Landcorp Farming Limited Research Report. November 2011

Transcription

1 Landcorp Farming Limited Research Report November 2011

2 Table of Contents 1 Executive Summary... 2 Company Background 2 Earnings Outlook 2 Assumptions 2 Valuation 3 Sensitivity Analysis 4 2 Company... 5 Background 5 Industry Outlook 5 Company Outlook 9 3 Assumptions Economic Assumptions 11 Sector Assumptions 11 Company Specific Assumptions 14 4 Financial Statements Financial Performance 17 Financial Position 18 Cash Flows 19 5 Discounted Cash Flow Valuation Forecast Cash Flow 20 Terminal Value 20 Cost of Capital 20 DCF Valuation 21 Sensitivity Analysis 21 6 Alternative Approaches Appendix A : Disclaimer Declarations 24 Qualifications 24 Independence 24 Disclaimer and Restrictions on Scope of Our Work 24 Limitation of Liability 25 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. A combination of high commodity prices and favourable weather conditions in the second half of the year resulted in record earnings for the Company in FY11. Earnings for the four prior years were affected by drought and volatile commodity prices, especially dairy prices which fell sharply in FY09 after a period of significant growth. In the short term, commodity prices are expected to ease from recent highs as production increases following recent supply constraints in the Australian and US markets. In the medium term, the outlook for commodity prices is uncertain and will be influenced by: The performance of the US and European economies in particular and the global economy more generally; Growing demand for protein as a result of income growth and broadening of consumption across an emerging middle class in Asian countries; and The relative strength of the New Zealand dollar against the major trading currencies (USD, GBP and EUR). 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 Landcorp is well placed for 2012 with livestock in good condition after a mild winter and commodity prices remaining high. The Company is forecasting to grow earnings by: Implementing on farm productivity improvements; Developing relationships that link production more closely to needs and preferences of consumers; and Optimising the use of land. Assumptions We have prepared a Base Case cash flow forecast using New Zealand dollar prices for livestock and dairy. We have used price forecasts for livestock for FY12 and FY13 prepared by the Ministry of Agriculture and Forestry ( MAF ) and others. We have developed a high and low scenario for changes in commodity prices for subsequent years. The high price scenario is based on the historical long run growth rate for commodity prices. The low price scenario is based on a decline from current high prices and prices remaining flat thereafter. We have used guidance provided by Management on the level of livestock and dairy production over the period to FY16. After FY16 we assume productivity improvements of 1.5% per year for livestock and dairy production. Executive Summary 2

4 Valuation Table 1 presents the low and high values for the Discounted Cash Flow ( DCF ) valuation under the base case cash flow forecast. Table 1: DCF Valuation $m PV Forecast Cash Flow 865 Debt (165) Equity Value 700 Implied Multiple of FY12 EBITDA 18.4x The DCF valuation for the Base Case cash flow forecast is $865 million. Deducting net debt of $165 million results in a value for Landcorp equity for the Base Case of $700 million. Landcorp revalues its land and buildings, forests, livestock and financial instruments to fair market value at each reporting date. The value of Landcorp s Net Tangible Assets ( NTA ) as at 30 June 2011 is $1,352 million (excluding Protected Land ), which represents the aggregate value that could be realised from the sale of the individual assets. There is a gap of approximately $650 million 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. Using our cash flow forecast, a discount rate of 5.25% is required for the DCF valuation to approximate the NTA value (as compared to a WACC of 7.4% calculated for Landcorp). 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 theory, the value of a company s share capital is the greater of: The net realisable value of the asset net of selling costs; and The risk adjusted present value of cash flows that the asset will generate over time (i.e. the DCF approach). In light of this, we consider that the value of Landcorp s NTA at 30 June 2011 of $1.3 billion is an appropriate basis for the commercial value of Landcorp s share capital. Executive Summary 3

5 Sensitivity Analysis The DCF valuation is sensitive to changes in the assumptions for price and production. A 5% change in assumed price or production over the forecast period has a 25% impact on the DCF valuation. The DCF valuation is relatively less sensitive to changes in the WACC and the terminal growth rate. Executive Summary 4

