Farm performance: David Cornish, Cornish Consultancy

27 years ago i attended my first aber outlook conference and have been lucky to attend several since while much has changed especially when it comes to technology much has stayed the same in fact i would argue that what makes a good agricultural investment then still makes a good invest agricultural investment today however as was the case then is it easy to get sidetracked by fads and trends which often result in disastrous outcomes for the investor as such what i hope today is to discuss how to avoid many of these issues the problem when given a topic like this is not what to discuss or what to leave out however for those who need to catch up on some sleep over the next 15 minutes as i appreciate it's after lunch here are the main messages one do your homework two if they're offering double digit high returns year on year then avoid and three if they claim if their claims can't be credibly backed up with true independent evidence avoid like the plague not hard is it yet for some reasons we have seen billions i'm talking about billions lost in agricultural investment i i write scams here maybe that's been a bit rough over the last couple of decades but maybe not for those who don't need to catch up on the beauty sleep i will now explore this in a bit more depth and hopefully pass on some lessons i have learnt on how to avoid some of the potential hand grenades every so often i'll pick up an article on why agriculture's next best thing and the argument goes something like this the main premise is the world is running out of food it's simple mass more mouths to feed less country to plow means demand will outstrip supply ipso facto this leads to price pressures and therefore improved returns economics 101 the family farm is a shock duck it can't keep up with increasing capital requirements technology advancements and scale required to be a profitable business corporate farming given its ability to better access capital and the best expertise money can buy is better positioned to take agriculture into the future its size advantages also means it can take up positions up and down the supply chain thereby capturing more of the profit taken by the middlemen and therefore ensuring a more profitable outcome than the family farm will ever be able to achieve and finally given the access to the best expertise money can buy they have a better understanding of where markets are going and therefore can pick winners and ensuring that investor capital will outperform the average what i hope to show with the rest of this presentation is why most of what i have just said should be viewed with a large dose of skepticism firstly the food is running out of the world is running out of food since the 18th century it has been predicted the world will run out of food as thomas malthus stated in 1798 the power of population is definitely greater than the power in the earth to produce substance for man in 1968 professor paul hillick heilig sorry if i've got that wrong wrote the population bomb and declared that the battle to feed humanity had been lost and there would be a major food shortage in the u.s in the 1970s as she's quoted saying hundreds of millions millions are going to starve to death again in 1972 the problem was brought to attention by the club of rome which stated that there will be a desperate arable land shortage before the land year 2000 another of my favorite doomsayers is a bloke called lester brown who stated in 1995 that in addition to raising food prices the failure to arrest the deterioration of our basic life support system could bring economic growth to a halt dropping incomes and food purchasing power through the world and then finally the economist in 2015 made this statement in the next 40 years humans will need to produce more food than they did in the previous 10 000 put together but with ruraling cities gobbling up arable land agricultural productivity gains decreasing and demand for biofuels increasing supply is not keeping up with demand the economist jan 2015. according to these futurists and don't you love that term things are cook and tell a rook if you're if you're a consumer and looking up if you're a producer for you food but are they first as history has shown us contrary to these projections made by these eminent people we haven't run out of food here are some of the facts the latest fao estimates indicated that global hunger reduction continues about 795 million people are estimated to be chronically under nourished in 2014 and 2015. just one in every nine people this is 216 million fewer and i say fewer than in 1990-92 in the same period the prevalence of undernourishment has fallen from eighteen point six percent to ten point eight percent globally fio two thousand fifteen growth of the world population is almost in free fall it is expected to decline to one percent in twenty twenty adding 76 million people to the 7.6 million people the lowest rate since the 1950s moreover more over this trend is yet is set to continue by 2050 the global population growth rate will be 0.5 percent bringing us back to the 17th and 18th century century figures world bank 2014. current cropland could be more than doubled by adding 1.6 billion hectares without impinging on land needed for forests protected areas or urbanization fao 2009 to add to this the uk institute of mechanical engineers report global food waste not what not found that between 30 to 50 percent or 1.2 to 2 billion tons of food produced around the world never makes it to the plate the garden in 2013. so who do we believe the futurist or foa world bank oecd oecd and let's not forget the uk institute of mechanical engineers from my perspective perspective as a producer it shouldn't matter who you believe what is important is what's happening regards to world demand and supply balances therefore on farm prices that i receive as a producer that is important so let's look at these if we look at wheat we get the following picture the graph shows that closing stocks have grown over the last three years to record and i repeat record levels more importantly if we look at the stock to use ratio the usda has estimated that closing stock levels for this financial year will