flow forecast. The Base Case assumes the mid-point of the low and high price scenarios for product prices. Company Specific Assumptions Production Figure 10 compares historical production to the level of production assumed in the forecast for sheep, beef and milk solids. We have relied on the Company s production forecast for the five year period to FY18. Thereafter, we assume annual productivity improvement of 1.5% for sheep and beef production and up to 1.0% for milk solid production. Figure 10: Forecast Production 31,000 26,000 21,000 16,000 11,000 6, Sheep Cattle Milk solids Landcorp is forecasting: A small decline in sheep production (i.e. lamb and adult sheep) in FY14 as the flock is rebuilt following the FY13 drought. Sheep production is forecast to grow at a CAGR of 3.5% over the five year period to FY18. Beef production is forecast to decline in FY14 as the herd is restocked following the FY13 drought. Modest growth in beef production is forecast beyond FY14 as the herd is reweighted in favour of dairy production. Assumptions 19

21 Milk sold production is forecast to increase by 75% (approximately 15 million kg/ms) over the five year period to FY18 following the investment made in the Shanghai Pengxin joint venture and further investment to occur in the Wairakei Pastoral joint venture over the period. Operating expenditure The Company is forecasting operating costs to increase due to the increase in the size of its dairy operations through the joint ventures with Shanghai Pengxin and Wairakei Pastoral. We have relied on Landcorp management s guidance for operating costs to FY16. We assume that operating costs increase with CPI thereafter. Taxation As at 30 e 2013, the Company had $53.6 million of tax losses available. We assume that the tax losses will be set-off against tax payable over the projection period. Subsidiaries We assume that the property held for sale is sold in line with guidance provided by Landcorp management over the three year period to FY16. Thereafter we assume that Landcorp will sell $5 million of land per year, with minimal development costs and a 20% development margin. Land set aside under the Protected Land Agreement with the Crown is held at cost and is not subject to annual revaluations. The Redeemable Preference Shares issued to the Crown under the agreement are paid up in full as at 30 e 2013 and have a face value of $118 million. Management informed us that there is a minimal contribution to operating cash flows from the Protected Land. We have therefore treated the Protected Land as a surplus asset for the purposes of the DCF calculation. The book value of the Protected Land is offset against the face value of the Redeemable Preference Shares in our calculation of the value of the Crown s share capital. Dividends Landcorp has a policy to pay up to 75% of Net Operating Profit after Tax as a dividend. We have assumed dividends will be paid to the shareholder in accordance with Landcorp s dividend policy. Assumptions 20

22 Capital Expenditure Table 7 presents the capital expenditure assumptions used in the Base Case forecast. Table 7: Forecast Capital Expenditure $000 FY11(A) FY12(A) FY13(A) FY14(F) FY15(F) FY16(F) FY17(F) FY18(F) Land & 44,661 28,113 25,037 33,863 58,492 45,904 15,439 15,706 Buildings Forests 1,376 3,252 3,242 2,681 1,700 1,490 2,004 2,052 Other 9,687 13,160 12,719 14,475 13,040 7,884 11,501 11,777 Total 55,724 44,525 40,998 51,019 73,232 55,278 28,944 29,535 Source: Landcorp The Company is forecasting approximately $180 million of capital expenditure over the three year period to FY16. Approximately half of this amount relates to investment in land development, infrastructure, irrigation and vehicles for conversion of approximately 8,000 ha into dairy production as part of its joint venture with Wairakei Pastoral. We have relied on guidance provided by Landcorp management on the level of capital expenditure for the period to FY16. Thereafter, we assume a normalised level of capital expenditure increasing by CPI. Capital expenditure is set equal to depreciation in the Terminal Value. Assumptions 21

23 4 Financial Statements The forecast financial statements for the Base Case are presented on the following pages Financial Statements 22