6 2 Company Background Landcorp 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 receives revenue from the sale of livestock (lamb, beef and deer) and milk solids. Table 2 presents a summary of historical financial performance of the Company. Table 2: Summary of Historical Financial Performance Statement of Financial Performance FY07(A) FY08(A) FY09(A) FY10(A) FY11(A) $000 $000 $000 $000 $000 Revenue Livestock gross profit 78,684 73,217 98,464 83, ,093 Milk solids income 39,473 71,564 54,164 70,193 94,615 Wool gross profit 7,292 7,003 6,020 5,914 10,888 Forest income (647) 1,087 1,096 2,735 5,215 Other income Total Revenue 125, , , , ,413 Operating Expenses Farm working 47,203 58,767 68,970 62,885 73,999 Personnel 34,980 40,122 41,501 42,054 44,203 Repairs & maintenance 8,747 9,973 11,239 10,869 11,349 Other 15,236 18,641 20,532 20,109 23,794 Total Operating Expenses 106, , , , ,345 EBITDA 19,163 26,046 18,095 27,034 66,068 EBITDA Margin 15% 17% 11% 17% 30% A combination of high commodity prices and favourable weather conditions in the second half of the year resulted in record earnings for the Company in FY11. Earnings for the four prior periods were impacted by drought and volatile commodity prices, especially dairy prices which fell sharply in FY09 after a period of significant growth. The quantity of livestock has decreased by approximately 10% over the five year period due to unfavourable climatic conditions and Management actively managing the portfolio of livestock. Also, the mix of livestock has changed. The size of the dairy herd has increased by 20% from approximately 40,300 heads in FY07 to 49,000 heads in FY11, while the size of the remaining herd / flock has decreased. 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 Farming. The Crown has acquired Redeemable Preference Shares in Landcorp Farming as consideration for the properties set aside under the agreement. Landcorp is not currently engaged in the sale of pastoral land. Management consider that there could be additional upside to the value of the Company if redevelopment and sale of pastoral land was part of its core operations. Industry Outlook The farming industry in New Zealand 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 Company 5

7 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 % 2008(A) 2009(A) 2010(A) 2011(F) 2012(F) 2013(F) USA 2.1 (1.4) (1.1) UK 2.5 (1.9) (3.7) Europe 2.4 (1.6) (2.6) China New Zealand 3.0 (1.6) Source: Beef and Lamb, New Season Outlook, September 2011 Uncertain global economic conditions persist in North America and Europe. There is significant risk that ongoing volatility in the financial sector could push these markets into an economic recession, which may result a lower level of demand for commodities and downward pressure on prices. However, this is balanced by a forecast for the continuation of relatively high rates of economic growth in developing Asian countries. Commodity Prices Figure 1 and Figure 2 below present the Meat, Skin and Wool and the Dairy series from the ANZ Commodity Price Index and the Compound Annual Growth Rate ( CAGR ) for the New Zealand dollar value for each of these series. Figure 1: Meat, Skin and Wool Series of the ANZ Commodity Index CAGR 1.9% Index Value (Base ) Meat, skins & wool (World Price) Meat, skins & wool (NZD) Company 6

8 Figure 2: Dairy Series of the ANZ Commodity Index CAGR 1.6% Index Value (Base ) Dairy (World Price) Dairy (NZD) Figure 1 and Figure 2 demonstrate that: Dairy prices spiked between February 2007 and December This was due to supply being disrupted by drought conditions in Australia and parts of New Zealand. Prices declined in response to a sudden deterioration in economic conditions following the collapse of global financial markets in September 2008 and increased milk production in other markets. Since 2008 there has been a broad and sustained increase in commodity prices. Recent increases in international meat and dairy prices have been moderated in New Zealand dollar terms by the strength of the New Zealand dollar. 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. The figures above show that, adjusting for short term price swings, over the long term commodity prices have demonstrated modest growth. 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 and dairy exports to Asia). Figure 3 presents the historical value of the New Zealand dollar relative to the USD, GBP and EUR. Company 7

9 Figure 3: Historical Exchange Rates 0.90 NZD / Trading Partner Currency Jul Jul Jul Jul Jul Jul Jul Jul Jul Jul Jul Jul Jul 2011 NZD/USD NZD/GBP NZD/EUR Linear (NZD/USD) Linear (NZD/GBP) Linear (NZD/EUR) Figure 4: presents the correlation between index values for international dairy prices and the USD/NZD since uary Figure 4: Historical Correlation of the NZD/USD and Dairy Prices 160 FX Index (Base 100 = 2009) Dairy Index (Base 100 = 2009) Figure 3 and Figure 4 demonstrate that: There has been an appreciation of the NZD relative to the USD and, to a lesser extent, the GBP. The NZD has remained relatively stable against the EUR. There is a historical relationship between changes in dairy prices and the value of the NZD. The strength of the NZD against the USD has a direct impact on the returns on beef and dairy exports. 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. Company 8

