v2 Report - Additional Information Supplement

ALF Allied Farmers Limited

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Operations Report

The Group made a pre-tax loss of $3.9 million for the year under review, which was brought about by a $4.0 million operating loss and costs on closure of the Allied Pine Sawmill and a $1.4 million one-time cost incurred in integrating the finance companies after acquisition. The continuing operating companies made earnings before interest and tax of $5.7 million, compared with $3.5 million in 2006. Operating revenue for the continuing activities of the Group grew from $79.2 million in 2006 to $103.2 million this year.

The 2006/07 year has been a period of great change for us. Your Board decided to purchase Prime Finance Limited in June 2006. This cost us $28 million, being $16 million in cash and a further $12 million for the disposal of impaired assets. Then in February 2007 the Board recognised that, with the consolidation and the upcoming government regulation of the finance sector, our finance company needed to have a $400 million book to be successful. Accordingly it successfully tendered for Nationwide Finance at a cost of $29.9 million. These two acquisitions have been merged into our wholly owned subsidiary Allied Nationwide Finance, and we see potential for great synergy between our rural operation and our finance arm.

Your Board took the painful decision to cease operations at the Wanganui-based Allied Pine Sawmill. Despite making significant operating improvements, this business had made a loss for every year the Group owned it. With the appreciation of the New Zealand dollar, the rise in shipping costs, and the changes in the international commodity market for lumber, it was clear that unless we spent many millions on rebuilding the mill it could never return a sustainable profit. 

The closure has had a $4.0 million negative impact on the  Group’s result. Rural services (livestock, merchandise, real estate, and Allied Farmers Wools) had a mixed year, although profit was steady and revenue grew. In the rural merchandising sector, margins decreased because of competitive pressure. The unusual spring also affected farmers’ buying  patterns and this had a further impact on revenue and profit. Livestock sales and veal meat processing had a very good year and we will continue to grow this side of our operation.

Finally your board took the decision to employ a Group Chief Executive Officer, a Chief Executive for Allied Nationwide Finance, a Group Chief Financial Officer and a Group Marketing Manager. The addition of a senior executive team has brought management skills and knowledge that already is contributing to future shareholder value.

Revenue from our livestock trading operation was 2.5% less than in the record-breaking 2005/06 year. The business mix, however, was different. There was a reduced number of and value for sheep; but store cattle and dairy cattle numbers traded increased by 8.8%. Net profit was down, affected by increased expenses and by a larger than normal number of trades being outside the Company’s network. The Rongotea stockyards achieved a 25% increase in revenue compared with 2006. Waikato and King Country divisions were slightly down on revenue, and Taranaki was almost the same as in 2006.

We are maintaining our large share of the dairy herd sales to the South Island. We also continue to have a significant share of dairy herd sales across the country, and are regarded as having specialist knowledge in this market. To make the most of this expertise, the Company will open a livestock office in Canterbury in the next financial year. By the time of the annual general meeting, Allied Farmers will be offering a new livestock website. This will allow our customers to buy and sell online, with the Company’s staff handling the contractual and logistical areas (as they do for paddock sales). As in the past, both the Company and its customers were well served by our loyal and expert livestock staff. 

The prospects for the next financial year are very good: at the time of writing, the livestock team is managing to source livestock in a short market and has achieved dairy herd sales for our vendor customers of $1,600-$2,150 per head with the record to date being $2,650. Although our bobby calf operation is not part of livestock, it makes sense to  report on it here. This year we processed and marketed, through third parties, an increased tonnage of veal and by-products. The packed meat was sold into the US through a third party, using the Company’s beef quota. This operation was again successful and we expect to increase numbers in the 2007/08 year.

This was the first full year of trading for the Taranaki Farmers Mitre 10 store in Hawera. It has proved more difficult than first thought to run this large retail store at a profit. The store has proved very popular with customers – but unexpected costs, a decline in gross profit and increased local competition has meant the store has traded at a  loss for this year. A rethink on how the store is staffed, along with better cost and inventory control, should see this store return to profit in the next financial year. We have already had an expert M10 store operator work with our staff for three months; customers will have noticed the reorganisation of the store and the improved stocking of the products.

