Chairman's report

 

The Year in Review

The Directors present the Annual Report for the year ended 30 June 2007. The trust’s financial result for the year ended 30 June 2007 is an audited surplus after tax of $3.3 million. This compares with $17.8 million achieved last year. The lower result this year is attributable to the understandably slower growth seen in the value of the Trust’s farm properties following the exceptional 86% ($75 million) growth in Trust equity over the last 5 years.

The Trust’s Net Asset Value increased to $3.46 per unit as at 30 June 2007 compared with $3.41 last year – a 1.4% increase.

Important features of the year were:

• Record dairy farm production of 1.5 million kilograms of milk solids.

• A higher Fonterra payout of $4.46 per kilogram of milk solids ($4.10 last year) resulting in an improved overall farm contribution.

• Lower product prices for sheep and beef affected the profitability of those farms.

• Waikoha Station in the Waikato (2,510 hectares) was directly farmed for the full year.

• Major development programmes at Eiffelton and Waikoha Station.

• Harvesting at Ngaruawahia forest temporarily ceased in December 2006.

The 2006-07 year was particularly testing due to combinations of severe weather events in some parts of the country and difficult economic conditions. Weather events ranged from floods in some areas, tornadoes in Taranaki, a very wet and cold winter and spring over much of the country, including heavy snow in Canterbury last winter, and a severe autumn and winter drought throughout the East Coast of the North Island. These hit hard on a rural economy already under pressure from the high exchange rate, lower meat and wool prices and rapidly rising costs .

During the year the rural property market - which had been buoyant for several years - slowed with a generally softer tone and fewer sales occurring. For the Trust this translated into property values remaining generally stable with only modest increases in value. Farm development, alternative land use and strategic location were the key value-moving considerations. The small overall increase in the value of the Trust’s farm properties at 30 June 2007 reflects the generally subdued tone of the rural property market which prevailed at that time.

A pleasing improvement in the contribution from farm operations has occurred this year. This was largely due to record milk production of 1.5 million kilograms of milk solids and an increased payout from Fonterra of $4.46 per kilogram of milk solids compared with $4.10 last season. The sustained rise in the New Zealand exchange rate over the last year impacted strongly on farm returns. Continued low returns for sheep meat and wool, combined with rising farm costs, negatively affected the profitability of our sheep and beef farms, despite good production levels being achieved.

Lamb prices this season averaged approximately $50 per head, which was similar to last year, but wool prices for crossbred fleece were among the lowest for two decades. A significant proportion of the fleece value is now needed just to pay the shearers. Fine merino wool fared better than crossbred with prices significantly higher than last season. Restricted farm profitability has impacted the capacity of sheep and beef farmers to absorb further costs, and in particular their ability to pay higher market rents.

Growth in the Trust’s rental income from its leased farm properties has therefore slowed. Rents for farms in the sheep and beef sector are now largely static although arable rents are still increasing. At the Ngaruawahia forest, harvesting operations ceased temporarily in December 2006 when the contract with the harvesting crew ended. A severe shortage of logging crews throughout the North Island meant that the crew was unable to be replaced with the result that no harvesting has occurred during the 2007 calendar year.

This plight affected many forest owners, not just the Trust. An area of 42 hectares, approximately half the expected area, was cut resulting in lower cash returns from the forest this year. Log prices improved through the middle of the year but have since fallen again as a result of soft export markets and high shipping costs. At this time last year there were some welcome signs of upward movements in log prices but this is not the case this year with forestry returns expected to remain depressed.

Harvesting will recommence at Ngaruawahia as soon as a suitable logging crew can be engaged and is expected to continue until harvesting of the current tree crop is complete in approximately another two years. The forest is being progressively replanted with the first blocks that were replanted now having been pruned for the first time.

 

Financial Performance

Rental income from leased farm properties was almost the same as the previous year at $2.3 million. However this year’s figure excludes rental from Waikoha Station which is now directly farmed. Adjusting for this, rents were 7.8% higher than in the previous year. Scheduled two-yearly rent reviews due in the year ahead are expected to show a further but modest overall increase being determined by the prevailing level of farm profitability. Fair rents will continue to be set to reflect the productive capability, improvements on, and the value of each farm.  

Despite the smaller area harvested, the Ngaruawahia forest contribution increased by $113,000 to $536,000. The main contributor to this result is a higher forest growth component which values the remaining area of trees in the forest. This is a reflection of the area and increasing age of the remaining trees rather than the prevailing log prices at the end of the financial year. The value to be extracted from the forest will inevitably depend on log prices at the time of harvest; nonetheless it is pleasing to note the increasing value of the remaining first rotation tree crop.

In contrast to last year, there was a pleasing improvement in farm profitability from the directly managed farms. The increased payout from Fonterra and higher milk production accounted for most of the increase, while the sheep and beef contribution was slightly reduced following the decision to undertake a major development and deferred maintenance programme as well as livestock purchases at Waikoha Station. This was the first year with Waikoha under direct management.