10 The historical relationship between dairy prices and the exchange rate suggests that changes in international dairy prices are moderated to some extent by movements in the value of the New Zealand dollar. Meat Industry Reform There have been calls from a range of stakeholders to restructure the red meat industry. Proposals have been developed to move away from the current model where generic product is sold into an open market to a model where production is more aligned to consumer preferences. There are initiatives underway to implement some of the proposals, such as Landcorp s investment in Farm IQ Systems (discussed below). The objective of these proposals is to increase the returns to the industry. However, it is too early to form a view on whether these proposals will be implemented, and if they are, what impact they will have on the returns for the industry. Outlook In the short term, commodity prices are expected to ease from recent highs as production increases following recent supply constraints in the Australian and US markets. In the medium term, the outlook for commodity prices is uncertain and will be influenced by: Ongoing weakness of the US and European economies in particular and the global economy more generally; Growing demand for protein as a result of income growth and broadening of consumption across an emerging middle class in Asian countries; and The relative strength of the New Zealand dollar against the major trading currencies (USD, GBP and EUR). Company Outlook Landcorp is well placed for 2012 with livestock in good condition after a mild winter and commodity prices remaining high. The Company is implementing the following strategies: Earnings growth from on-farm productivity improvements. Systems are being implemented to monitor performance, feed management and condition of individual stock units. Information from these systems will allow Landcorp to respond to adverse weather events, identify opportunities for productivity improvements and to enhance the condition of the herd/flock. Developing relationships that link production more closely to needs and preferences of consumers: In FY11 Landcorp entered into fixed price contracts for the supply of 25% of the Company s lamb production to Tesco, a UK supermarket operator. Landcorp considers that this relationship positions it closer to the end consumer in the market, which is consistent with the objectives of the broader industry reform. Landcorp has invested in Farm IQ Systems, with Silver Fern Farms (a meat processor) and the Crown. Farm IQ Systems is a seven year programme with the objective of linking meat production more closely to consumer preferences in export markets. The programme involves gathering data from the farm and the processor and linking this with the results of consumer testing for taste preferences. As the data from this programme becomes available, Landcorp will refine its farming practices to optimise production to align with consumer preferences. Company 9

11 Optimising the use of land. The Company is managing its portfolio of land to sell less productive land or convert it to higher yielding alternate uses. For example, land that is uneconomic for farming due to ground conditions or difficult access might be planted with trees for carbon sequestration. Company 10

12 3 Assumptions Economic Assumptions Table 4 presents the economic assumptions used in our cash flow forecast for the Company. Table 4: Economic Assumptions FY08(A) FY09(A) FY10(A) FY11(A) FY12(F) FY13(F) FY14(F) FY15(F) GDP 3.1% (1.6%) 1.1% 1.7% 1.2% 2.9% 2.5% 2.1% CPI 3.4% 3.0% 2.0% 4.5% 2.4% 2.3% 2.3% 2.3% NZD/USD NZD/GBP NZD/EUR Source: NZIER Quarterly Predictions September 2011, MAF Situation Outlook June 2011 We have used NZIER s quarterly predictions for the Consumer Price Index (CPI) over the period to FY15. Thereafter we assume annual CPI growth of 2%. We have used price forecasts prepared by MAF (discussed further below). Table 5 presents the exchange rate assumptions implicit in MAF s price forecasts. Sector Assumptions Table 5 presents historical and forecast prices for deer, lamb, beef and milk solids published by MAF in June We compare MAF s forecast prices to more recent price forecasts published by Beef + Lamb 2 in the discussion below. Table 5: MAF Price Forecasts $/Kg FY08(A) FY09(A) FY10(A) FY11(A) FY12(F) FY13(F) FY14(F) FY15(F) AP Stag Lamb Beef Milk Solids Source: Ministry of Agriculture and Forestry, June 2011 Lamb There has been a long term decline in the size of the national flock as a result of low returns for lamb and wool relative to the returns from alternative land uses. Recently, lamb prices have spiked due to supply shortages following recent droughts in Australia and New Zealand. MAF is forecasting prices to ease from the peak in 2011 as production is expected to increase in New 1 Situation and Outlook for New Zealand Agriculture and Forestry, Ministry of Agriculture and Forestry, June Sheep and Beef New Season Outlook , Beef + Lamb New Zealand, September Assumptions 11

