Financial performance of the forestry sector
The financial performance of the New Zealand forestry sector is comparable across two dimensions. It can be compared relative to other sectors in New Zealand, and it can be compared relative to forestry sectors in other countries. In both instances, a sectoral comparison is fraught with difficulty, since relative profitability is dependent on the choice of pricing points across time, as well as specific niches companies operate in, quality of management in individual companies and the host of accounting devices that impact on declared profits.
In general, the broad measure of relative profitability is the internal rate of return on investment. If all investment decisions were left entirely to free-market forces, investment decisions would be made according to comparisons of competitive advantage, which would be consistent with relative returns on capital. In the real world, however, investment decisions are significantly more complex and are affected by a number of intangible factors. These include, imperfect information, the presence of non-financial costs and benefits, and government interventions. Thus, internal rates of return provide only a very broad measure of the relative profitability of an investment – although they are generally accorded significant weight in investment decisions.
It is far beyond the scope of this study to investigate the relativities of international forestry and cross-sectoral IRRs. There are, however, some useful surrogates that point to the relative financial performance of the forestry sector in New Zealand – as well as some broad conclusions on cost comparisons that can be drawn.
In terms of comparisons with the financial performance of international wood processing sectors, the key factors for consideration are the relativities in input prices such as log costs, labour, energy, costs of capital and plant, as well as the costs of transporting products to markets, market prices and exchange rate relativities. Many of these factors are addressed in Part II of this report, and this analysis shows clearly that New Zealand is broadly competitive across all spheres. In some countries logs are sold at a subsidised discount, energy is subsidised, or labour is cheaper. There is not, however, a coincidence of factors in any one country that makes wood processing in New Zealand financially uncompetitive – particularly when shifts in the NZ$/US$ exchange rate during the past 5 years are taken into account. What does, of course, have to be taken into account is that radiata pine is generally a relatively low value end-use species, and thus returns for an equivalent degree of processing relative to, for example, Douglas-fir, will be lower. In general, then, we could conclude that New Zealand’s major challenges with competitiveness are at the market end – in terms of costs of delivery to specific markets, the relative price of our product, and the exchange rate effect on returns. In financial performance terms, there is currently little reason to suspect that returns to New Zealand wood processors are lower than general international norms.
In New Zealand, however, recent cross-sectoral comparisons of financial performance appear to be less favourable. Probably, the best indicator of sectoral financial performance, given public-domain information constraints, is the relative performance of the publicly listed forestry companies, Carter Holt Harvey and the Fletcher Group. While using these companies as a benchmark for national sectoral performance is fraught with difficulties relating to distinct financial situations, management performance, and product mixes, these companies constitute a significant proportion of the forestry sector, and if they are performing poorly, then the sector surely cannot be in robust health. And in general, the performance of these companies relative to many other major New Zealand corporates has been modest.
Figure 7 for example charts the course of the Fletcher companies’ share-prices relative to the NZSE40 market average through the period March 1996-September 1999.
Figure 7: Indexed Share Performance Fletcher Forests (100=price at January 1998).
Source: ABN Amro
Figure 7 shows indexed Fletcher stocks have significantly under-performed the market average during the past three years. Fletcher Forests shares and the NZSE40 are assigned indexed values of 100 in January 1998. Thus the divergence between the two lines in September 1998 is representative of a modest decline in the indexed value of the NZSE40, compared with a larger decline in the Fletcher share. The convergence of the two lines through most of 2000 is indicative of a relatively stable NZSE40 around the 100 index value. Essentially, the advent of the Asian crisis pushed the indexed Fletcher stock below the market average, and it has remained significantly below the market line since. In the 1999 Fletcher Forests Annual report CEO Paul Fowler noted:
The first six months of the year saw a continuation of falling commodity prices as a result of the Asian downturn, with log prices reaching 20 year lows in the second quarter…. Prices have since retrenched to the lows experienced earlier in the year as suppliers rushed in to take advantage of the upturn. …The market downturn has highlighted the urgency with which we must continue to pursue our long-term strategy to migrate our business from commodity logs and lumber to high value solid wood solutions, which meet the needs of our customers. …. We’ve also continued to drive down costs and improve productivity.
Carter Holt Harvey’s recent financial performance has also been relatively weak compared to the top performing New Zealand companies. For example, the return on average shareholders' funds during the past five years has averaged 4.6 percent, with a high in 1996 of 9.3 percent and a low in 1999 of 1.3 percent. By comparison, for example, Baycorp Holdings has averaged a 37.8 percent annual return on shareholder funds during the past 5-years. CHH Chairman Sir Wilson Whineray noted in the company’s 1999 Annual Report,
"the closing years of our first century have been difficult. We have not achieved an acceptable financial return and this has impacted on our ability to increase Shareholder value."
Figure 8 charts the Carter Holt Harvey share price performance during the past 3.5 years. This share has also under-performed the market average for most of this period, apart from a period of resurgence in late-1999.
Figure 8: Indexed Share Performance Carter Holt Harvey (100=price at Jan. 1998)
Source: ABN Amro
Sir Wilson noted that,
"The most pressing issue was cost competitiveness. In recent years we have experienced severe price downturns for all of our products. Some are market-related reflecting cyclical oversupply of products such as logs, pulp and paper in the international market and the uncertain position of customers in markets such as Asia. Others are structural, reflecting changed circumstances, like the removal of tariffs in the New Zealand market which, together with increased competitive pressures, triggered $100 million in price erosion for the packaging industry….The speed of this change meant the market competitiveness of our products became increasingly difficult to maintain.
Both Fletcher Forests and Carter Holt Harvey clearly note their susceptibility to changes in commodity prices, and the need to drive costs ever lower to retain price competitiveness. The interview process reveals similar sentiments throughout the industry. The wood processing industry is one of highly competitive markets and tight margins. In good years, processors can earn good returns if they do all things well. There are, however, fairly narrow margins for error and the volatility of markets means prospects are never stable. At the same time, because primary forest products markets are largely commodity markets, all participants are aware that price is a key competitive factor. Thus, all participants are bound to efforts to maximise efficiency and minimise costs – and consequently, competitive advantage in terms of price is likely to be transitory at best.
Contact for Enquiries
Rural Affairs Coordinator
Sector Performance Policy
MAF Policy
Ministry of Agriculture and Forestry
PO Box 2526
Wellington
NEW ZEALAND
Phone: +64 4 894 0675
Fax: +64 4 4 894 0745
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