24 Financial Performance Statement of Financial Performance FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 FY22 FY23 $000 $000 $000 $000 $000 $000 $000 $000 $000 $000 Revenue Livestock gross profit 100, , , , , , , , , ,531 Milk solids income 122, , , , , , , , , ,094 Wool gross profit 7,666 8,006 8,444 8,324 8,326 8,330 8,335 8,343 8,352 8,363 Forest & other produce income 2,701 2,169 1,905 1,949 1,996 2,044 2,093 2,143 2,195 2,247 Other income 5,400 5,164 5,581 5,711 5,848 5,988 6,132 6,279 6,430 6,584 Total Revenue 237, , , , , , , , , ,820 Operating Expenses Farm working 88,087 91,357 99, , , , , , , ,741 Personnel 54,954 56,060 58,340 59,696 61,129 62,596 64,099 65,637 67,212 68,825 Repairs & maintenance 13,445 14,060 14,936 15,283 15,650 16,026 16,410 16,804 17,207 17,620 Services & supplies 12,238 11,688 12,499 12,790 13,097 13,411 13,733 14,062 14,400 14,745 Standing charges 10,291 11,347 12,482 12,772 13,079 13,393 13,714 14,043 14,380 14,725 Other 4,316 4,137 4,163 4,260 4,362 4,467 4,574 4,684 4,796 4,911 Total Operating Expenses 183, , , , , , , , , ,569 EBITDA 54,592 44,290 62,876 96, , , , , , ,251 EBITDA Margin 23% 19% 24% 32% 33% 33% 33% 32% 32% 31% Depreciation 12,276 13,164 13,328 14,170 8,867 6,543 7,775 8,990 10,216 11,474 EBIT 42,316 31,126 49,548 82,384 96,456 99,847 99,798 99,234 98,534 97,777 EBIT Margin 18% 13% 19% 27% 30% 31% 30% 30% 29% 28% Interest Expense (11,941) (11,860) (13,060) (13,563) (13,563) (13,563) (13,563) (13,563) (13,563) (13,563) Gain (Loss) on sale of Land 3, ,023 1,024 1,024 1,024 1,024 1,024 1,024 Other Income (Expense) Profit Before Tax 33,424 20,112 37,007 69,845 83,917 87,308 87,259 86,695 85,995 85,238 Income Tax Expense/ (Benefit) ,707 24,048 24,259 24,323 24,356 24,385 Movement in Deferred Tax (1,877) (1,881) (1,829) (1,992) (377) (49) (278) (518) Fair Value Adjustments Net Profit After Tax 35,300 21,993 38,836 71,837 61,587 62,862 62,827 62,421 61,917 61,372 Net Profit Margin 15% 9% 15% 24% 19% 19% 19% 19% 18% 18% Financial Statements 23

25 Financial Position Statement of Financial Position FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 FY22 FY23 $000 $000 $000 $000 $000 $000 $000 $000 $000 $000 Current Assets Cash on Hand 20,612 20,797-51,023 70,976 69,089 66,309 63,618 61,016 58,825 Inventory 11,913 11,913 11,913 11,913 11,913 11,913 11,913 11,913 11,913 11,913 Debtors 45,629 44,673 50,841 58,202 60,836 62,016 63,241 64,389 65,537 66,705 Livestock 293, , , , , , , , , ,660 Forest 21,639 23,339 24,829 26,833 28,885 30,986 33,138 35,341 37,598 39,908 Property Held for Sale Total Current Assets 393, , , , , , , , , ,012 Non-current Assets Fixed Assets 46,643 46,519 41,075 38,405 41,315 46,831 51,404 55,059 57,792 59,577 Land 1,224,024 1,305,197 1,397,708 1,440,675 1,486,091 1,532,983 1,581,395 1,631,374 1,682,967 1,736,223 Protected Land 119, , , , , , , , , ,358 Other Assets 69,748 69,748 69,748 69,748 69,748 69,748 69,748 69,748 69,748 69,748 Deferred Tax Asset 11,468 13,349 15,178 17,170 17,547 17,149 16,975 17,024 17,302 17,820 Total Non-current Assets 1,471,240 1,554,170 1,643,066 1,685,356 1,734,059 1,786,069 1,838,881 1,892,564 1,947,167 2,002,726 TOTAL ASSETS 1,864,599 1,957,691 2,041,081 2,160,027 2,235,455 2,293,891 2,352,882 2,411,136 2,470,175 2,530,738 Current Liabilities Overdraft - - 1, Creditors 15,068 15,505 16,621 17,008 17,416 17,834 18,262 18,700 19,149 19,608 Other creditors 8,161 8,161 8,161 8,161 8,161 8,161 8,161 8,161 8,161 8,161 Tax Payable ,707 24,048 24,259 24,323 24,356 24,385 Total Current Liabilities 23,229 23,666 26,540 25,169 48,283 50,043 50,681 51,184 51,666 52,155 Non-current Liabilities Debt 207, , , , , , , , , ,100 Deferred Tax Liability Total Non-current Liabilities 207, , , , , , , , , ,100 TOTAL LIABILITIES 230, , , , , , , , , ,255 NET ASSETS 1,633,869 1,700,625 1,762,442 1,882,759 1,935,071 1,991,748 2,050,101 2,107,852 2,166,408 2,226,484 Equity Retained Earnings 146, , , , , , , , , ,244 Revaluation Reserve 1,244,583 1,305,345 1,368,326 1,417,329 1,454,245 1,495,206 1,537,852 1,579,998 1,623,076 1,667,485 Ordinary Share Capital 125, , , , , , , , , ,000 Redeemable Preference Shares 117, , , , , , , , , ,755 TOTAL EQUITY 1,633,869 1,700,625 1,762,442 1,882,759 1,935,071 1,991,748 2,050,101 2,107,852 2,166,408 2,226,484 Financial Statements 24