13 Zealand and Australia. Price increases from FY14 are forecast as a result of an assumed depreciation of the New Zealand dollar. MAF s forecast FY12 price is 11% lower than Beef + Lamb s forecast price of $5.87 / kg. Beef Record prices for beef were recorded in April 2011 due to farmers reducing herd sizes in the US in response to high feed prices and weather events impacting Australian production. MAF is forecasting beef prices to ease as herd rebuilding occurs in the US and Australia and production increases in developing regions such as South America. Price increases from FY14 are forecast as a result of an assumed depreciation of the New Zealand dollar and growth in consumption in Asian markets. MAF s forecast FY12 price is consistent with Beef + Lamb s forecast price of $3.75 / kg. Venison The price for venison is influenced by German 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. Appreciation of the New Zealand dollar relative to the Euro has exceeded increases in the world price for venison, resulting in a decline in the New Zealand price. MAF is forecasting a strengthening of the venison price due to the combined impact of the assumed increases in consumption and depreciation of the New Zealand dollar. Milk Solids The price for milk solids is currently at near record levels due to increasing demand for dairy products, in particular milk powders from developing countries such as China. MAF is forecasting an easing in the price for milk solids as global dairy production increases in response to higher prices. Price increases from FY14 are forecast as a result of an assumed depreciation of the New Zealand dollar. Table 6: Comparison of Forecasts for the Milk Solids Price $/KgMS FY08(A) FY09(A) FY10(A) FY11(A) FY12(F) FY13(F) FY14(F) FY15(F) MAF In May 2011 Fonterra forecast a price of $6.75 / kgms for the 2012 season. Price Assumed in Forecasts The forecast product prices used in the DCF valuation are presented in Figure 5 and Figure 6. Historical prices are included for comparative purposes. Assumptions 12

14 Figure 5: Forecast Deer, Lamb and Beef Prices $/kg Deer Lamb Beef Figure 6: Forecast Dairy Price $/kgms Milk solids The post FY13 price scenarios assume: Low scenario: prices ease over the period to FY16 and remain relatively flat thereafter; and High scenario: prices grow at the historical long term growth rate of approximately 1.5% per year. Assumptions 13

15 In Section 5 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 7 compares historical production to the level of production assumed in the forecast for sheep and beef meat and milk solids. Figure 7: Forecast Production 18,000 16,000 Tonnes produced 14,000 12,000 10,000 8,000 6, Sheep Cattle Milk solids Sheep 5yr avg Cattle 5yr avg Milk solids 5yr avg Livestock production decreased over the five year period to FY11 due to unfavourable weather conditions and the Company actively managing-down its portfolio of livestock. We have relied on guidance provided by Management for rebuilding of livestock and dairy production over the period to FY16. Beef production is not forecast to return to FY08 levels as the composition of the herd is reweighted in favour of dairy production. Milk sold production is forecast to increase due to a combination of productivity improvements (discussed above) and dairy conversions that are forecast to occur during FY12 and FY13. After FY16, we assume productivity improvements of 1.5% per year for livestock and dairy production. Opex While Landcorp s scale of operations offers it cost advantages for some input costs, it incurs higher costs in other areas relative to smaller scale farms. We have relied on Management s guidance for operating costs to FY16. We assume that operating costs increase with CPI thereafter. Assumptions 14

16 Taxation The Company has indicated that it has sufficient tax losses available to offset forecast taxable income for next 10 years. We assume that the Company will not be required to pay tax over the forecast period. Subsidiaries Landcorp Estates has experienced reduced margins due to deterioration in the property market. Market conditions are expected to remain flat for the foreseeable future. We assume that the current property held for sale is sold in FY12, and that land, other than farming land, is developed for sale in line with guidance provided by Management over the five year period to FY16. From FY17 to FY21, we assume that Landcorp will sell $5 million of land per year, with minimal development costs and a 20% development margin. We assume that land will be retained for farming purposes and will not be developed for sale in the Terminal Value. 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 June 2011 and have a face value of $118 million. The face value of the Redeemable Preference Shares is equal to the cost of the protected land. 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. Due to the summer weighting of revenue, dividends are paid in the month of October in the following financial year. We have assumed dividends will be paid to the shareholder in accordance with Landcorp s dividend policy. Capital Expenditure Table 7 presents our capital expenditure assumptions Table 7: Forecast Capital Expenditure $000 FY09(A) FY10(A) FY11(A) FY12(F) FY13(F) FY14(F) FY15(F) FY16(F) Land & Buildings 39,461 17,618 44,661 26,656 22,277 8,915 8,814 7,859 Forests n/a n/a n/a 2,394 2,914 2,914 2,788 2,760 Other 10,919 8,965 9,867 12,390 10,117 9,319 8,999 8,131 Total 50,380 26,583 54,528 41,440 35,308 21,148 20,601 18,750 For the period to FY16 we have relied on guidance provided by Management on the level of capital expenditure for land and buildings and other capital expenditure. After FY16 we have normalised capital expenditure and increased by CPI thereafter. Capital expenditure is set equal to depreciation in the Terminal Value. Assumptions 15

17 4 Financial Statements The forecast financial statements are presented on the following pages Financial Statements 16