finish at 33 so what does this mean relative to other years since 1970 according to a bears that places current closing stocks in the top 25 percent of all years i really question if high closing world stocks is really conducive to booming prices however you may argue that david has picked one only one commodity to support his argument fair call if we accept the premises that tightening food stocks and improvement disposal income should lead to increasing commodity prices and let's look what happened to real prices for wheat lamb cattle from 2003 to june 2015 in real terms and by real i mean i'm removing the effect of inflation now you can get these numbers yourself off the grain and graze website as the slide identifies for most of our broad acre commodities prices have roughly kept up with inflation but certainly not exceeded it to any great extent so in my mind this price relationship would suggest there is no new paradigm i'm not going to have to unpack anything and we don't need to start a new discussion on food okay when it comes to commodity prices so hopefully you can now put to one side that invest in agriculture is some kind of coal mine due to the fact that it's inevitable that substantial price rises are just around the corner now you might ask why i've spent so much time on that point that point if if you ever look at investment ims time and time again i see reams of iems that that focus on that one point and as i said hopefully if you look at the facts you'll agree that it's very questionable i'm certainly not seen as a producer that we're seeing food demand resulting in higher prices for my commodity which happens to be lamb okay so in my opinion investment in agriculture does make sense but in australia how you make it and more importantly with whom you make it will be far more important than what commodity you invest in so this is where the homework needs to be done so the first thing you need to get right is whom you get into bed with as i believe this is the biggest factor that will affect your returns often agricultural investments are seen as asset plays in my experience you're investing in people first and other assets second what surprises me is how caught so-called sophisticated investors and institutional investors let the guard down when it comes to agricultural investments from my own experience with working with institutional investors i constantly came across the three characters that need to be avoided being one the agricowboy that's new term apparently i googled it it's not there two the snake oil salesman and three the used car salesman so let's start with the agri cowboy firstly he and i use the term he on purpose oozes confidence usually located in sydney or melbourne is there nothing they don't know or people they don't know is there nothing they can't do the problem is once you take the rm williams boots and hats and scrape off and scrape away the anecdotes and get over the helicopter rides the reality doesn't always live up to the height what you often find is you're left with a following one over burdensome and expensive administration systems you have excessive promotional administration costs making them uncompetitive except for their tax advantages maybe poor operational management running an agricultural business and ensuring optimal financial performance requires significant management skills as you are managing a biological system in a risky environment local knowledge and i repeat local knowledge and the ability to do this quickly is essential very hard to do when you're sitting in an office a thousand kilometers away they ignore the fundamentals of an agricultural investment the critical issue is that profitability profitable operations can be identified by their cost structure cost efficient producers will make sustainable long-term profits while inefficient producers will not in summary on the evidence available time and time again these corporate operations significantly underperform family farm operations when it comes to the returns to investors and kate there's always an exception to the rule wherever you are number two the snake oil salesman or zealot these are easily identified by the passion for their their way of farming they excited to be around and usually offer an investment which will change farming practices for the better plus based on their excel spreadsheet superior returns again these should be avoided like the agricowboy because again once you work through the hype and media pizzazz there's no substance to the form of true evidence-based facts which can be independently verified and finally the used car salesman these guys usually don't know much about egg but boy do they know people who do what you usually find what you usually find out about these people is they end up with the deals that have already done the circuit they find it hard to understand the meaning of no and always out to do a deal the problem is no amount of wheeling dealing can turn a pig's ear into a silk purse you enter these deals at your peril so what to look for track record have they made a dollar or they just talk evidence-based this is their system based on fact not fiction skin in the game and this is probably one of my critical points skin and gains are these fellows just clip it tickers tickets ticket clippers or do they actually have equity at risk while most of those risks following risks can be mitigated by the above mentioned by avoiding the above mentioned fellows believe the following are still worth mentioning just in case size isn't everything or the curse of the y chromosome i am being a bit nasty to blokes aren't i i'm sorry is a loud i reckon this is a male thing but for some reason we've been males or want to be the next sydney kidman the bigger the better just look at any excel spreadsheet that's what it will tell you the problem with this is just as there are economies of scale there are also diseconomies of scale as the graph highlights and i thank david for letting me borrow this gareth all farming operations have a tipping point when it when where profitability declines this is only magnified in a corporate model where administration costs and hr costs magnify this problem the difference between a top 25 return and average