NZ Farming Systems Uruguay Limited - 2009 Annual Meeting

NZ Farming Systems Uruguay Limited Ordinary Shares | 9:47 am, 15 Oct

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NZ Farming Systems Uruguay Limited - 2009 Annual Meeting

NZ Farming Systems Uruguay Limited
2009 Annual Meeting

Thursday 15 October 2009

Welcome

Good morning ladies and gentlemen, I am Keith Smith, Chairman of the Board of Directors of NZ Farming Systems Uruguay Limited. Welcome to the Annual Shareholders’ Meeting for 2009.

This is just our third annual meeting, and thus reflects a year in which the company remained very much in its development phase. It will be our pleasure to bring you up to date on the operations of the company, and to provide insight into where we go from here.

Chairman’s address

We now move to the main business of the meeting and I will shortly give you an overview of the Company’s progress over the past year. Michael Thomas will then report, on behalf of the Manager, on the Company’s operations.

There will be an opportunity for questions and general discussion after our reports and I will outline the procedure for that part of the meeting when we reach it.

Our agenda comprises six items, including four resolutions, which were outlined in the notice of meeting. Voting on the resolutions will be by ballot while postal votes have also been received.

The first item of business is to receive the statement of accounts, and the reports of the directors and auditors, as set out in the annual report.

When I look back to my report last year and the general satisfaction that we expressed about the development of the Company and the rapid progress we had made towards achieving the Company’s objectives, it seems that I was talking about another era when we reflect on the course of the global economy over the past year or so.

Without doubt, this year has been a very difficult year, with major short-term impacts overshadowing the progress we continue to make towards longer-term goals. Falling dairy prices, the international credit crunch and a one in 30 year drought hard on the heels of previously difficult climatic conditions, all impacted heavily on the Company’s short-term results and overshadowed progress towards longer-term goals.

Despite this, the Company remains positive about prospects for the business in the medium-term. We believe a number of factors including the performance of pasture under irrigation, the continuing development of the local Uruguayan farming talent and the recent increases in international dairy prices give us good reason to be confident.

The success of the recent bond issue, which provided much needed development funding, was also a significant milestone for the Company.

After a bright start in the first quarter, the Company experienced a significant deterioration in operating conditions with the drought having dramatic impact on the business. Winter has seen ground moisture levels increase to seasonal norms. With milking stock generally in good condition considering the recent drought the Company is well positioned for the current spring surge in pasture growth.

The Company took action during the year to counter the deteriorating conditions, cutting costs where possible, scaling back farm development spend and selectively reducing beef stock numbers to conserve cash and provide a platform to take advantage of the improved climatic conditions once they arrived.

Despite the slowing of development spend, the Company has advanced significantly towards completing on-farm infrastructure, including construction of further roads, fences and dams, installation of irrigation equipment and completion of milking sheds.

This year we have commissioned 15 milking sheds bringing the present total to 26 in operation.

For the financial year, the Group recorded an operating loss of $15.6 million before mark to market adjustments which was in line with guidance previously issued earlier this year. This loss was due, in part, to the impact of low dairy prices, the drought which was compounded by the fact that we had only very limited irrigation in place during the summer months.

Funding

The bond issue is a very positive signal in terms of the Company being able to access the development funding it needs to complete farm development. The bond issue was heavily over-subscribed, with strong support from Uruguayan Pension Funds and other investors. This support is very positive in terms of reinforcing our close links to the community in Uruguay. The funding will allow the Company to develop five more milking sheds, to connect irrigation to 1,600 hectares for the coming summer, to commence the electricity improvement project in conjunction with government authorities and to purchase further irrigation units for operation in the following summer.

In addition, the Company was successful in securing $16 million of long-term bank funding during the year.

In our view, full development and dairy production is preferable to land-banking. On that basis we sold a small undeveloped farm in June 2009 and will shortly settle the sale of another undeveloped farm of just under 2,000 hectares. Further we will undertake various forms of cropping where the economics make sense.

We estimate that a further $50 to $60 million will be needed on top of the first bond issue of $30 million to complete development of the existing 35,000 hectares. About half of this money is expected to come from a further bond issue of around $30 million, expected to be in the second half of the current 2009/10 year, with the remainder from outright sale or sale and leaseback of certain farms, or other funding arrangements

With the share price currently at a substantial discount to net asset value the sale of farms is a preferred option to equity raising.