18 Financial Performance Statement of Financial Performance FY11(A) FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 $000 $000 $000 $000 $000 $000 $000 $000 $000 $000 $000 Revenue Livestock gross profit 108, , , , , , , , , , ,594 Milk solids income 94,615 86,647 90,237 93,468 96,313 99, , , , , ,575 Wool gross profit 10,888 8,490 8,678 8,689 8,768 8,805 8,863 8,929 8,997 9,066 9,136 Forest income 5,215 2,653 2,740 2,844 2,950 3,048 3,109 3,171 3,235 3,299 3,365 Other income 602 4,563 4,109 5,755 7,322 8,312 8,478 8,648 8,821 8,997 9,177 Total Revenue 219, , , , , , , , , , ,848 Operating Expenses Farm working 73,999 79,114 80,341 81,964 82,291 83,461 85,130 86,833 88,569 90,341 92,148 Personnel 44,203 44,600 45,676 46,642 47,587 48,278 49,244 50,228 51,233 52,258 53,303 Repairs & maintenance 11,349 12,142 12,081 12,300 12,484 12,652 12,905 13,163 13,426 13,695 13,969 Other 23,794 4,072 4,150 4,224 4,240 4,251 4,336 4,423 4,511 4,601 4,693 Total Operating Expenses 153, , , , , , , , , , ,670 EBITDA 66,068 45,926 54,130 59,102 66,483 70,462 71,880 73,602 75,391 77,249 79,178 EBITDA Margin 30% 22% 25% 26% 28% 29% 29% 29% 29% 29% 29% Depreciation 12,461 10,883 11,776 12,089 12,802 8,861 5,788 6,767 7,785 8,831 9,837 EBIT 53,607 35,043 42,354 47,014 53,681 61,600 66,093 66,836 67,606 68,418 69,341 EBIT Margin 24% 17% 19% 21% 23% 25% 27% 26% 26% 26% 26% Interest Expense (10,668) (11,951) (12,550) (12,304) (12,064) (11,981) (11,981) (11,981) (11,981) (11,981) Gain (Loss) on sale of Land 1,403 2,879 3,205 2,874 1,925 1,000 1,000 1,000 1,000 1,000 Profit Before Tax 25,778 33,282 37,669 44,251 51,462 55,111 55,854 56,624 57,437 58,360 Income Tax Expense/ (Benefit) Movement in Deferred Tax Net Profit After Tax 25,778 33,282 37,669 44,251 51,462 55,111 55,854 56,624 57,437 58,360 Net Profit Margin 13% 15% 17% 19% 21% 22% 22% 22% 22% 22% Financial Statements 17

19 Financial Position Statement of Financial Position FY11(A) FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 $000 $000 $000 $000 $000 $000 $000 $000 $000 $000 $000 Current Assets Cash on Hand ,398 52,579 56,774 60,611 65,644 63,100 60,911 59,369 58,572 58,276 Inventory 9,659 9,659 9,659 9,659 9,659 9,659 9,659 9,659 9,659 9,659 9,659 Debtors 44,501 42,243 44,638 46,365 48,346 49,642 50,775 51,849 52,951 53,934 55,243 Livestock 297, , , , , , , , , , ,841 Forest 16,807 19,201 22,115 25,029 27,817 30,577 31,982 33,414 34,875 36,366 37,886 Property Held for Sale 25, Total Current Assets 393, , , , , , , , , , ,904 Non-current Assets Fixed Assets 40,885 44,353 42,028 39,237 35,387 34,523 38,945 42,593 45,430 47,434 48,649 Land 1,058,426 1,129,378 1,211,302 1,286,943 1,368,218 1,455,729 1,495,045 1,535,453 1,576,978 1,619,651 1,663,499 Protected Land 117, , , , , , , , , , ,766 Other Assets 51,971 51,971 51,971 51,971 51,971 51,971 51,971 51,971 51,971 51,971 51,971 Deferred Tax Asset Total Non-current Assets 1,269,048 1,343,467 1,423,066 1,495,917 1,573,342 1,659,988 1,703,727 1,747,782 1,792,145 1,836,822 1,881,885 TOTAL ASSETS 1,662,973 1,671,638 1,768,717 1,838,483 1,925,211 2,021,019 2,069,374 2,118,487 2,168,733 2,220,076 2,272,789 Current Liabilities Overdraft Creditors 19,591 23,848 23,638 24,088 24,350 24,561 25,402 25,910 26,428 26,883 27,496 Other creditors 8,337 8,337 8,337 8,337 8,337 8,337 8,337 8,337 8,337 8,337 8,337 Tax Payable Total Current Liabilities 27,928 32,185 31,975 32,425 32,687 32,898 33,739 34,247 34,765 35,220 35,833 Non-current Liabilities Debt 165, , , , , , , , , , ,063 Deferred Tax Liability Total Non-current Liabilities 165, , , , , , , , , , ,063 TOTAL LIABILITIES 193, , , , , , , , , , ,896 NET ASSETS 1,469,382 1,454,190 1,528,879 1,601,095 1,692,761 1,791,058 1,838,572 1,887,177 1,936,905 1,987,792 2,039,893 Equity Retained Earnings 123, , , , , , , , , , ,655 Revaluation Reserve 1,103,371 1,073,293 1,139,661 1,202,460 1,283,063 1,368,495 1,402,231 1,436,872 1,472,444 1,508,972 1,546,483 Ordinary Share Capital 125, , , , , , , , , , ,000 Redeemable Preference Shares 117, , , , , , , , , , ,755 TOTAL EQUITY 1,469,382 1,454,190 1,528,879 1,601,095 1,692,761 1,791,058 1,838,572 1,887,177 1,936,905 1,987,792 2,039,893 Financial Statements 18

