AACo and Elders look to strengthen their balance sheets

Media speculation of a plan to break up Australian Agricultural Company (ASX: AAC) has forced the board to issue a statement denying the rumours. In fact it appears the opposite is true, with the release stating:

“The board is resolute and unanimous in executing AACo’s strategy of building a vertically integrated company, supplying red meat into the global market, in particular Asia. To do this, AACo requires the ability to produce high-quality beef on its properties, and then be able to slaughter, market and transport efficiently.”

Vertically integrating the company’s operations would appear to be a very sensible plan, which makes the proposed Darwin Abattoir essential. The response to the break up rumour comes just days after the Chairman Mr Donald McGauchie sent the CEO Mr David Farley out the door. The reason given by Mr McGauchie for Mr Farley’s removal was the need for a new CEO with “a different skill set to lead the company in its next stage of growth.”

Before this next stage of growth can occur though, the firm must deal with its $423 million debt load, which equates to gearing of around 40%. It’s been a tough few years for AACo’s business with the live export ban in 2011 coupled with drought leading cattle prices to plummet to levels not seen in decades. Critically this is putting further strain on an already stretched balance sheet.

AACo’s announcement confirmed that the company was considering a capital raising to help construct the Darwin Abattoir and strengthen the balance sheet with discussions with underwriters and sub-underwriters already underway.

News of another capital raising that will further dilute shareholders in AACo won’t be welcome news for many, however the need to secure the Darwin Abattoir and shore up the balance sheet would appear to be necessities.

Weak balance sheets and weak earnings appears to be a common them across the agricultural sector at present. Fellow agricultural company Elders (ASX: ELD) announced last week it had finally reached an agreement to sell its Futuris automotive parts business. At just $69 million it was an enormously disappointing outcome for shareholders that do little to improve on the company’s  debt predicament.

Foolish takeaway

With Graincorp (ASX: GNC) and PrimeAg (ASX: PAG) both close to being delisted from the stock exchange, there are declining opportunities for investors to gain listed exposure to Australia’s comparative advantage in agriculture.

While AACo and Elders both have the potential to benefit from Australia’s opportunity to increase agricultural exports to Asia, given their weak balance sheets, investors should realise there are significant risks involved.

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Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.

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