Although our intention is to complete the farm development by mid 2012 we are carefully monitoring the cost and benefit of each stage of development.

Market conditions

Unprecedented turmoil in global financial markets has affected supply and demand in many commodities, including dairy where prices collapsed. The price paid by Conaprole, to whom all the company’s production is sold, reduced from 40c per litre at the start of the year to 20.5c per litre at the end of the financial year, in line with international dairy price trends.

International dairy prices have recently bounced back somewhat, with positive signs from Fonterra auctions, equating to a milk price close to 30c/litre.

Board and management have taken a conservative view in forward planning and assumed that current milk prices of just over 20c may prevail until mid-2010.

Shareholder Value

We have endured tough, unexpected and for the most part uncontrollable hurdles this year which have hurt investor confidence and this is reflected in the significant discount shown by the share price relative to the net asset backing.

However opportunity arises in the toughest of times and a new shareholder, Olam International, has acquired a 14.35% stake in the Company. Olam’s investment can be seen as vote of confidence because of its position as a knowledgeable industry player.

With its growing dairy business, its global sales and marketing footprint and its supply chain and risk management experience, Olam brings real strengths to our shareholder register.

For our part, the Company needs to focus on the value adding factors that are within our control in order to contribute as much shareholder value as possible. This is primarily around driving on-farm performance, both to achieve breakeven operational cashflow as soon as possible, and to lift net asset backing over time and therefore support a higher share price.

The Company’s monitor farms are our leading edge in this regard and we intend to continue to provide further information this year on their performance as a means to further build confidence in the NZ Farming Systems Uruguay model.

As you would expect there will be no performance fee paid to PGG Wrightson this year, as a share price of $NZ1.75 or higher in the last quarter of the 2008/09 was required before any performance fee would have been generated.

Outlook

I’ll conclude my report with some comments on the outlook for the Company’s operations and the global dairy markets.

As I mentioned, uncertainty remains over milk prices however expectations are for gradual improvement over the course of the coming year. It is likely that the next 12 months will continue to be difficult although supply should continue to fall through cow culling and farm closures around the globe leading eventually to a supply/demand situation similar to that of two years ago. Recent Fonterra auctions reflect this likelihood.

The Company expects its milk production to nearly double this financial year and the development of the farming infrastructure to continue at a measured pace. Operating expenses will be tightly managed in accordance with the operating environment.

The Company believes that sound progress continues to be made in developing the Uruguayan dairy enterprise. Whilst the unprecedented operating conditions have delayed progress, confidence in the vision to establish a competitive business based on highly productive pasture and genetically superior milking cows remains high.

We have worked very hard despite all the external factors to develop our farming team, and I believe we have been successful with a step change in the capability and experience of the team during the year and a high level of motivation for the future.

Despite the tough conditions this year, there are a number of bright spots within the 2009 result, and for the future. Our first bond issue has provided good confidence around the ability to access the required development funding, we have seen solid pasture performance on the small irrigated area on the Monasterio demonstration farm, we have made good progress in reducing our farm operating costs, and international dairy prices appear set to consolidate at better levels over the coming months.

On this basis, I look forward to reporting more positively next year.

Balance of agenda

I will now make some remarks about other items on the agenda and other Company issues.

Let me deal firstly with the “fudge issue” which you will all know about after extensive media coverage.

There is no question that we take our compliance and reporting obligations most seriously. The “fudge” issue was an administrative error and an error of judgment which we regret but we also believe it was disproportionately treated by certain media. The Board has investigated the matter and is satisfied that it is an isolated incident that will not occur again with appropriate checks and controls now in place.

Having said that we certainly regret the negative impact the matter caused.

I can also advise that the Securities Commission has confirmed it intends to take no further action, having completed a review following referral of the matter by NZX.

Performance fee

The performance fee of $NZ 17.8 million due to PGG Wrightson has yet to be paid. We plan to pay the fee in cash to PGW at the expiry of the loan agreement at the end of March 2010. It is our intention to pay it from a combination of banking arrangements and asset sales.

Fund/farm management contracts

The PGG Wrightson Board and Independent Directors of NZFSU have just concluded changes to the Fund Management and Farm Management agreements with NZS. The discussions were initiated by the Independent Directors within the terms of the original agreement, and incorporate feedback from institutional investors and the Uruguayan bond-holders on certain key terms. We believe the changes will be to the benefit of all stakeholders.