20 Cash Flows Statement of Cash Flows FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 $000 $000 $000 $000 $000 $000 $000 $000 $000 $000 Cash Flows from Operating Activities Cash Receipts from customers 208, , , , , , , , , ,539 Cash Payments for Operating Expenses (157,922) (162,652) (166,072) (168,491) (171,445) (174,691) (178,250) (181,815) (185,521) (189,091) Interest Paid on Debt Facilities (10,668) (11,951) (12,550) (12,304) (12,064) (11,981) (11,981) (11,981) (11,981) (11,981) Income Tax Paid Cash Flows from Operating Activities 39,813 40,240 45,295 52,508 57,448 59,300 61,027 62,797 64,714 66,467 Cash Flows from Investing Activities Land and Improvements (26,656) (22,277) (8,915) (8,814) (7,859) (15,202) (15,506) (15,816) (16,133) (16,455) Forestry (2,394) (2,914) (2,914) (2,788) (2,760) (1,405) (1,433) (1,461) (1,491) (1,520) Proceeds from the sale of Property and Land 31,863 10,611 11,199 10,318 7,632 6,000 6,000 6,000 6,000 6,000 Property, Plant and Equipment (12,390) (10,117) (9,319) (8,999) (8,131) (9,904) (10,386) (10,594) (10,810) (11,018) Cash Flows from Investing Activities (9,577) (24,697) (9,949) (10,283) (11,118) (20,511) (21,325) (21,872) (22,433) (22,994) Cash Flows from Financing Activities Funds from borrowings 19,600 22, Repayment of borrowings - - (2,900) (5,200) (2,700) Dividends distributed (10,892) (24,962) (28,252) (33,188) (38,596) (41,333) (41,891) (42,468) (43,078) (43,770) Cash Flows from Financing Activities 8,708 (2,362) (31,152) (38,388) (41,296) (41,333) (41,891) (42,468) (43,078) (43,770) Net Increase/(Decrease) in Cash Held 38,944 13,181 4,195 3,836 5,033 (2,544) (2,189) (1,543) (797) (296) Opening Cash ,398 52,579 56,774 60,611 65,644 63,100 60,911 59,369 58,572 Closing Cash ,398 52,579 56,774 60,611 65,644 63,100 60,911 59,369 58,572 58,276 Financial Statements 19

21 5 Discounted Cash Flow Valuation Forecast Cash Flow The 10 year forecast cash flows used in the DCF valuation are presented in Table 8. Table 8: Forecast Free Cash Flows Forecast Free Cash Flows FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 $000 $000 $000 $000 $000 $000 $000 $000 $000 $000 EBITDA 45,926 54,130 59,102 66,483 70,462 71,880 73,602 75,391 77,249 79,178 Tax paid Proceeds from the sale of property 31,863 10,611 11,199 10,318 7,632 6,000 6,000 6,000 6,000 6,000 Capital expenditure (41,440) (35,308) (21,148) (20,601) (18,750) (26,511) (27,325) (27,872) (28,433) (28,994) Movement in net working capital 4,555 (1,939) (1,257) (1,671) (951) (598) (594) (612) (553) (729) Forecast Free Cash Flows 40,904 27,494 47,896 54,528 58,393 50,771 51,683 52,907 54,262 55,455 Source: PwC calculations 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 Where 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 7 0% The relative proportion of equity in the capital structure R d 7% The Company 's cost of debt T c 28% The corporate tax rate R e 8.4% The cost of equity (calcuated using CAPM) R f 5% The risk free rate based on government stock yields T i 28% Investor tax rate B e 0.64 The equity beta, a measure of the relative riskiness of equity returns B a 0.45 The asset beta, the equity beta adjusted to remove the impact of gearing PTMRP 7.50% Tax Adjusted Market Risk Premium WACC 7.41% Weighted Average Cost of Capital Source: PwC estimates Our estimate of the risk free rate is based on yields for 10 year government bonds at 30 September New Zealand s sovereign credit rating was downgraded by two ratings agencies on 30 September We have rounded the observed yield for 10 year government bonds of 4.75% to 5.00% to reflect the uncertainty in yields following the downgrade of the sovereign credit rating. Discounted Cash Flow Valuation 20