Inflation of farm costs is a significant factor facing all farmers. High world demand for fertiliser, for example, has meant price increases of between 12 and 24%. Careful cost control is essential, but continued investment is also necessary to maintain soil, pastures and farm improvements to protect future productivity. Trust expenses increased by $458,000 this year to $4.3 million. Rising interest rates, a higher management fee resulting from the increased value of the Trust, and higher operating and trustee fees all contributed to this increase.

Revaluation movements, at the lower level of $3.3 million, were again the most significant item in the financial statements. The farm properties increase accounted for $2.8 million of this while the change in value of the tree crop at the Ngaruawahia forest and investments held by the Trust provided the balance of $509,000. The Trust’s investments comprise mainly shares in Fonterra to support production from the dairy farms. Equity of $162.9 million at year end shows the Trust remains in a very strong financial position. The increase in equity this year is $3.5 million.

 

Investment Activities

There was significant investment in specific Trust properties again this year. The major development project on the 396 hectare Eiffelton property which commenced last year is now almost complete. Three centre pivot irrigators, underground irrigation mainlines, and new higher capacity deep well irrigation pumps, a new stock water system, fencing, pasture renewal, and a central lane have all been installed. This property has been transformed over two years from a mixed cropping and livestock unit to an attractive and high producing dairy support farm that can be fully converted to dairy in the future.

As well as the development work undertaken on Waikoha Station, development investment on other farms included an additional house at the Shenstone dairy farm in Southland, an effluent pond and irrigation system upgrade at Tatarepo, continued pasture renewal on other dairy farms, drainage, additional fencing and stock water supply. All development work is undertaken with the objective of more efficient operation of the farm, increasing both the revenue obtainable from the property and the capital value.

 

Distribution

The Trust will make a distribution of 1.0 cent per unit on 28 September 2007. There will be no imputation credits attached to the distribution. The register closed for entitlement to this distribution on Friday 14 September 2007.

As in previous years, the distribution is based on 100% of the Free Cash Flow, which is the cash available from net operating profit after tax plus net forest harvest proceeds less maintenance capital expenditure. The lower distribution this year is directly attributable to the smaller area harvested at the Ngaruawahia forest.

Market Price of Units

The market price of units traded during the financial year varied between $1.95 and $2.35 with trades subsequent to 30 June 2007 generally in the range $2.30 to $2.35. This compares with sales between $1.65 and $1.96 during the previous year. A steady but relatively small number of Trust units are traded on Sharemart and the Unlisted share trading platform.

 

Impact of Adopting New Zealand Equivalents to International Financial Reporting Standards (NZ IFRS)

The Trust plans to adopt NZ IFRS for the accounting period ending 30 June 2008. As some of the requirements of NZ IFRS are still to be finalised, the likely changes to our accounting policies from its adoption have not been fully assessed. The main areas of impact on the Trust from the adoption of NZ IFRS identified to date are; deferred taxation, property carrying values and financial instruments. At this stage the best estimate of the impact of these three items, based on the 30 June 2007 financial statements would be an increase in Unitholders’ funds of approximately $3 million.

The actual impact of adopting NZ IFRS may change from this estimate and the variation may be material. Full disclosure will be made and information provided in the 2008 Annual Report.

 

Outlook

Following the end of the financial year there have been major movements in the exchange rate as well as a substantial upward move to $6.40 in Fonterra’s indication of the likely level of dairy prices for the current season. The latter is very encouraging from the Trust’s perspective. There has been widespread media comment on current record world prices for dairy products, which reflect strong and ongoing growth in world demand. Milk supply is currently unable to meet that demand. All this bodes well for the dairy industry in particular, but should also have flow-on benefits for other sectors.

World protein and grain prices have increased substantially due to the mandatory production of crops for biofuels, and arable farmers are already seeing increased grain contract prices for the coming season. Sheep and beef farmers will have to wait longer, but the benefits of higher world protein prices and the flow-on effect of biofuel production should also pass through to them. The actual quantum of the benefit to farmers and the Trust will ultimately depend on the sustainability of prices and the strength of the New Zealand dollar.

While the outlook is positive currently, it needs to be noted that both of these have been historically volatile and difficult to predict. The Directors expect a significant improvement in the contribution from the directly farmed dairy properties in the year ahead. Rapidly rising farm operating costs will however impact on farm profits and careful control will be needed to ensure that as much as possible of the benefit of improved prices is retained.

Overall, the year ahead will have its challenges but the Directors believe the outlook for the rural sector in New Zealand and the dairy industry in particular is very encouraging. The Trust’s sound financial position and high quality portfolio of rural properties places it in a strong position to benefit from the expected upturn.

New Zealand Rural Property Trust

Sir Selwyn Cushing

Chairman

New Zealand Rural Property Trust Management Limited