The rest of our merchandise is traditional rural farm supply. The net profit on this rose 1.4% on the previous year, in spite of a very strange spring and considerable price competition as new suppliers entered Taranaki. This area of merchandise faces continuing  pressure from direct suppliers and increased debtor balances. Our sheep farming customers’ low return was felt in revenue and profit by a number of our stores. With the change in exchange rates and the predicted increased Fonterra payout, merchandise will have a much better year in 2007/08.

This year real estate made a loss. This was, however, several magnitudes less than in the previous year. Revenue was above budget, but advertising and increased selling commissions eroded the gross profit. The urban real estate market is extremely competitive. Across Taranaki, the actual numbers of houses sold have dropped month on month and the number of days a property takes to  sell has expanded significantly. Thesefactors, plus increased advertising rates, do not give a picture of future growth. It is clear that the four-year boom in house prices and in the number of properties being sold in the province has come to an end.

On a happier note, we continue our high profile in rural sales and have on average sold over one farm per week – which is good for both the Company and its farming clients. During  the year we sold the Feilding branch and undertook branch restructuring in an attempt to generate net profit. More work along these lines is in train for the new financial year.

Our wool business had a great year for net profit. Volumes of bales sold were down on the previous year, but this was more than made up by the storage revenue we received. Next year, however, revenues will be down because of the loss of a significant third-party processing contract. Looking further ahead, your Board is keeping itself up with the play  on the various suggested changes to the New Zealand wool market. 

There was significant change in the finance business over the year, with two amalgamations and the successful acquisition of Nationwide Finance in May 2007. Allied Nationwide Finance was created in June 2007 through the amalgamation of Allied Prime Finance and Nationwide Finance.  The finance business contributed total earnings before tax of $3.1 million to the Group in the 2006/07 year, which was up on its $1.0 million contribution for the previous year.

The Nationwide Finance contribution to the Group result was only for the two-month post-acquisition period (from 1 May 2007 to 30 June 2007). Over the full financial year, Allied Prime Finance and Nationwide Finance achieved a total net profit before tax of $6.65 million. Allied Nationwide had total assets of $302 million as at 30 June 2007, including $45  million cash and a $250 million loan book that was diversified across rural, property, capital equipment, business, and consumer finance. It had shareholder equity of $35 million and debenture stock of $261 million on issue to around 13,000 investors.

The business was restructured during the second half of the year, with the appointment of a new management team, changes to operating structure, implementation of a new IT system, and a complete exit from large-scale motor vehicle lending. These changes will deliver significant benefits over the 2007/08 financial year. The future focus of Allied Nationwide is the provision of rural, property and commercial finance throughout New Zealand. Operating from offices in Auckland, Wellington and Christchurch, it has a management team with significant experience in the finance sector and a total staff of 40.

A key strategy of Allied Nationwide is to be a leading provider of non-bank finance to the rural sector. It will continue to leverage off the Allied Farmers rural servicing business and extensive client base to drive growth in rural finance. It is also working on a number of new initiatives, including the provision of livestock leasing to the dairy sector.  At present, the finance sector is being challenged by the pressures on the global credit market and the flow-on impact of these on the New Zealand market and finance companies.

With the changes made to its finance business over the last 12 months and its strong liquidity, Allied Nationwide is well positioned to weather the changing fortunes in the New Zealand finance market. Allied Nationwide is committed to delivering on its strategy of prudent long-term growth and the establishment of its position as a top-tier New Zealand  finance company. With this  in view, it is working towards achieving a credit rating with an international agency in the first half of 2008. It would prefer to be rated sooner, but it must have six months of audited accounts as a starting point. Allied Nationwide already  has in place – and will be enhancing – all the necessary IT systems, procedures and controls that the rating agency will review.