Select Harvests

Paul Thompson is the CEO of Select Harvests, the integrated almond grower and seller. Now, the interesting thing about this business is that it had an approach for a takeover last year which was rejected. The approach was from an Abu Dhabi investment company and they seemed to have gone away. They bid 5.85 per share, or at least they said were thinking of bidding 5.85 a share, and when the price was $4. SHV’s price popped up to 5.20 in response and is basically still there. The question, I guess, for the board and for Paul Thompson is when is the price going to go above 5.85? Because they rejected it on the basis that the business was worth much more than the Abu Dhabi investment company was offering. 

So, I guess investors who saw that are getting a bit impatient now wondering what the hell is going on. Because, the profits of this business have become quite volatile. They had a fantastic year 2015 and it’s back down again. They’re still paying a dividend but nowhere near as much and so I think this is a business that’s now looking quite expensive and they have quite a lot of work to do to justify the price of around 5.20, they have a lot of work to do. They reckon the price is going up, the price of almonds that is, because demand is rising and soaking up virtually any supply that’s coming on. There’s been some frost in California and so they reckon they can get the price up. Their harvest is going pretty well but this is an agricultural business, it depends on the weather, it depends on demand for the product and so you have to have a strong stomach to invest in Select Harvest, that’s for sure. That’s certainly been the experience of the last couple of years. 

Here is Paul Thompson to explain what went on, the CEO of Select Harvest.

Paul, can we just start with last year’s takeover approach that you had from the Abu Dhabi investment firm named Mubadala, I think they’re called.  You said in the announcement about the approach, you said maybe they’ll come back or maybe they’ll withdraw it, but I haven’t heard anything since then.  Did they just go away or what, have you heard anything from them since?

We haven’t been in communication with them so I can’t answer if they’ve gone away or not but I think considering what happened and the volatility of our earnings I think they would have waited to see what was happening with our result which we’ve just put out before probably they were making any substantial changes to their strategy or approach.

You announced it on October the 9^th and you said that they approached you on I think September the 19^th.  On the day of the approach the price was $4.  Now, obviously it popped up to 5.20, they offered 5.85 or at least their indicative price was 5.85.  But, the price hasn’t gone anywhere near 5.85.  Is that surprising to you at all?

I think our price, we trade very much in line with where almond pricing is.  The bid premium really from the board’s perspective didn’t reflect the potential earnings of the company as our young orchards come on stream.

The fact that it was announced the fact that they’d approached you on the same day as you announced the capital raising, was that just a coincidence?  Had you been working on that for a while or did you think you’d take advantage of the hop in price that was going to occur?

We didn’t announce the Mubadala approach, it was announced in the press the day before we did our capital raising.

Right, okay.  So, it leaked out?

Yes.

Okay, so you mentioned that your earnings have been very volatile, tell us about why that is?  I mean obviously 2015 was a big year and now you’re back to where it was sort of eight years ago.  Tell us what’s been going on?

Well, I suppose the difference between the company today and eight years ago is eight years ago 90% of Select Harvest income came from managing farms on behalf of Timbercorp which ultimately became Olam.  So, we’re a very different organisation to the organisation that was around eight years ago.  Today we’re much more of a grower, processor and marketer than a farm manager so our income is much more volatile, it has been more volatile as it’s more dependent on crop size, market price, currency, rather than just effectively clipping the ticket for the management of a farm which had no relation to performance or the profitability of the industry.

Perhaps a good way to explain the volatility is to tell us what happened in 2015, why was that such a good year?

2015 almond price was closer to $12 than $7.75 as it is today, as we announced today.  We had a very big crop that year, our crop was close to 21,000 tonnes we processed for ourselves and other growers who we’re processing for.  Today our crop would be closer to 15,000 tonnes our own and we’d probably process about 2,000 or 3,000 tonnes from the external market place plus then there’s that price leverage as well.  Then, farming costs were significantly lower, things like water in the temporary market was closer to $25 to $35 whereas today it’s $120 to $150.

I think a lot of investors would have kind of expected a relatively stable price for almonds given the demand that you’ve been talking about.  A lot of people are switching to almonds, there’s a big growth in demand for it around the world.  Has there been volatility in demand or is it all about supply and cost?

Demand, at that point in time there was a significant drought in California, that broke two years ago.  There’s also been significant plantings put into California and Australia.  Plus, also the prices of other commodities has moved around a bit too such as cashews and if you look at our investor presentation, if you look backwards during that point almonds has traditionally been the low priced commodity where it’s back there today, and during that period the almond was at a higher price, between now and 2015 the almonds have been trading at a higher price than both cashews and Walnuts, and there’s a reasonable amount of interchange with those products.