22 We have estimated an asset beta of 0.45 based on our recent experience in valuing companies with rural land-based operations. The Post Tax Adjusted Market Risk Premium is based on research undertaken by PwC 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 Enterprise Value 865 PV of cash flows from Protected - Adjusted Enterprise Value 865 Net Debt (165) Protected Land 118 Redeemable Preference Shares (118) Equity Value 700 The DCF valuation for the Base Case cash flow forecast is $865 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 $165 million results in a value for Landcorp equity for the Base Case of $700 million. Sensitivity Analysis Figure 8 presents sensitivities of the DCF valuation for the Base Case for the Low and High Price Scenarios and for changes in key assumptions. Figure 8: Sensitivity Analysis Base Case DCF $700 million Low / High Price Scenario Production +/- 5% Price +/- 5% Opex +/- 5% WACC +/- 0.5% Terminal Growth Rate +/- 0.5% (300) (200) (100) Change to Base Case DCF Value ($m) Discounted Cash Flow Valuation 21

23 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 operations comparable to Landcorp; and The value of the Net Tangible Assets as at 30 June Multiples Approach Table 11 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 11: Listed New Zealand and Australian Companies with Rural Operations Company Enterprise Value Market Cap EV/EBITDA (x) EV/EBIT (x) $m $m LFY LTM t+1 t+2 LFY LTM t+1 New Zealand LIC x 2.6x na na 3.6x 3.6x na PGG Wrightsons Ltd x 10.2x 8.1x 7.0x 12.9x 12.9x 9.3x NZ Farming Systems Uruguay Ltd x -9.8x 27.3x 13.3x -9.0x -9.0x -66.6x Australia Australian Agricultural Company Ltd x 85.4x 16.0x 15.5x x 330.9x 19.3x PrimeAg Ltd x -6.8x 14.2x 9.3x -6.5x -6.5x 16.0x Rural co Holdings Ltd x 8.3x 6.2x 5.8x 14.0x 10.1x 7.2x Ridley Corp Ltd x 7.8x 6.6x 6.2x 10.6x 10.6x 8.5x Elders Ltd x 8.1x 7.8x 6.7x 20.3x 14.5x 13.6x Landcorp x na 18.4x 15.3x 16.2x na 23.9x Company Enterprise Value Market Cap PE (x) ROA % ROE % $m $m LFY LTM t+1 t+2 LTM LTM New Zealand LIC x 6.3x na na 8.4% 10.5% PGG Wrightsons Ltd x -26.7x 11.8x 8.9x 0.7% -1.9% NZ Farming Systems Uruguay Ltd x -51.1x -25.4x 20.1x 0.7% -1.5% Australia Australian Agricultural Company Ltd x 125.2x 58.5x 44.1x 2.4% 0.6% PrimeAg Ltd x 85.1x 17.2x 14.3x 1.2% 1.2% Rural co Holdings Ltd x 8.8x 11.8x 10.5x 4.7% 12.7% Ridley Corp Ltd x 11.0x 10.2x 9.5x 6.9% 10.1% Elders Ltd x 63.2x 86.7x 15.1x 2.4% 0.2% Landcorp x na 27.3x 21.2x 2.0% 1.8% None of the listed companies have business operations that are directly comparable to Landcorp. Of the listed companies, Australian Agricultural Company Ltd and New Zealand Farming Systems Uruguay Ltd have the most comparable business operations to Landcorp. The forward (t+1 and t+2) EV/EBITDA multiples implied from the Base Case DCF valuation and the ROA and ROE for Landcorp are broadly similar to the multiples and returns for Australian Agricultural Company Ltd and New Zealand Farming Systems Uruguay Ltd. The Crown owns the entire share capital of Landcorp and has control over the 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 Alternative Approaches 22