26 Cash Flows Statement of Cash Flows FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 FY22 FY23 $000 $000 $000 $000 $000 $000 $000 $000 $000 $000 Cash Flows from Operating Activities Cash Receipts from customers 230, , , , , , , , , ,652 Cash Payments for Operating Expenses (182,794) (188,212) (201,108) (206,539) (211,484) (216,559) (221,757) (227,079) (232,529) (238,110) Interest Paid on Debt Facilities (11,941) (11,860) (13,060) (13,563) (13,563) (13,563) (13,563) (13,563) (13,563) (13,563) Interest Received / (Paid) on Cash Balance Income Tax Paid (22,707) (24,048) (24,259) (24,323) (24,356) Other Cash Flows from Operating Activities 36,200 33,823 44,764 76,017 89,534 69,358 69,165 69,694 70,165 70,623 Cash Flows from Investing Activities Land and Improvements (33,863) (58,492) (45,904) (15,349) (15,706) (16,083) (16,469) (16,864) (17,268) (17,683) Forestry (2,681) (1,700) (1,490) (2,004) (2,052) (2,101) (2,152) (2,203) (2,256) (2,310) Proceeds from the sale of Property and Land 79,289 40,329 20,129 6,140 6,144 6,144 6,144 6,144 6,144 6,144 Property, Plant and Equipment (13,475) (13,040) (7,884) (11,501) (11,777) (12,059) (12,349) (12,645) (12,949) (13,259) Livestock Purchases (8,254) (10,635) (10,870) Other Cash Flows from Investing Activities 21,016 (43,538) (46,019) (22,714) (23,390) (24,099) (24,825) (25,568) (26,329) (27,109) Cash Flows from Financing Activities Funds from borrowings - 25,900 18, Repayment of borrowings (28,898) Proceeds from Share Issue Share Capital Redemption Dividends distributed (7,000) (16,000) (40,000) (523) (46,191) (47,146) (47,120) (46,815) (46,437) (45,705) Cash Flows from Financing Activities (35,898) 9,900 (21,300) (523) (46,191) (47,146) (47,120) (46,815) (46,437) (45,705) Net Increase/(Decrease) in Cash Held 21, (22,555) 52,780 19,953 (1,887) (2,780) (2,690) (2,602) (2,191) Opening Cash (706) 20,612 20,797 (1,758) 51,023 70,976 69,089 66,309 63,618 61,016 Closing Cash 20,612 20,797 (1,758) 51,023 70,976 69,089 66,309 63,618 61,016 58,825 Financial Statements 25