Now, as you say, it’s the lowest, it’s under $8, both cashews and walnuts are well over $10 aren’t they?

Yeah, and as trading goes on in different markets probably the biggest trading area is in the snacking market in developed countries.  That’s where there’s a fairly high interchange with cashews in particular.

What do you think investors can expect in the future in terms of prices, and I know you probably don’t want to predict prices too much but I mean how does it feel to you, is the demand going to be reasonably strong?

I think there’s been a big shift in the source of demand so if you look at the shift, if you went five years ago, ten years ago, further back more and more of the product, nuts was being eaten as a snack in a bowl of nuts and things like that whereas today it’s become more and more of an ingredient.  As it becomes ingredient I think there’ll be less price sensitivity to it.  Let’s use the example of if you were buying a bag of nuts at the supermarket in the fresh produce section 90% of the product cost of that is the nut price.  If you were buying muesli the nuts could be 5% or 10% of it or a muesli bar or an almond milk, it’s a much lower percentage.  So, the sensitivity of a price increase is a hell of a lot less across the total product.

And you also mentioned the water price.  Now, to a large extent almonds and walnuts are basically a water conversion business I think.  Tell us about how sensitive you are to the water price and what’s it doing this year?

The water price is about 20% of our total cost depending on where we are and where we’re going.  The water price has remained pretty stable for us year on year.  We’ve got a risk mitigation strategy around water.  We’re growing almond orchards in an aquifer, we will own or lease 100% of our requirements basically married up to the life of the orchard.  The reason we do that is you just can’t get water in and out of an aquifer obviously, so we need to make sure that we own sufficient water that in drought periods, that when there’s a lower allocation, that we will be able to supply our trees with sufficient water to yield a good crop.  Where we work in the connected network, so on the river and channel network and where there’s an aquifer as part of that network we effectively currently aim to own about a third of our water entitlements, long term lease about a third of it and then buy on the spot market for a third of it.  If you look at some things like some of the general entitlements they can be when there’s an abundance of water as low as $10 for a megalitre and when there’s a lack of water they can be as high as a couple of hundred bucks.  So, it’s really trying to do a bit of an arbitrage between those three sorts of models.

And are you saying that that third, a third, a third structure for a water supply, that’s something you’re going to hang onto, that’s going to be what you’ll do going forward?

Our current policy is to do that.  We review that policy on an annual basis and it may well change but at the moment we think it’s served ourselves pretty well.  The other side of that is we’d much prefer to invest our capital in farms than water.

A lot of other businesses – I mean, I’m thinking of Webster’s, the walnut business, they see themselves as a water owner business, their capital is going into water.  You don’t agree with that strategy I guess.

No, I don’t disagree with it, I think someone’s got to own it and someone’s got to lease it.  They also own a lot of walnut plantations and they use a lot of water on an annual basis on their cotton farms.  I don’t think it’s a flawed strategy at all it’s just not our preferred strategy.

Tell us about this year’s crop, how big is it going to be and how much have you harvested now?

If we were just using standard yields the crop would be about 15,800 metric tonnes plus or minus 5%.  We know that we’ve had frost events in New South Wales during the pollination period and it’s very difficult to judge frost because it doesn’t sort of impede the whole farm as one, there’s high spots where it hasn’t affected, most spots where it’s affected it significantly.  We have to do the biological accounting, we’ve used a 15,000 metric tonne crop for that.  Currently as of today we’re about just under 50% harvested and that’s all in one variety because the varieties come in streams so this is the major variety that comes in – no, it’s not all of one variety, it’s nearly all of one variety and it’s a small part of the other varieties.  But, we start in South Australia and move North to New South Wales so we’re well in advance in South Australia and Victoria and New South Wales a little bit behind where the frost area is.

Right, and how much of your crop do you sell under your own brand and how much do you sell as ingredients?

We sell about 80% of the crop offshore, we consume about 10% to 15% within our own businesses and we add value to probably another 5% of it and sell it out into the open market place.

I suppose I’m just trying to get a sense of to what extent you’re a price taker and to what extent you actually determine your own future, your own prices.  I guess everything you sell offshore is…

We’re largely a price taker.

Yeah, and is the price at 7.75, is it going up or down, which direction is it moving?

California during pollination had three severe – and that’s where 80% of the world’s almonds grow, had three severe frost events and they’ve basically had cold, wet, miserable weather for the last half of their pollination which means that A, there’s potentially frost damage on their trees.  B, the bees aren’t able to pollinate what’s been left because they don’t come out unless the temperature is over 14 degrees and it’s been well below that.  So, we’ve been seeing the market price of the almonds rise over the last two weeks above that 7.75 number.

