Old-fashioned set-up has last laugh when the tough times hit

BY ROB O'NEILL

The conservative approach of the co-operative model proved wise business when the downturn hit.

It isn't just New Zealand's banks that have stood up well during the global financial crisis.

Finance companies have collapsed horribly, private equity darlings such as Yellow and Media Works are struggling under immense debt burdens and the likes of Feltex have failed, but one sector that has barely missed a beat is the up to 22% of our economy generated by co-operative businesses.

Sometimes criticised for being inefficient and outdated – and even socialist – they admit to being conservative and "prudent".

"All through the financial crisis, co-operative businesses continued to strengthen and grow," said NZ Cooperatives Association chairman Peter Macdougall.The sector not only boasts New Zealand's biggest company, Fonterra, and other dairy and meat businesses that are the backbone of New Zealand's export industries, but other large enterprises such as supermarket operator Foodstuffs, retailers such as mobile phone chain Orb Communications, Plumbing World and Interflora. Agricultural suppliers such as Ballance Agri-Nutrients and Ravensdown Fertiliser feature alongside packing houses such as EastPack and Fruitpackers (HB) Co-operative and growers such as NZ Hops, honey producers and blackberry growers.

Paper Plus, Mitre 10, ITN, Buildlink... few economies are as dependent on co-operative businesses as ours.

Cooperatives Association executive director Ramsey Margolis says about half of the local co-ops are agricultural. The rest are in a wide range of industries, including retail, financial services, community co-operatives and even in the motor trade.

"Co-operatives are not profit maximising entities," Margolis said. "They are set up to maximise the profits of their members. Co-ops do not take unnecessary risks. They are there to serve the members' needs.

"We are quite conservative organisations. We have this image of being radicals or revolutionaries, but the opposite is the case."

Overseas, the co-operative model is thriving too, though some building societies did collapse in the US. Among the big names built on co-operative structures is Rabobank, ranked among the 10 safest banks in the world.

Some co-operative banks have even picked up the pieces of failed US multinationals. Credit Mutuel CIC, France's second-largest retail bank, bought Citigroup's German retail operations for 5.2 billion ($9.5b) in 2008.

There are even moves to "remutualise" some institutions. Northern Rock, the bank that first signalled problems with the UK's financial system during the global crisis, used to be the Northern Rock Building Society. It was demutualised and listed on the London Stock Exchange in 1997 before being nationalised in 2008 after it failed.

Now there are serious voices suggesting it and other failed banks should be remutualised, though the process would be complex.

Co-ops can be really simple. Take the Capricorn Society, a buying co-op for the automotive trade, which has a simple $1-in, $1-out share structure to participate and leave.

The co-op was formed in 1975 and now has a turnover of around $1b across Australia, New Zealand and South Africa, says Russell Green, the society's New Zealand chairman.

Capricorn delivers "power in numbers" allowing small member operators to wield their collective buying power, offer credit, simplify accounting through providing a single invoice and offering rewards points.

Green, who operates a mechanical repair business in Puhoi, north of Auckland, says Capricorn has just launched its own general insurance mutual for members, offering general insurance at discounts of 20% or more.

More complex is a co-operative such as EastPack, a grower-owned kiwifruit packing operation based in Edgecumbe, in the Bay of Plenty.

EastPack, which reported $56 million in sales in its 2008 financial year, is a hybrid co-operative, director Adrian Gault explained.

In agriculture, a traditional co-op is one where the grower or supplier has a stake equivalent to the level of their supply to the co-operative. So, if a kiwifruit grower supplies 10,000 trays of kiwifruit, they would be required to have 10,000 transactor shares, the value of which is set by the board.

"A hybrid co-op can take several forms, but essentially is a variation of the traditional co-op structure that allows a second type of share, an investor share," Gault explained. "In EastPack's case, the investor shares are optional, and can only be purchased by transactor shareholders at a ratio of four investor shares to one transactor share."

Investor shares carry 40% of voting rights and trading in them takes place on the Unlisted market with prices set by the market. Transactor shares receive rebates while investor shares receive dividends.

So what are the advantages and disadvantages of the co-operative model?

David O'Reilly, chief financial officer of Tauranga-based Ballance Agri-Nutrients, said good co-ops are no less commercial than any other business. A real strength of the structure is a close link with shareholders.

