Agri-Food - Funding New Routes to Growth
EY partners Graham Reid and John Higgins interviewed agri-food companies and banks about how Ireland can maximise its potential in this expanding market, and ask is there a lack a funding that will potentially strangle this growth?
Ireland’s image is green. The image of Ireland as a producer of high quality food is priceless. Competitor countries envy the reputation that Ireland holds. Agri-food is Ireland’s largest indigenous industry, processing beef, pork, lamb, poultry, cereals, dairy produce, seafood,
prepared food, organic and other products. The industry employs more than 160,000, exports €10 billon’s worth of goods to more than 170 countries, and accounts for eight per cent of gross domestic product.
The potential for more growth is significant. Expanding markets in Asia and Africa, and the global growth of middle class markets is increasing the demand quality food, in particular protein based food, from trustworthy sources. This offers opportunities for growth in exports, helping Ireland to achieve a soundly based economic recovery. Some of this has begun already. China is now Ireland’s second largest dairy market, and third largest supplier of pork, according to Bord Bia. Bord Bia also announced recently that food and drink industry exports grew by nine per cent to €10 billion in 2013, with double-digit growth in dairy, beef and prepared foods. This positive result for the industry was delivered during a year which included challenges such as a fodder crisis and the horse meat scandal.
All sectors including meat and livestock (beef, lamb, pigs, poultry), prepared food, beverages, seafood, horticulture and cereals are expected to contribute to the delivery of the industry’s growth agenda. Most noteworthy is the dairy sector which is expecting to grow output by 50% following the abolition of EU milk quotas next year.
The 2020 Food Harvest Plan (FH2020), a blueprint prepared by the Department of Agriculture and Fisheries with industry input set demanding targets for growth in the decade leading up to 2020.
EY advise some of the key players and has advised on some of the most important transactions in the industry in recent years and therefore has a unique perspective on the agri-food industry. We have been talking to senior representatives from organisations and finance providers across the sector, to gauge progress towards FH2020. We have interviewed major actors, gauging progress towards FH2020 at the halfway point, in particular seeking to gain an understanding of the funding opportunities and growth.
Overall there is an acceptance that good progress is being made. However, challenges remain, and will require structural changes, continuing innovation and evolution of the sector. The general trend among producers in Ireland is to move away from commodity products towards value added and brand-centred products that focus on the requirements of customers in target markets. It is important these trends continue to help ensure that Irish produce earns premium prices so as to minimise the impact of volatile commodity prices.
Ireland has competitive advantages in food production, such as our grass-based cattle feeding, and a strong food brand globally. However the industry needs to continue to invest and drive efficiencies throughout the supply chain to ensure we remain competitive in the global market place. This will require sustainable investment in operational improvements, new capacity, sales and marketing, research and development (R&D), new products and exploring new markets.
Investment needs vary across the different sectors but the focus should be in the development of more efficient primary producers and processors. Examples of opportunities to increase efficiency in the dairy sector include increasing farm and herd sizes, consolidating existing processing capabilities and, where required, building greenfield and highly- efficient processing plants.
There remains strong rationale for the consolidation of the processing capabilities of the dairy sector. However arriving at a feasible structure will be complex and will take time. Glanbia’s proposed acquisition of Wexford Creamery, subject to Competition Authority approval, is an example of this consolidation process. The drivers for further consolidation may include farmers switching co-oper- atives as they seek to optimise their farm gate milk price, lack of processing efficiency, poor financial performance and a lack of investment, all of which are interconnected. This theme extends into the other agri-food sectors with the need to increase economies of scale and production efficiency to compete in the global market.
Given the current strength of the dairy sector, combined with the current high in international prices, there is evidence of farmers switching from tillage and beef to dairy farming to take advantage of the potentially higher return. This will increase supply in the market but the new dairy farmers may face challenges such as funding the cost of new facilities and plant, developing a new herd and delivering the required product quality and consistency.
To facilitate the sector to deal with these challenges the ability to access funding, right across the sector from farm to fork, will be vital.
At farm level
At farm level, the main funding requirements are working capital and capital expenditure (land, plant and machinery, farm expansion etc.) with an expectation that the funding will be split 50/50 between these two broad categories.
Banks continue to provide the main funding for primary producers, and AIB, Bank of Ireland and Ulster Bank, are lending to primary producers.
The graph on page 1 in the gallery illustrates total lending to the agriculture sector by BOI and AIB (based on annual reports) over the last few years.