In addition to merging the two agreements, PGW will:

- reduce the management fee percentage from 1% to 0.75% for gross assets above $US400million;
- accept shares rather than cash for any future performance fee payment;
- remove the ability to charge an additional margin for Farm Management;
- include a management performance review clause, including the ability to terminate the agreement for non-performance; and
- any agreed farms sold and managed under a sale and leaseback arrangement would incur a reduced management fee of 0.5% of farm value.

In exchange, NZFSU will extend the Farm Management Agreement to align with the Funds Management Agreement. We believe this is an excellent outcome for the Company, particularly when remembering the reduction in the management fee from 1.5% to 1% from July 2008.

NZX Regulation has indicated that it will grant a waiver of the application of Listing Rule 9.2.1 in respect of the requirement to obtain approval from shareholders to the variation of the Farm and Fund Management contracts. The variations to the Farm and Fund Management contracts remain subject to receipt of the formal waiver which is expected to be received today.

Director elections

As you will know from the notice of meeting, we have before the meeting a resolution to elect as a Director of the Company, Paul Grogan who has been nominated by ST and CJ Bell Limited.

Paul Grogan is not currently a Director of the Company but is eligible to stand and, if elected, would qualify as an Independent Director.

You will find details of Mr Grogan’s biography in the Notice of Meeting.

As also outlined in the Notice of Meeting, the Board is currently undertaking a process to review the required skillset and succession planning, which is expected to be completed in the near future.

On this basis, the Board prefers to complete the review process and then consider candidates. It therefore does not support the resolution to elect Paul Grogan, but will be adding his name to the list of potential candidates.

Farm development and NZS business model - learnings from progress to date

So what have we learnt from the difficulties of the past year?

On reflection, and in the context of relatively easy capital availability and significantly higher dairy prices at the time, land acquisition to build up a land bank was the best strategy when we first started. It’s true to say, however, with much lower dairy prices and the global financial crisis, we would obviously prefer to have had more-developed farms, which would imply a smaller landholding. Clearly, this is consistent with the limited sales of less-developed farms that we have made recently.

On another matter, we clearly would have liked to have had more irrigation in place – however we would still have had constraints around getting infrastructure in place. Again, with the benefit of experience of drought conditions, we would have done some things differently.

I think the third observation I would make is about the challenges we have encountered in adapting the NZ model to Uruguay. It is proving more complex and difficult than originally anticipated. Although we anticipate it will take longer than expected to achieve the target productivity, we are making solid progress towards those targets.

I now invite Michael Thomas to give an overview of the operations.



Michael Thomas

Good morning.

I can certainly endorse the Chairman’s remarks about the state of the operating environment and the effect it had on the business. It was a tough year, with a number of uncontrollable hurdles which added to the challenges of getting our business established. After the solid start of the previous year it was disappointing to have to confront such a negative combination of factors so early on in the Company’s history.

It is, however, with some satisfaction that I can report that we have been able to make steady progress on developing the business despite the very troubled times.

A year ago we saw 2008-09 as a time for putting the building blocks in place – developing the farms and infrastructure and building a management team well-equipped to run the business. We set challenging development targets, which we made progress on despite the influence of unexpected forces.

The foundations are solid, and we have added further to these foundations during the year as I will now outline.

Slide – NZS to date

To recap on the company’s history. – NZFSU was established in 2006 and the current land-holding stands at 35,500 hectares.

We are now just over two years into the farm development programme, and although the ramp-up of milk production has been slower than we would have liked, the farming operations are gathering momentum even in the context of the difficult climatic conditions we have experienced.

NZFSU is now the largest milk producer in Uruguay and all of the milk we produce is sold to Conaprole. We continue to have a very positive relationship with Conaprole, working closely with them on long-range capacity planning to ensure there is adequate processing capacity for our milk in Uruguay. Importantly, we believe the milk price we receive is consistent with returns we should expect from an efficient processor given world market prices.

We currently expect to complete our farm development by mid 2012 and thus reach our full production capacity in the spring of 2013, subject to accessing sufficient funding and assuming reasonable climatic conditions.