24 companies. It is reasonable to expect that the multiples implied for Landcorp will be higher than the multiples for the comparable listed companies. Due to differences in business operations and the low levels of profitability of the listed companies, it is difficult to interpret anything more from this analysis. 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 balance sheet carrying value of Landcorp s Net Tangible Assets as at 30 June 2011 was $1,352 million (Net Tangible Assets or NTA is the fair market value of assets less the value of liabilities and the Redeemable Preference Shares). The NTA approach was presented by the Board of Landcorp as the commercial value of the Crown s investment for Statement of Corporate Intent (SCI) reporting purposes. Table 12 compares the NTA for Landcorp at 30 June 2011 to the DCF valuation for the Base Case. Table 12: Comparison of the DCF Valuation to Landcorp NTA $m Equity Value per DCF Base Case 700 Net Tangible Assets 1,352 Difference 652 There is a gap between the Equity Value calculated using the DCF valuation and the NTA value of approximately $650 million. 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 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. Using our cash flow forecast, a discount rate of 5.25% is required for the DCF valuation to approximate the NTA value. The gap between the DCF valuation and Landcorp s NTA demonstrates the challenges in applying the DCF approach to value rural land. 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 23

25 Appendix A: Disclaimer Declarations We have prepared this Report at the request of the Treasury. The terms of our engagement as agreed with the Treasury require us to prepare a research report solely for the purpose of providing the Crown with an independent view on the value of the share capital of Landcorp Farming Limited. This Report should not be used for any other purpose. This Report is not an investment recommendation. We consent to this Report being placed on the Treasury s website. Certain numbers included in tables throughout this report have been rounded and therefore may not add exactly. Qualifications This Report has been prepared by the Corporate Finance division of PricewaterhouseCoopers, which provides advice on mergers, acquisitions and divestments, valuations, independent expert s reports and appraisals, financial investigations and strategic corporate advice. Independence We currently provide internal audit services to Landcorp Farming Limited. The partners and staff involved in the preparation of this Report are from a separate division of PricewaterhouseCoopers. Disclaimer and Restrictions on Scope of Our Work The statements and opinions expressed in this Report are based on information available as at the date of the Report. In preparing this Report, we have not independently verified the accuracy of information provided to us, and have not conducted any form of audit opinion of Landcorp Farming Limited. In forming our opinion, we have relied on forecasts and assumptions about future events which by their nature are not able to be independently verified. Inevitably, some assumptions may not materialise and unanticipated events and circumstances are likely to occur. Therefore, actual results in the future will vary from the forecasts upon which we have relied. These variations may be material. This Report has been prepared based on publicly available information and limited information provided by Landcorp Farming Limited. The valuation of Landcorp Farming Limited share capital contained in this Report does not constitute an independent business valuation in the manner prescribed by the New Zealand Institute of Chartered Accountants (NZICA) Advisory Engagement Standard No. 2 (AES-2). The statements and opinions expressed in this Report have been made in good faith and on the basis that the information provided by Landcorp Farming Limited for the purposes of preparing this Report is true and accurate in all material aspects and not misleading by reason of omission or otherwise. Accordingly, neither PricewaterhouseCoopers nor its partners, employees or agents accept any responsibility or liability for any such information being inaccurate, incomplete, unreliable or not soundly based or for any errors in the analysis, statements and opinions provided 24

26 in this Report resulting directly or indirectly from any such circumstances or from any assumptions upon which this Report is based proving unjustified. The views expressed in this Report have been arrived at based on economic, market and other conditions prevailing at the date of this Report. Such conditions may change significantly over relatively short periods of time. We reserve the right, but will be under no obligation, to review or amend our Report if any additional information, which was in existence on the date of this Report, was not brought to our attention or subsequently comes to light. Limitation of Liability This Report has been prepared under a Contract for Services with the Treasury. Our engagement, and any duty of care as a result of this engagement, is solely with the Treasury. We accept no responsibility or liability to any other person. Under the terms of our Contract for Services with the Treasury, our liability to pay damages for losses arising as a direct result of breach of contract or negligence on our part in respect of services provided in connection with, or arising out of this engagement but, to the extent permitted by law, any liability of PricewaterhouseCoopers, its partners and staff (whether in contract, tort, negligence or otherwise) shall in no circumstances exceed five times the fees paid in the aggregate in respect of all such services. 25

27 Appendix B: Glossary Base Case CAGR CAPM CPI DCF EBIT EBITDA EUR EV FY GBP Landcorp or the Company MAF Management NTA NZD NZICA PTMRP SCI Terminal Value USD WACC The mid point of the low and high price scenarios for commodity prices Compound Annual Growth Rate Capital Asset Pricing Model Consumer Price Index Discounted Cash Flows Earnings Before Interest and Tax Earnings Before Interest, Tax, Depreciation and Amortisation Euro Enterprise Value Financial Year Great British Pound Landcorp Farming Limited Ministry of Agriculture and Forestry The Landcorp management team Net Tangible Assets New Zealand Dollar New Zealand Institute of Chartered Accountants Post Tax Adjusted Market Risk Premium Statement of Corporate Intent The recurring annual cashflow expected to be generated by the Company for each year after the end of the forecast period. United Stated Dollar Weighted Average Cost of Capital 26