"The shareholders are our customers," he said. "There's a direct one-on-one relationship."

That means increased customer loyalty and immediate feedback on issues and performance.

It's a view shared by Mike Whitty, acting CEO of the Ravensdown fertiliser co-operative, based in Christchurch. Customer intimacy is built into the structure of agricultural co-operatives, he said.

"If they are run efficiently, shareholders, as well as customers, benefit."

Another benefit is that co-ops can take a slightly longer-term view of business strategy than a company subject to the whims of the sharemarket, O'Reilly said. Boards are focused on maintaining the company for future generations and not just on what is happening today.

There are weaknesses, however. O'Reilly and Whitty agreed that co-operatives rely on maintaining a strong capital base, especially when markets are highly seasonal.

"They generally run a slightly more conservative balance sheet than other companies to cover unforeseen circumstances," O'Reilly said.

With constant pressure from shareholders, co-operative managers need to keep a close watch on how much profit is distributed, he said. A few bad years can see gearing increase to unacceptable levels.

Whitty said a strong balance sheet had stood Ravensdown in good stead over the last 18 months of difficult trading.

This is especially important for "input" co-ops, those like Ballance and Ravensdown that sell supplies into their shareholders' businesses. Such co-operatives don't control their shareholders' finances in the way Fonterra, an "output" co-operative that sells its shareholders' produce, can, Whitty said.

For EastPack's Gault, the use of investor shares enables extra capital raising and investment while keeping investment closed reduces any risk of takeover.

But perceptions that a co-op can have trouble raising capital are unfounded, Gault said. "Co-ops are as bankable as any business with a good balance sheet and good business plan."

Grower directors have "skin in the game" and independent directors can be appointed to bring extra expertise to the board.

A risk is that the co-operative has to be able to redeem transactor shares if a grower leaves the business.

EastPack, Gault said, has a vision of "world class from orchard to market". The co-operative has invested heavily in new technology and equipment and in adopting and training staff on "lean manufacturing" culture.

"These factors will drive quality and productive efficiency throughout the co-op which in turn will result in better orchard gate returns, rebates and dividends to its shareholder members," he said.

"Like any business, the strength lies in the governance and management of the operation. Maintaining good business disciplines is fundamental regardless of the business's structure. With co-ops, the shareholder is directly affected by its business performance, there is no place to hide for the directors if the co-op performs poorly."

TOP CO-OPS

Six New Zealand co-ops made the International Co-operatives Alliance's top 300 list

1. Fonterra2008 Rank 31

2. Foodstuffs (Auckland) 2008 Rank 135

3. Foodstuffs (Wellington) 2008 Rank 178

4. PPCS (now Silver Fern Farms) 2008 Rank 182

5. Foodstuffs (South Island) 2008 Rank 191

6. Alliance Group2008 Rank 280

BALLANCE HOPES TO RETURN TO PROFIT IN 2010

Fertiliser co-op Ballance Agri-Nutrients is battling volatile seasonal markets, but expects a much improved 2010 financial year, which ends tomorrow.

Despite boosting sales by 27% ($828 million) in the year to May 31, 2009, due to higher fertiliser prices, the company registered a $6 million loss before tax, well down on the $78m profit it reported in 2008.

Volumes shipped declined in the year by as much as sales increased, just over 27%, leaving the co-op with expensive inventory on hand when prices suddenly tanked at year-end.

The result: operating earnings of $30.6m and a stock write-down of $36.7m.

Chief financial officer David O'Reilly said seasonal patterns remain difficult in 2010. Farmers were cautious with purchasing early in the year, he said, but by this autumn had developed a better appetite to spend on "maintenance" fertiliser.

He said Ballance expects to post an improved result, mainly due to close management of working capital.

"Demand has picked up progressively and we are in good shape," he said.

2009 equity declined to 50%, at the low end of what Ballance considered acceptable, after bank debt grew by $160m, according to the co-op's annual report. The company now aims to restore that to around 60%.

Mike Whitty, acting CEO of the Christchurch-based Ravensdown fertiliser co-operative, described 2009 as "horrible", but the co-op still increased sales from $672.4m to $891.5m. Profit fell, but only to $36m from $41.7m.

Like Ballance, Ravensdown's 2010 year ends this month. Whitty, too, expects to report improved financial performance on the back of increased demand in the second half of the year, he said.

- © Fairfax NZ News