This year has without doubt been a very difficult year, with major short-term impacts overshadowing the progress we continue to make towards longer term goals.


Slide – farms map

This slide shows the location of the Company’s farms, with the larger concentrations in the Centre and East of Uruguay, and the original farms in the West.

Slide – full year overview

I’ll briefly cover the key highlights for the year.

During the year we commissioned 15 milking sheds bringing our total now to 26 in operation.

We have had three material negative impacts – the worst drought in Uruguay for decades; the global financial crisis making it very difficult to access development funding; and dairy prices halving during the year.

As a result the Company has recorded an operating loss which was in line with guidance previously issued in April this year.

In hindsight, the challenges of adapting the NZ pastoral farming model to Uruguayan conditions have proven more complex and difficult than was anticipated at the outset. We recognise that there are still hard yards required to achieve what we believe is possible, and some of the original targets are still some way off.

However there were a number of bright spots within the result as touched on by Keith, such as:

- Our first bond issue, which closed very successfully in July, providing good confidence around ability to access funding required to complete farm development.

- The 70 hectares of irrigated pasture at Monasterio demonstration farm performed pleasingly during the drought, with strong pasture growth and durability of the pastures.

- International dairy prices now recently starting to bounce back, although we do anticipate ongoing volatility.

- We have worked very hard despite all the external factors to develop our farming team, and I believe that we have been successful, with a step change in the capability and experience of the team during the year, and a high level of motivation looking to the future.


Slide – key financials – P&L

Revenue for the year more than doubled to $15.8 million, made up of milk sales of $10.0 million and livestock sales of $4.3 million, together with rice sales of $1.5 million.

Livestock physical changes, which is the births, natural weight gain of the livestock herd, less losses such as deaths, generated income of $6.2 million, which is non-cash income.

Farm working expenses were $22.7 million, depreciation $2.4 million, and overhead costs $4.1 million.

The operating result before fair value adjustments was a loss of $15.6 million. This was in line with previous guidance of “about $20 million”, which included a livestock writedown at the half year of $4.5 million.

We have separated out fair value adjustments in order to avoid distorting the underlying operational result. The fair value adjustments comprise mark to market adjustments for our farms (writedown of $3.6 million) and our livestock herd (writedown of $20.2 million). These adjustments are based on the independent valuations of the farms and livestock herd at June 2009.

- Independent farm valuations have been carried out. Three of the farms increased in value slightly – in the west of the country, whilst the centre and eastern hub farms generally reduced in value by single digit percentages after allowing for the development spend during the year. There was a total reduction of just over $16 million following last year’s increase of nearly $32 million. Where individual farms had insufficient revaluation reserve from the prior year, this writedown has been charged to the Income Statement, which is the $3.6 million included as part of the fair value adjustments. Where there was sufficient revaluation reserve, the writedown has been charged against the revaluation reserve.

- Livestock – the herd was valued at year end. There has been significant movement in livestock values, with a large overall reduction as also seen in NZ. For example, milking cows were valued at $1300 per head last year, fell to under $200 at the height of the drought, before recovering to about $740 at year end. Although we are required under International Financial Reporting Standards to adjust the entire herd to market value, this will result in an ongoing distortion to the Income Statement each year, and is somewhat academic as we have no intention to sell material numbers. For this year there is a writedown of $20.2 million, in contrast to an increase of $14.3 million last year (which was off a smaller number of mature animals), illustrating the material movements that can and will continue to be experienced.

The net loss after tax for the year was $45.9 million.


Slide – key financials – farm working expenses

Year on year, farm working expenses have increased but by a smaller amount than the increase in milk production and number of milking sheds. This is due to two factors – firstly we have focused on very tight cost control in the context of low dairy prices and the drought, and we have achieved some economies of scale.

By way of example, in the last six months to end of September this year we have had the same level of operating expenses as in April to September 2008, but that is with almost double the number of milking sheds in operation, and more than double the milk production.

On the flip side, the drought increased supplementary feed costs and pasture maintenance expenses.

Slide – key financials – operating cashflow

Operating cashflow was negative as expected during the year. As milk production continues to increase, we are moving closer to a breakeven operational cashflow although if current milk prices of around 20c per litre were to prevail we would still anticipate up to two years of operating cashflow losses.

