I will talk a little about a stock we own this week, and have no intention of selling. I seldom do this, but I believe we are probably finished buying (absent a decent retreat in prices) as it has already grown to our 5th largest holding. In any case, it is a good instructive example of the type of very good returns available from time to time to the alert. Also, the gains here are primarily income driven rather than capital gain driven, so it is different to many of our holdings.
EGP has, over the last year or so become the 3rd largest shareholder in Rural Farms Poultry (RFP.NSX) an NSX listed chicken growing business. We purchased as aggressively as possible, given the very thinly traded nature of the stock and have managed to accumulate a stake amounting to about 2.5% of the business.
RFP was an unlisted entity managed by Rural Funds Group (RFF.ASX). In mid-2014, they listed the entity on the NSX, to give the unit-holders the possibility of liquidity they did not have in an unlisted vehicle. Unfortunately, it took a few months to come to my attention, but once it did, I acted in reasonable size (relative to our small fund).
Through most of the time we were buying, we were paying very close to (or sometimes less than!) the cash on the balance sheet. We were effectively getting the income producing part of the business for free.
In total, the stake we paid cash for (we received some stock in lieu of dividends while a DRP was in operation) cost us about 84.3 cents per share. At the 30 June 2015 balance date, the entity held cash of 89.7 cents per share on the balance sheet and NTA of about $1.07 or so. Because we have had a decent uplift in the underlying capital value of our holding, the IRR we have generated owning RFP has been more than 50% annualised so far, though over time, this will trend closer to the yield set out below as the holding period lengthens.
The part we got ‘for free’ is the income of the chicken farms. In FY15, they generated PBT amounting to 31.1 cents per share. Now FY15, as management have pointed out at great length was an abnormally good year. Energy costs fell after the abolition of the Carbon Tax and this led to energy rebates (which are based on prior year consumption/price). In any case, FY16 earnings have been guided to be more like 21 or 22 cents before tax. The current underlying earning capacity of the business is probably closer to the 21c than the 31c. The timing of the growing cycle can also have a meaningful effect; a year where an extra cycle is fit in will also result in an outcome as much as 20% higher (there are 5 to 6 cycles annually).
Management have guided for a continuation of the 2.5125c per share quarterly dividend, which based off 22cps PBT is only a 65% payout ratio, so assets (cash) will continue to grow unless the scale of business is expanded (in which case, presumably earning will grow!). Based on the cost of our holding, this amounts to a grossed up return of 17.03% annually on our cost base, when you factor in the shares received as part of the DRP (effectively for free), our grossed up return more like 17.8% or so. The current dividend also amounts to a still respectable 14.36% grossed up annually on the last traded price of $1 per share.
To those of you whose interest was piqued by that last sentence, you need to be cognisant of the fact that there are higher risks in a single output business. From time to time, an issue such as Newcastle Disease can pop up and cause havoc, though Australian quarantine practices have a pretty good record in keeping out virulent disease. The size of RFP also adds a little protection as they operate 154 sheds across 17 farms in two geographic areas. RFP also operate with a single customer at this stage, which also presents obvious risks.
There are more than 600 million chickens slaughtered annually in Australia. RFP produce around 30 million or so birds per annum, or nearly 5% of Australian consumption. Chicken meat is both the fastest growing source of protein in Australia, and the largest protein source, so there are sound industry tailwinds too. Chicken meat is relatively good on sustainability grounds too; the conversion of feed into protein is much higher than other animal proteins. Part of the reason chicken meat has grown to the largest source of protein is because it keeps getting cheaper too. Efficient corporate chicken farmers like the one we part own will no doubt keep pushing to ensure these trends hold.
So if you’re having a barbecue this weekend, maybe grill a couple of chicken breasts. You will be creating demand in an industry you own a small slice of at least – Tony Hansen 23/10/2015
|
|
Apr 1st 2011 |
Jul 1st 2015 |
Current Price |
Since July 1st 2015 |
Since Inception |
|
EGP Fund No. 1 |
1.00000 |
1.57872 |
1.66602*1 |
5.53% |
95.95%*2 |
|
37333.23 |
50922.68 |
51497.83 |
1.13% |
37.94% |
EGP Fund No. 1 Pty Ltd. Up by 5.53%, leading the benchmark by 4.40% since July 1st 2015. Since inception, EGP Fund No. 1 Pty Ltd is Up by 95.95%, leading the benchmark by % all-time (April 1st 2011).
*1 after a 31 May 2013 dividend of 2.333 cents per share (cps) plus 1.000 cps Franking Credit, a 31 May 2014 Dividend of 7.000 cps plus 3.000 cps Franking Credit and a 31 May 2015 Dividend of 8.6667 cps plus 3.7143 cps Franking Credit
*2 calculated based on dividends reinvested
RFP
Thanks for another interesting blog post, Tony.
RFP came to my attention late last year and I made a decision not to invest based on 2 things that concerned me at the time.
From my notes I discovered in the 2014 AR,
“Minimum lease payments under non-cancellable operating leases of sheds not recognised in the financial statements, are payable as follows:”
With a total amount of over $167,000,000. I couldn’t understand what the impact of such a disproportionate amount might have on the business and that scared me!
The second concern I had was the businesses exposure to legislative change around how chickens are bred and raised. I dont know how RFP farms operate, but I do know most chicken farming in Australia is carried out in horrifying conditions and that there is considerable political pressure to improve the conditions – and this I saw as a significant risk to the profitability to the business.
I would be interested to hear your thoughts on these two points.
RFP
The enormous lease commitments actually offer considerable forward security for the business. Their prime locations would not be replicable in todays nimbyist environment.
As to the conditions, I have met management and there are considerable benefits (financial & ethical) for RFP in achieving industry leading low mortality rates and growing conditions. I am satisfied that their farms operate on a global best practice basis – Tony
Thanks for taking the time to
Thanks for taking the time to reply Tony, I see upon having a further look, that the lease commitments are really just noted for transparency and seeing them as a single dollar some is intimidating, but of course the yearly cost is represented as a recurring cost in the financials and its not like they will ever have to pay the amount in one hit.
Also good to hear your impressions that they operate on a “global best practice basis”, although I suspect there is still a risk there, some of the practices of intensive chicken farming are truly horrifying and I suspect governments will act at some point to ensure conditions are greatly improved. At least RFP should see less impact if they are already doing the right thing.
No Problems
The leases are ranging from 10-22 years, backed by supply agreements, as I said, I’m happier to have these in place than the alternative.
RFP are scored, like all suppliers to Bartter/Baiada on metrics to do with conversion of feed into weight and mortality, there is a bell-curve and bonus earnings are generated when you are on the right of the bell-curve & penalties apply when you’re on the left of the curve.
I try to think about environmental & ethical things mostly in terms of sustainability. Based on this, the conversion by chickens of feed into protein is matchless. Consumption of feed/water and general degredation caused as a result of the farming practices are better for broiler farming than any other production scale animal protein.
If I were to measure via some other basis, such as minimising, the number of lives lost in order to create sufficient food for humans, then I would prefer cattle. Better still, by the basis of how much food can be generated for a single lost life, I would be compelled to support whaling. A single adult Minke whale would generate as much food as 2000 – 2500 chickens… A single adult cow replaces the lives of perhaps 220 chickens. Less lives are lost…
Ethics is obviously an area of enormous complexity. As far as animal protein goes, I think Australian broiler farming practice is excellent in terms of global standards & I understand RFP are one of the best in Australia – Tony