27 5 Discounted Cash Flow Valuation Forecast Cash Flow The 10 year forecast cash flows used in the DCF valuation for the Base Case are presented in Table 8. Table 8: Forecast Free Cash Flows Forecast Free Cash Flows FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 FY22 FY23 $000 $000 $000 $000 $000 $000 $000 $000 $000 $000 EBITDA 54,592 44,290 62,876 96, , , , , , ,251 Tax paid (12,951) (27,672) (27,846) (28,056) (28,121) (28,154) Proceeds from the sale of property 79,289 40,329 20,129 6,140 6,144 6,144 6,144 6,144 6,144 6,144 Capital expenditure (58,273) (83,867) (66,148) (28,853) (29,534) (30,243) (30,969) (31,712) (32,473) (33,253) Movement in net working capital (6,451) 1,393 (5,052) (6,974) (2,226) (762) (798) (709) (699) (709) Forecast Free Cash Flows 69,157 2,145 11,805 66,867 66,755 53,857 54,105 53,891 53,601 53,280 Terminal Value We assume that the free cash flow beyond the projection period will grow at an annual rate of 2.5% and that Landcorp will pay tax at the corporate tax rate in our calculation of the Terminal Value. Cost of Capital We have used an estimate of Landcorp s Weighted Average Cost of Capital to discount future cash flows for the purpose of the valuation. The WACC has been estimated using the following model: WACC = D/V * R d* (1-T c) + E/V * R e Re is the Cost of Equity derived using the Brennan Lally version of the Capital Asset Pricing Model (CAPM) as follows: R e = R f * (1-T c) + B e * TAMRP The individual components of the model are outlined in the Table 9 below: Table 9: WACC Weighted Average Cost of Capital Item Value Description D/V 30% The relative proportion of debt in the capital structure E/V 70% The relative proportion of equity in the capital structure R d 6% The Company's cost of debt T c 28% The corporate tax rate R e 8.4%-9.0% The cost of equity (calcuated using CAPM) R f 5% The risk free rate T i 28% Investor tax rate B e The equity beta, a measure of the relative riskiness of equity returns B a The asset beta. The equity beta adjusted to remove the impact of gearing PTMRP 7.50% Post Tax Market Risk Premium WACC 7.19%-7.57% Weighted Average Cost of Capital Source: PwC estimates Our estimate of the risk free rate is based on our assessment of yields for government bonds with long dated maturities as at 30 e Discounted Cash Flow Valuation 26

28 We have estimated an asset beta in the range of 0.45 to 0.50 based on our recent experience in valuing companies with rural land-based operations. The Post Tax Adjusted Market Risk Premium is based on our research into historical returns from the New Zealand share market and historical yields on government bonds. DCF Valuation Table 10 summarises the DCF valuation for the Base Case cash flow forecast. Table 10: Valuation Summary $m Base Case PV of Cash Flow Years 1 to 3 78 PV of Cash Flow Years 4 to Terminal Value 684 Enterprise Value 1,021 PV of cash flows from Protected Land - Adjusted Enterprise Value 1,021 Net Debt (237) Protected Land 119 Redeemable Preference Shares (118) Equity Value 785 The DCF valuation for the Base Case cash flow forecast is $1,022 million. We have treated the Protected Land as a surplus asset for the purposes of the DCF calculation. The face value of the Redeemable Preference Shares is deducted from the book value of the Protected Land in our calculation of the value of the Crown s share capital. Deducting net debt of $237 million results in a value for Landcorp equity for the Base Case of $785 million. Discounted Cash Flow Valuation 27

29 Sensitivity Analysis Figure 11 presents the change in Base Case Equity Value calculated using the DCF approach for the Low and High Price Scenarios and for changes in key assumptions. Figure 11: Sensitivity Analysis Base Case Equity Value $785 million Low / High Price Scenario Production +/- 5% Price +/- 5% Opex +/- 5% WACC +/- 0.5% Terminal Growth Rate +/- 0.5% (600) (400) (200) Change to Base Case Equity Value ($m) Figure 11 shows that the valuation is: More sensitive to the low price scenario than the high price scenario as the beef and venison prices are subject to a cap in the high price scenario (as discussed in Section 3). More sensitive to changes in commodity prices and production volume and relatively less sensitive to changes in operating costs, WACC and the terminal growth rate. Discounted Cash Flow Valuation 28

30 $m Movement from 2011 DCF Valuation The Equity Value calculated using the DCF approach in our 2011 report was $700 million. Figure 12 presents the movement in Equity Value from the DCF valuation prepared in 2011 to the 2013 valuation. Figure 12: Movement in Landcorp Equity Value since The increase in the Equity Value calculated using the DCF approach in 2013 is primarily due to the forecast increase in EBITDA arising from Landcorp s investment in dairy production through its joint venture arrangements with Shanghai Pengxin and Wairakei Pastoral. Discounted Cash Flow Valuation 29