Slide – key financials – balance sheet

As I mentioned, the land and livestock have been revalued, resulting in writedowns of around $16 million and $20 million respectively. The property, plant and equipment has continued to increase year on year with development spend.

During the year we eliminated the previous back to back funding arrangement of $96 million, which has therefore reduced the reported cash assets and liabilities.

Net asset backing now stands at $NZ1.06 per share based on the June asset valuations and June exchange rate of US 65c to the NZ dollar. At the current exchange rate, it is 94c.

Slide – livestock

Our livestock herd has evolved this year with numbers increasing slightly, but with a larger number of more mature dairy animals and fewer beef cattle.

In-calf percentages have been lower than anticipated in our North American Holstein herd – but we expect improvement over time with increasing New Zealand genetics . It remains a key management issue.

Briefly on calf rearing – this year we have trialled mob rearing the calves in the west, which has been successful, and we also intend to use smaller guachera (traditional calf rear) groups in future. We intend to roll these initiatives out this year.

We experienced higher than acceptable levels of lameness with some new dairy conversions.

This is caused by – a high percentage of first-time milkers that are not used to walking to milking sheds, new farm races (which soften over time as the material beds down and manure is deposited) and farm race material (we have made some changes to materials to reduce the issues).

We consider these are first year issues (New Zealand dairy conversions typically also experience these issues) and other than the changes we have made to farm race material, there is no further action required.

Slide – operating conditions

As previously commented on, the year has been difficult, with a positive start quickly reversed by drought conditions.

Irrigation has been delayed by: lack of funding; the timelines required to implement electricity infrastructure; and a lack of water in dams until rains in the autumn.

We are however pleased with the irrigation performance on Monasterio demonstration farm, which had 70ha irrigated for much of the year other than late spring.

Slide – milk production

This slide shows the month-by-month production figures for the year.

Milk production has increased substantially year-on-year as new milking sheds come online, with the first quarter of the new financial year continuing that trend.

Milk productivity - productivity per cow in 09/10 is likely to be in line with last year. Productivity per hectare should continue to lift as irrigation expands, and as soil fertility increases and with a subsequent lift in stocking rate.

Initial target productivity of 940 kgms/ha on average is still some way off – we anticipate that target will be achieved in the 2013/14 year across the farm portfolio. However, I stress that is the average which does hide the very real progress on more developed farms. A long tail, particularly in the quality of our herd, tends to distort averages, and we are developing reporting metrics that better reflect progress and performance over the coming year.

As an example, for the first quarter of the new year, productivity per cow and per hectare is in line with last year, but those farms in their second or subsequent years are tracking ahead of last year as you would expect.

Slide – rolling 12 months milk production / farm working expenses

This slide shows a rolling 12 months to date milk production and farm working expenses, starting with the 12 months to June 2008. It highlights that the increasing milk production is being achieved more efficiently, with farm working expenses for the rolling 12 months prior, being steady since January 2009. This has been achieved through careful cost control, as well as economies of scale and some reduction in input costs such as fertiliser now starting to benefit us.

Slide – key operational statistics

I’ll now look at some of our key operational statistics.

It’s good to see that productivity is increasing – milk production per cow and per hectare have both lifted over last year’s figures, despite the impact of adverse climatic conditions.

We anticipate continuing progress towards the steady state productivity targets, although step-change increase in productivity per hectare will only come with further irrigation.

Funding was constrained during the year, however we have still made significant advances in commissioning milking sheds and as a result increasing the milking herd.

The herd profile has matured over the year – although total numbers are only slightly above the previous year, this includes many more milking cows, and more mature animals - heifers rather than heifer calves. There were fewer beef animals as we focused on dairy, and sold some beef animals during the drought in order to dedicate available feed to dairy animals.

Slide – development status

This slide summarises the way farm development continued during the year.

There have again been impressive advances in the development during the period, despite funding constraints.

The total investment was $28 million. The majority of farm infrastructure is now in place; around half of the milking sheds are now built, but significant further investment is still required in irrigation and electricity. As mentioned we are working with Government authorities on electricity installation.

The funding from the bond issue has allowed us to advance with this project.


Slide – productivity – monitor farms

On our demonstration monitor farms, there has been solid progress made towards steady state targets, which has provided confidence in the original model.