Right, okay.  So, do you think you’ll get above $8 for your crop?

I think at the moment if we were to sell the crop, and we presold some of it, we’d be getting around the $8 mark.  It’s got to be recognised that for every 1% movement we get $1.2 million in EBIT.

A 1% movement in the price?

Sorry, yeah in the price.

I suppose what investors have got to be wondering is are they ever going to see 5.85.  I mean you guys turned that offer down by saying, and you said at the time, that you thought the company was worth a fair bit more than that which means that you think that you’re going to achieve a price of 5.85 on the share – I mean, obviously you can’t control the share market but you clearly think that the business is worth more than that.

Yeah, I think there’s two things.  I think that when they approached it was very opportune, the market price of almonds was lower than low term average at that point in time, it didn’t reflect the fact that in four years’ time we’ll have 40% more almonds in production and we’re highly leveraged to those two things, price and volume.

Yeah, I think in 2015 you paid – I’m just trying to look it up here as I speak to you, but you paid a dividend of quite a lot.  What was it, the dividend was 50 cents, that’s right, then 46 cents in 2016 and then 10 cents last year, and last year was 10 cents dividend and an 80% payout ratio.

Yeah, and this year we just paid a 5 cent dividend this half, interim dividend, reflecting that we think we’re going to have strong operating cash flows on the back of this year’s crop.

And your capital raising got the gearing down as well.  Do you think you’ll borrow some more money?

No.  It depends, we plan to keep our gearing at relatively low levels from now on recognising the volatility in our earnings and would we borrow more money, depending if an opportunity came to buy a large material orchard we’d definitely potentially borrow more money to acquire that.

What has to happen for your share price to go above 5.85 as you kind of said last year it would?  Is it just simply about the almond price?

It’s about the almond price, it’s about increasing productivity, increasing the yields of our existing assets as they come to pay the existing farms we’ve got plus the introduction of the new almond orchards into production.  It takes three years for orchards to start yielding and five years before they’re sort of cash generative and seven years before they fully mature.  If you refer to our presentation you can see we’ve got a lot of those orchards coming on stream in the next three years so we’ve got a lot of acreage coming on.  34% of our farms are immature at the moment and that acreage starts coming on stream next year and doesn’t fully come into production until the year 2025 so there’s a lot of volume that’s going to come through.  Most of the capital in those farms, so all of the infrastructure has already been paid and invested in them so there’s little capital to be invested and moving forward.  I think we’re also very positive about the market in general, that there will be upward pressure on price as demand continues to increase.

Do you think you’re in a situation where demand is such that however much the industry produces it can be absorbed?

Yeah, I think it’s pretty close to that.  I mean if you look at the US crops, the Australian and the Spanish crops combined the compound annual growth has always been between 6% and 8%.

In demand you mean or production?

Volume, yeah.

In volume, right.  The other thing you’re doing is you’re going to generate power from a biomass.

Our waste, yeah.

From your waste.  So, tell us how important that’s going to be.

So, the first cousin to the almond is the peach, so about 75% of the crop that we harvest is waste.  Traditionally that crop, the excess, the waste, has been sold into the dairy industry and the stockfeed industry as stockfeed.  So, it’s a low cost high protein source for the cattle industry and as the dairy industry has shrunk so has the pricing and also demand for the product.  By burning it we’re going to get a higher return, we’ll be able to generate 20% of the total company’s power and avoid the sort of increases that are going on in the electricity market.

Does it cost much to build the generator?

It costs around $20 million.  We’re expecting it to contribute around $2 million EBIT per annum.

Right, that’s 10%.  The other thing you’re doing is par boiling, tell us about that.

Every year a certain percentage of the crop is a lower quality product, so it’s scratched or maybe an insect has nibbled on it, what we do is we par boil it, basically we blanche the product, so take the skin off it so you’ve got the raw almond and then we slice it and dice it, grind it and turn it into almond meal and sell it for industrial use.  Those nuts, if we were to sell them to another manufacturer to process themselves they would buy those probably a third of the price of a good quality nut, spend a $1 on costs on it and they’d sell it for $1.70 or $1.80 more.  We’re just doing that in-house.

Right, okay.  So, that’s just another way of improving margins.

Yeah, little value add.

Yeah.  Great to talk to you, Paul, thank you.

Thanks, Alan.

That was Paul Thompson, the CEO of Select Harvest.