Thursday 18 January 2018

Emmet Oliver: Food groups show the way in avoiding Ireland's debt trap

The author of the banking report, Peter Nyberg, described it as a "speculative mania''. Others have described it as a national addiction.

Either way, Ireland's gorging on cheap debt and property over recent years has left virtually every sector of the economy bogged down in leverage that may take a decade or more to substantially shift.

Ireland's companies are literally working for the banks (and a few hedge funds too).

Management strategy in many companies now is about managing debt, not managing the firm's capital.

Not a single sector appears to be immune from overly geared balance sheets -- from banks, to telcos, to media companies, to semi-states, to retailers to the Government, debt is ubiquitous.

But to the surprise of many, the sector that has managed to avoid the fatal addiction is agriculture and consumer foods.

The last two weeks have seen fresh financial statements from the big names of the Irish agrifood sector -- Kerry and Glanbia -- and while there are considerable challenges ahead for both, unsustainable debt burdens aren't something they need to worry about.

Glanbia's debt is less than 2.5 times its earnings, Kerry's is 1.7 times and Greencore's is 2.3 times. None of them are even close to breaching banking covenants and their interest cover is reasonably reassuring.

Balance sheet strength, of course, doesn't equal runaway profits, but in the current environment investors are looking for firms with low leverage, that also boast reasonable, but sustainable, profits.

For Glanbia chief executive John Moloney, Kerry chief executive Stan McCarthy and Greencore chief executive Patrick Coveney, this sweet spot has been reached.

Glanbia and Kerry, for example, boast profit margins of 6.7pc and 9.5pc respectively.

This is hardly the stuff of NASDAQ-listed tech companies, but the profitability is sustainable and has been produced without stretching balance sheets beyond prudent levels.

It is curious that the food companies of Ireland managed to avoid a debt trap so many others fell into.

Maybe the sector is just innately conservative due to its roots in the agricultural economy.

But the sector has seen bubbles before, like the runaway land prices of the 1970s. But for whatever reason, the sector has much to boast of in terms of behaving responsibly during the Tiger years.

It is not as if they haven't been spending money and expanding. Glanbia, for example, splashed out $144m (€100m) on a sports supplement business, Bio-Engineered Supplements and Nutrition, in January.

Greencore likewise has recently bought Uniq, the UK convenience food group for £113m (€128m). Interestingly in that case, the company is funding a large part of the purchase price by raising equity, rather than bank debt.

The only way the Irish economy will bounce back to GDP growth that can really get the wheels turning again is by either defaulting on debt (ruled out in most cases), by slow painful incremental debt reduction (long and laborious) or by growing profits and revenues, thereby shrinking the debt in comparative terms. The last method is the preferable one.

The agrifood sector is showing the rest of Irish industry how to grow profits without blowing up your balance sheet.

Debt forgiveness will happen -- unofficially

Kindergarten solutions to the financial crisis continue to mount up.

First there was 'leave the euro and devalue', then there was 'burn the bondholders and send the IMF back home', now there is something ambiguous called 'debt forgiveness'.

As empty sloganeering goes it takes some beating. Forgiveness of what precisely, and for whom, has yet to be specified or costed.

One figure looms large, but doesn't get mentioned too often -- there is €98bn of mortgages in the Irish banking system and the figure is far larger if foreign banks are included.

Any meaningful "forgiveness'' scheme would either cost a truckload of money, or not be worth it in the first place.

There is a rationale for no longer making mortgage loans fully recourse to the borrower and for moving towards the US system where the asset simply gets sold and the proceeds are used to pay off as much of the loan as possible.

This would boost the jobs market (labour mobility), the property market (create new transactions and a proper price level) and also allow parts of the country to climb out of a negative equity swamp.

The Irish banks are going to be writing off huge amounts of mortgages anyway over the next few years -- it just won't be officially called debt forgiveness, nor should it.

Almost €10bn of mortgage losses will occur over the next three years at Ireland's banks the Financial Regulator Matthew Elderfield reckons. Deals done behind closed doors are likely to form a part of this €10bn, whatever the banks claim.

While the banks will claim to be pursuing all debts, they will simply end up giving up in many cases. It will never be officially known as debt forgiveness, but that's what it will be.

ESB staff shares are dwarfed by Bord Gais windfall

It was called buying workers' loyalty. The decision in recent years to award stock to semi-state employees in exchange for 'change' is now having real practical effects.

This week ESB staff have been told they will soon be able to buy and sell the shares which make up their 5pc holding in the company.

While a theoretical price will be set to facilitate the grey market trading, nobody really believes this price would fully reflect the true value of ESB if a rational buyer came forward.

Either way, staff are being asked to take a punt not on ESB, but on the likelihood of ESB being sold at some point. All the mood music from Government indicates that this will not happen.

In that case, the price set for staff is likely to remain very much theoretical.

However, over at Bord Gais, employees own 3.2pc of the company's stock, valued conservatively at €42m.

Spread over its almost 1,000 employees, staff members are sitting on €42,000 worth of shares each. Before the economy collapsed, these numbers were also purely theoretical; now they are real.

Bord Gais is expected to be the first state-owned company to be sold, with the mandate for its sale potentially being issued later this year.

While staff are certainly eyeing some kind of payday, the hefty debt burden at the gas company (€1.8bn) should prevent the windfall from becoming Eircom-like in scale.

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