The figures quoted on the slide are for total milk production and pasture growth on the two monitor farms – Monasterio and Menafra. For Monasterio they include about 20% irrigated area and 80% non-irrigated. For Menafra this includes irrigation on 50% of the dairy area from autumn onwards – prior to that the newly constructed dam had not filled up because of the drought.

Milk production this year was
- 320-340 kg MS per cow
- 680-700 kg MS per hectare
- These figures are substantially ahead of the average of all farms, which is around 290 kg MS per cow and 420 kg MS per hectare
– For the first quarter of the new year productivity per cow and per hectare average of all farms is in line with last year, whilst those farms in their second or subsequent years are tracking ahead of last year

Slide – productivity – monitor farms (contd)

Pasture growth on the monitor farms this year was
- Around 9 mt of Dry Matter per hectare on non-irrigated land –despite the impact of severe drought
- Around 15.5 mt of Dry Matter per hectare on the small irrigated area at Monasterio

Both figures are not yet at our steady state targets. However we are confident that further improvements can be achieved through increased irrigation, improved pasture productivity and soil fertility.

We have also seen pleasing pasture durability under irrigation at Monasterio, with good clover content evident, which helps to increase nitrogen levels in the soil.

Slide – productivity - irrigation

Irrigation installation has been slower than originally anticipated but is expected to advance steadily in the next 12 months.

We currently have around 400 hectares under irrigation, and with the bond issue funding we are completing the commissioning of a further 1,200 hectares so that we expect around 1,600 hectares will be irrigated for this coming summer.

The bond issue allows the electricity infrastructure project to move ahead, and pivots for a further 1,600 hectares to be purchased. Due to installation timelines on the electricity project this irrigation won’t be available until the summer of 2010-11.

We have undertaken a feasibility study that shows our original projection that 30% of the land could be irrigated, which is about 10,000 hectares, remains achievable and financially attractive.

The majority of farms in East have access to the India Muerta dam, with good availability of water.

Other farms in the Centre and West depend on their own dams, however design specifications indicate that there will be enough water available for the levels of irrigation desired.

Slide – funding the NZFSU model

Cashflow from operations has been negative due to low milk prices; the drought impact; and the company still being at an early stage of development in terms of productivity.

However, the bond issue is a positive signal in terms of the Company being able to access the development funding it requires to complete the farms.

I’ll briefly recap on the key terms of the bond issue, which were outlined in the market update issued at the end of July when the bond offer closed.

The bond offer obtained an investment grade rating of A- (Uy) for the bonds with repayment secured through the assignment of part of the company’s milk revenues and security over some of the company’s farms, to a trust on behalf of the bond-holders.

The bonds’ interest rate and repayments were designed to align to the company’s cashflows, with an interest-only period until March 2016, a fixed interest rate of 5% until September 2010, and thereafter a variable interest rate intended to match company profitability.

The variable interest rate has a minimum of 5% per annum and maximum of 15% per annum. It will be set annually, using the prior year’s actual milk revenues (ie both volume and price), and a cost index calculated using external references for the key farm inputs, which are urea, fertiliser, diesel, Uruguayan wages index and Uruguayan inflation. These indices are relative to the base year of 2007/08.

If milk production or price increases faster than we anticipate, or costs are lower than we anticipate, then the company will be more profitable – but the interest rate will also be higher. In this way the bond-holders are partners in the success of NZFSU, but in return they are also assuming some downside risk.

NZFSU also has the option to redeem the bonds at any time after January 2018, although they are expected to be in place for approximately a 15 year period.

Slide – funding the NZFSU model (contd)

As the Chairman mentioned, we anticipate between $50 to $60 million further development funding on top of the first bond issue. About half of this money is expected to come from a further bond issue of around $30 million, with the remainder from outright sale or sale and leaseback of certain farms, or other funding arrangements.

In that regard, we will shortly settle the sale of the Casupa farm in the Centre region. At just under 2,000 hectares, this undeveloped farm has been sold for $3,500 per hectare, which is marginally lower than the latest June 2009 valuation. We also sold an 800 hectare farm in June 2009 at valuation (and above the original purchase price).

We continue to focus on tight cost control as we work to get the Company to a breakeven cashflow position as soon as possible. If milk prices around 20-21c per litre were to prevail, we would expect to require around $20 million to fund operations over the next two years in addition to the development spend, with this money to come from banking arrangements or asset sales. Recent moves in international milk powder pricing would suggest that is a conservative scenario.