return can be simpler can simply be a matter of days precision and speed can get lost as operations get too big show me the numbers this is a big issue for me the number of iems i have looked through that spend most of the time talking about the value of agriculture investments lesson actually on performance staggers me avoid like a plague any investment that can't justify projected performance with past performance value-add versus added costs expertise and risk what i'm trying to say here is quite simply is that people will often induce you into an investment because of their ability to add value to the product down the supply chain in my experience only about one in ten of any value-add project actually works in most cases what happens is that you add costs and the return is not you don't get the return you only get the risk projections with straight lines it's likely slightly amusing me or makes me cry depending on how i feel when i talk to fun gatekeepers that we need fun gatekeepers and they're the people you have to actually talk to to actually get to the fund it's a bizarre world um that we need to keep it so when they're helping you try to talk to a farm what they'll do is they'll try and brief you on how you do it what they often say to me is is you've got to keep it simple or you will confuse them okay so if you present risk and return graphs like i have here and what i've got there is oh i'll get that right there we go that's here is a co-investment model that we use which allows a investor and farmer to work out what their actual return and risk risk return profiles are going to be like um and so it gives them as we were talking before about a full spectrum of what their likely potential returns are and the risks they're taking on the second one that annoys me in agriculture is we often use as averages or mean when we're looking at things the second is an example of when i was looking at dairy returns across different areas of australia and new zealand as you can see some of those returns are quite close but if you actually look at the variability by the box and whisker graphs you can see quite a bit of variability and depending on where you want to go daring okay i'm very conscious that this talk might sound like i'm pointing the bone at others and that i'm perfect nothing could be further for the truth and i have made my fair share of stuff ups however what i've learned that these from these is that you cannot understand the importance of the six days of ag investments and these are simply due diligency due diligency that's hard to say anyone can buy a farm farming property but buying the wrong one or paying too much for one will mean no matter how well you run it you will never make a commercial return be careful what you outsource to third parties to do and remember those who's left holding the baby when the experts ride out of town skin in the game contrary to recent reports in the media the death of the family farm is grossly exaggerated in my experience investing along corporate farming lines and joint in my experience of investing along corporate vines and joint venture with farming family farming operations the g the jv has delivered significant superior returns with significantly less hassle especially around hr in delivering of the results no structure works better than a family operation there are many reasons for this but the most critical is a concept of skin in the game my anecdotal example of this is a dairy operation that i'm involved with they run both a corporate style and a jv with a young married couple the difference in performance and hassle is staggering i experienced this being the case with other co-investment models that we have set up in the broadacre industry with overseas investors and family farming operations costs cost efficiency is critical hopefully the takeaway message from the first couple of slides is that prices will do what prices will do they will go up they will go down but over the long term they'll revert to the mean this means high cost operations over long run will run at a loss and low cost will run at a profit in the australian context systems that require high inputs of labor and energy will always be at a disadvantage to those that don't flexible farming options and realistic exit options again to quote the great farming consultant dorothy mckellar we farm in a country of droughts and flooding rains add to this fire frost locusts plagues and other vermin adaptability of our farming system is essential to success the value of adaptability farming systems borne out in some work done in the 1990s by a beer that looked at the coefficient of variation of operating profits in broadacre regions of australia it was not surprising the farms in the wheat sheep zone had the best coefficient variations given the ability to vary farming operations depending on climate conditions and equivalent profitability of the livestock versus grain with regards to exit options and i can't reiterate how important this is and it is so often over is is missed is the ability to get out of the investment it is often assumed that the end of the investment period we just put it on the market and bob's your uncle come in comes the money as per the excel spreadsheet i love excel farming as my colleague continues to remind me buying farmers easy running a farm is hard selling a farm is harder still if you do want to be sydney kidman then when you get bored of it remember the market demand for these large lumpy operations are small and it can take years to sell the operation so in summary yep in summary some of you may think i'm down on investment in agriculture nothing could be further from the truth in fact i want people to invest with both eyes open and avoid the spin and ticket clippers that populate the space in my opinion agriculture can provide a return that is commensurate with other investment classes an example here are the returns from my superannuation fund for the nine years from 2006 to 2015 and this is an industry fund australian shares total returns 5.53 international shares 4.79 property 5.4 fixed interest 5 cash 3.82 and alternatives 2 done properly ag investment can easily out do these returns done done badly even 2 will look good thank you