31 6 Alternative Approaches We have cross checked the DCF valuation to the following approaches: Multiples of EBITDA, EBIT and Price to Earnings derived from listed companies with agricultural operations; and The value of Landcorp s Net Tangible Assets as at 30 e 2013 Multiples Approach Table 9 presents a comparison of multiples derived from the Base Case DCF valuation for Landcorp to multiples for New Zealand and Australian listed companies with rural business operations. Table 9: Listed New Zealand and Australian Companies with Rural Operations Enterprise Market EV/EBITDA EV/EBIT P/E Company Segm ent Value Cap LTM t+1 t+2 LTM t+1 t+2 LTM t+1 t+2 New Zealand LIC Genetics x n/a n/a 6.5x n/a n/a 8.6x n/a n/a PGG Wrightson Retail x 7.1x 6.5x 10.3x 8.4x 7.6x (0.9x) 10.0x 8.9x A2 Corporation Milk processor x n/a n/a 53.6x n/a n/a 122.0x n/a n/a Fonterra S/h Fund Milk processor n/a n/a n/a n/a n/a n/a n/a n/a n/a Sy nlait Milk Milk processor x 16.0x 13.8x 24.6x 21.7 x 19.0x 44.0x 31.1x 23.1x Australia Australian Ag. Co Farming n/m n/a n/a n/m n/a n/a (6.9x) n/a n/a Elders Retail x 12.2x 7.7 x 300.8x 30.5x 12.5x (0.2x) (4.8x) 4.8x PrimeAg Australia Cropping x 18.6x 18.6x n/m 11.4x 17.2x (3.6x) 32.9x 26.6x Ruralco Holdings Retail x 6.4x 5.3x 9.5x 7.0x 6.0x 55.1x 13.5x 10.4x Ridley Corporation Animal feed x 6.3x 5.7 x 11.2x 8.8x 7.2x (14.9x) 13.1x 11.4x Low x 6.3x 5.3x 6.5x 7.0x 6.0x (14.9x) (4.8x) 4.8x High x 18.6x 18.6x 300.8x 30.5x 19.0x 122.0x 32.9x 26.6x Average x 11.1x 9.6x 59.5x 14.6x 11.6x 22.6x 16.0x 14.2x Median x 9.7x 7.1x 11.2x 10.1x 10.0x (0.2x) 13.3x 10.9x Landcorp - DCF 1, x 18.7 x 23.1x n/m 24.1x 32.8x n/m 16.6x 23.2x Source: PwC analysis, CapitalIQ There is a wide range in the multiples presented in Table 9. We make the following observations: The Fonterra Shareholders Fund and Synlait Milk have only recently listed on the NZX and do not have a sufficient trading history for the multiples to be meaningful. Australian Agricultural Company Ltd (AAC) farms cattle in Australia and has a meat processing facility. AAC reported a loss in its last financial year and there is no broker forecast information available for the company in the market. The remaining companies are engaged in a wide range of business operations that are not directly comparable to Landcorp. The Crown owns the entire share capital of Landcorp and has control over its business operations. The DCF valuation includes the value to the Crown of control over Landcorp s business operations. On the other hand, the multiples for the Australian and New Zealand listed companies are derived from shares prices expressed from the perspective of a minority, non-controlling shareholder. The multiples do not include any allowance for the value of a controlling shareholding in these companies. It is reasonable to expect that the multiples implied for Landcorp will be higher than the multiples for the comparable listed companies. Alternative Approaches 30

32 Net Tangible Assets Approach Landcorp revalues its land and buildings, forests, livestock and financial instruments to fair market value (as assessed by independent valuers) at each reporting date. The Board of Landcorp uses the Net Tangible Assets approach to assess the commercial value of the Crown s investment for Statement of Corporate Intent (SCI) reporting purposes (Net Tangible Assets or NTA is the fair market value of assets less the value of liabilities and the Redeemable Preference Shares). Table 10 compares the NTA for Landcorp to the DCF valuation for the Base Case for our 2011 and 2013 valuations. Table 10 Comparison of the DCF Valuation to Landcorp NTA $m Equity Value per DCF Base Case Net Tangible Assets 1,352 1,302 Difference There are significant gaps between the Equity Value calculated using the DCF valuation approach and the NTA approach. The reasons for these gaps include: The DCF valuation approach is based on a cash flow forecast assuming a single scenario for use of the land owned and leased by the Company. There may be upside to the DCF valuation for the option value of alternative uses for the land which may yield higher returns. Historical cash returns for Landcorp are lower than the WACC estimated for the Company. This suggests that investors in the farming industry may be willing to accept lower cash returns than implied by a WACC calculated using the Capital Asset Pricing Model. The DCF model does not include land value holding gains. The gap between the DCF valuation and Landcorp s NTA demonstrates the challenges in applying the DCF approach to value a rural land based business. The value of Landcorp is directly related to the aggregate value of its underlying assets (i.e. rural land). The DCF approach does not capture all the value that investors may attribute to the underlying assets. Alternative Approaches 31