With the share price currently well below net asset backing, and confidence in the ability to earn good returns on these assets, the Board and management consider it more appropriate to raise funding via a combination of debt and asset sales, rather than equity.

Slide – competitive advantage

I’d like to recap on the competitive advantage we see in NZ Farming Systems Uruguay. The completed development of Company’s farms is expected to remain around $3,500 per hectare. Combined with the low original investment in land acquisition, the total investment for a farm with 60% dairy area and 50% of that with irrigation is expected to be around $6,300 per hectare, or around $NZ 8,500 per hectare at the current exchange rate.

A further source of competitive advantage is expected to come from low farm working expenses. The production cost per litre is expected to fall rapidly as milk production increases and costs are tightly managed. As a comparison (and I note that it’s conservative and not strictly correct to divide total dairy and dry stock expenses by milk production, but to illustrate the trend and given that dairy production is the primary objective), cost per litre is expected to fall from last year’s 51c per litre to around 27-30c per litre in the new financial year, with a steady state figure expected to be between 10 and 15c per litre, as we achieve both economies of scale and as the current high level of dry stock activity falls as a percentage of the total.

This level of spend will be competitive or better than even pasture-fed regimes such as NZ, let alone grain-fed such as the US or Europe.

Slide – market conditions

The 2009 year saw a reversal of the previous excess of demand over supply in international dairy markets.

Growth in consumer demand still remains somewhat weak, although there are some signs of gradual recovery in Asian and Middle Eastern markets, which are key importers of dairy products.

Current milk prices in Uruguay are lifting from their lows, with 22c per litre at the farmgate in September, equivalent to around $2,300 per tonne for wholemilk powder or around $NZ 4.35 per kg of milksolids, just under the current Fonterra milk price forecast of $NZ 4.60 per kg of milksolids excluding distributable profit.

A reduction in supply in response to lower prices has taken some time to appear, but is now evident, particularly with US cow culling – the US is likely in 2009 to have slightly lower milk production than 2008, which is the first year on year fall for many years.

US and European marginal dairy production is clearly uneconomic, even at current prices so we anticipate ongoing supply weakness.

The conditions are thus set for international dairy prices to sustain their move higher. We have seen the first positive indications in the last month or two, but remain cautious in the outlook and expect ongoing volatility.

Slide – immediate priorities

I’ll finish by looking at our priorities for the current year.

Not surprisingly, our target is to maximise milk production from available feed:

We will maintain our appropriate tight control on spending.

We will undertake a programme of targeted development funded through the $30million bond issue. This development will include:
- building a further five milking sheds taking the total to 31
- advancing the electricity infrastructure project and installing additional irrigation as mentioned.

We will continue to advance debt funding initiatives, with a further bond issue and other funding likely during the second half of the 2009-10 year.

Once that is obtained we will be in a position to complete the majority of development.


Slide – outlook

We have been anticipating that international dairy prices would sustain their move higher – but with ongoing volatility. It is pleasing to see that realised over the past six weeks.

Conservatively we are forecasting prices near current milk levels for at least this financial year, although in reality, we would expect improvement from the recent international market uplift to flow through.

Although in the uncertain environment it is very difficult to provide guidance, we do anticipate milk production to nearly double to around 80-85million litres, with the milking herd expected to increase to around 18,000 animals by June 2010, and the 5 new milking sheds funded by the bond issue likely to be commissioned in autumn 2010.

Whilst we also expect operating losses and an operating cashflow deficit this year, based on current expected milk price, the reality is that with a fully developed capital cost below New Zealand equivalents, and an ongoing operating cost below the level at which world supply can meet world demand, we remain well placed to generate solid returns on investment.

Slide – summary

Despite difficult conditions both globally and climate-wise in Uruguay, the results and progress achieved indicate our value proposition remains attractive – to be an internationally competitive dairy farming enterprise through low cost operation, and superior pastures and milking cows.

The global dairy market is likely to return to an excess of demand over supply in the medium term

And the development risk is now largely behind us.

We believe the combination of Uruguayan and New Zealand ideas we’ve put in place and the progress we’ve made, are positioning us very well for a successful future.


I trust this summary has provided you with a current view of the Company’s progress and an insight on where we are going.

We look forward to the future and maintain our confidence that the business is destined for success.