This suggests that total lending decreased from 2010 to 2012, which anecdotally may be due to old loans being repaid quicker than new loans were issued. Both banks increased lending in 2013 which is in line with their aim to increase exposure to the industry. Our interviews suggest that bank funding is making its way into the industry at farmer level to support expansion, especially dairy farming given the current positive dynamics in that sector.
Typical offerings include working capital products, farm development loans and asset finance. Banks are offering tailored debt products, with an example being volatility -adjusted term loans for primary producers, where a higher proportion is repaid when milk prices are high, and vice versa. Banks reiterate the importance of a robust business case, strong repayment history and a carefully-planned funding structure with equity factored in. Our research indicates primary producers are - by and large - able to obtain debt-related funding from banks.
The FH2020 “milestone review” in 2013 suggests that primary producers have also used state-led initiatives such as Microfinance Ireland. Microfinance Ireland provides small (€2,000-€25,000) unsecured loans to viable businesses declined credit facilities by their bank, through the Micro-Enterprise Loan Fund.
As farmers take on debt, it is important that they do not over-extend, and that their financial position is robust throughout the commodity cycle. In particular given the current high levels of prices in the dairy sector, this has been highlighted as a concern. It is also important that funding is directed towards the most productive assets. For example farmers should beware of paying more than an economic price for land and perhaps focus on renting land and instead investing in required plant and stock.
At processor level
At processor level, processing and value-added food and beverage companies’ funding requirements not only include capital expenditure and working capital, but lso funding to deliver overseas expansion and mergers and acquisitions.
Banks are also the main funding source for these enterprises, with AIB, Bank of Ireland and Ulster Bank, lending across the spectrum from Small, Medium Size Enterprises (‘SMEs’) to large corporates, while international banks are also active in the sector, with a particular focus on the medium to large and export-led companies. Our interviews suggest that while funding may have been more readily available for larger corporates, a significant level of lending is being targeted right across the industry including SMEs.
There is a broad suite of banking products on offer. For larger entities there are examples of syndicated funding being utilised, typically with a mix of indigenous and international banks, to deliver competitive funding packages. For working capital funding the companies we interviewed are utilising a range of products from standard overdraft facilities to invoice discounting facilities. Invoice discounting can be an attractive funding source for companies operating in the sector given the often-seasonal working capital requirement. For export-led companies, trade finance and foreign exchange products are also important sources of finance.
Banks are reverting to tried and trusted lender criteria. These include a robust business plan, efficient working capital management, a strong management team, and a deep understanding of the financial performance of the business and the underlying asset base. The key metrics used for credit decision-making and covenant testing vary depending on the debt product. For cash flow based term loans, earnings leverage multiples are typically used and are monitored at different times in the year, so the efficient management of working capital for seasonal businesses in the industry is very important.
The government continues to play an important role in supporting the agri-food industry particularly through Enterprise Ireland with support for expansion, cost competiveness (Lean Offer scheme), R&D, marketing, management development and export development. The government also offers tax credits to agri-food companies with eligible R&D expenditure.
The state-led Credit Guarantee Scheme provides support where viable SMEs are refused credit by their banks due to perceived high risk or insufficient collateral. For a fee, the state guarantees 70% of the credit facility advanced to SMEs by participating banks (primary agriculture is excluded but downstream processing is eligible).
While banks continue to play a dominant role, for a sustainable financing mix, new funding sources and in particular equity funding will likely be required. This may require shareholder investment as well as equity from external parties. There are indications that other financial institutions and funds may introduce new capital to the sector, in the form of debt, equity (more likely for value-added food and beverage companies), or hybrid products. The Ireland Strategic Investment Fund has announced a panel of fund managers for a number of new investment funds, which have already received commit- ments from third party investors. This may indicate an increased interest in Ireland as an investment location.
Given the progress made to date, and what we learnt from our interviews, we believe that the agri-food industry is in a very strong position to meet and even exceed the already ambitious targets set for 2020.
Key priorities now need to include strong consumer focus and sustainable investment to achieve efficiencies, scale and innovative product development. The overall message we have received from companies and banks is that funding is available for enterprises of all sizes across the industry. It is especially important that adequate funding is accessible to primary producers and SMEs as they play an important role in delivering growth. Discipline is required, so that the industry remains financially strong through what can be volatile commodity pricing and to ensure that investments are made in productive assets. Independent advisors should be used to assist companies determine the optimal funding source and structure and deliver help competitive funding packages.
We believe this is a great opportunity capable of having a very positive impact on the agri-food industry in Ireland and on the Irish economy as a whole.